American Taxation Association
February 27th, 2004
Denver, Colorado
SOX 404
Tax Shelter Disclosure Regulations
Sarbanes-Oxley 404 –
Tax Role
Robert Lund –Director-Tax Services
Executive Summary of SOX 404
Annual report must contain a report from management on
internal control that:
– States management’s responsibility for establishing and
maintaining an adequate internal control structure and
procedures for financial reporting, and
– Contain management’s assessment, as of the end of
the fiscal year of the effectiveness of the internal control
structure and procedures for financial reporting
Executive Summary of S-O 404
External auditor must attest to and report on
management's assertion concerning its assessment of
internal control
Effective Date

The Act does not impose a deadline for the creation of rules to
implement §404. If adopted, would apply to companies whose
fiscal years end on or after June 15, 2004. ( Who Knows ?)
Internal Control
•Focus is on reliability of financial reporting
•Committee of Sponsoring Organizations (COSO) of the
Treadway Commission provides detailed internal control
criteria and defines five components of internal control:
Internal Control, continued
Control Environment
‒ The control environment sets the tone of an
organization, influencing the control consciousness
of its people
Risk Assessment
‒ Every entity faces a variety of risks from external
and internal sources that must be assessed both at
the entity and the activity level
Control Activities
‒ These policies & procedures help ensure
management directives are carried out
Information and
Communication
‒ Pertinent information must be identified, captured
and communicated in a form and timeframe that
supports all other control components
Monitoring
‒ Internal control systems need to be monitored – a
process that assesses the quality of the system’s
performance over time
Management’s Assessment of Effectiveness
Should:
Cover each of the five components of internal control and
include:



An inventory and documentation of significant controls
consistent with management’s assertion (see next slide)
An evaluation of the design effectiveness of controls
An evaluation of the operating effectiveness of controls based
on testing or other procedures
Include documentation of the results of the evaluation
Provide for communication of findings to the auditor or to
others, if applicable
Management:
Supporting the Evaluation
Determining which controls are significant:


Controls that address significant classes of transactions,
account balances, disclosures and related assertions
Consider likelihood that control failure could cause
misstatements and the potential magnitude
Management:
Supporting the Evaluation
Should include:




Fraud programs and controls
Controls on which other controls are dependent (e.g., general
controls)
Controls over significant non-routine transactions, journal
entries, and accounts involving judgments and estimates
Controls over closing process and preparing F/S
Management:
Evaluating Operating Effectiveness
Procedures must be sufficient to verify operating
effectiveness:



testing of controls by internal audit or others under the direction
of management
use of service organization reports
self-assessment processes
Inquiry alone is not adequate
Procedures performed and controls and locations selected
are affected by risk assessment and monitoring processes
All significant controls and locations must be evaluated
annually
Auditor’s Consideration of Management’s
Evaluation
Inadequate documentation of controls may result in a
significant deficiency or a material weakness
Absence of sufficient evidence to support assertion
constitutes a material weakness
Tax Involvement with Section 404
Significant Transactions and Activities

Tax is often a significant activity subject to significant financial
risk and substantial disclosure considerations
Tax Involvement with Section 404
Significant Activities and Risk

Tax is based on self-assessment
– Unlike typical accounts payable


Tax functions are often decentralized
Estimates and judgments are often utilized in tax reserve
analysis computations.
Tax Integration with S-O 404
Scope and Depth of Tax Transactions

Tax impacts nearly every line on the income statement and
balance sheet
Tax is Embedded in Every Aspect of
Business
Customs
duties
Transfer
pricing
issues
PROFIT AND LOSS
ACCOUNT
Sales
X
Purchases
(X)
Manufacturing
(X)
Overheads
(X)
Financing
(X)
Profit
X
Tax charge
X
Profit after tax
X
VAT and sales taxes
Cross border issues
Location of
activities
Property taxes
Employee taxes
Treasury
International
executive taxation
Foreign exchange
Location and
exploitation of
intellectual property
Cross border issues
BALANCE SHEET
Tangible assets
X
Intangible assets
X
Net current assets X
X
Capital
X
Reserves
X
Funding debt
X
X
Funding
Tax considerations may impact areas of S-O 404
attest and advisory services
Trade debts
Liabilities
Profit repatriation
flows
Monetising tax
assets
Tax Integration with S-O 404
Tax Subject Matter Requirement


Tax content knowledge is necessary to evaluate tax-related
internal controls
Broad Range of Taxes (Income/Sales)
Tax Areas Requiring Internal Controls
Sales & Use
Taxes
Income Tax
Property Tax
Transfer
Pricing
FAS109
Tax
Incentives,
Holidays, &
Credits
Non-US
Income Tax
Customs
Payroll Tax
VAT
International
Executive
Tax
Comp &
Benefits
Excise Taxes
Unclaimed
Property
The tax function extends beyond income tax; non-income tax areas
may account for a disproportionately large share of the risk
Significance
There is no formula to “calculate” significance, however,
there are general guidelines:
Quantitative factors:


Value of transactions
Volume of transactions
Qualitative factors:

Risk of significant misstatement of a financial statement
element in the absence of internal controls.
Management ultimately decides significant controls.
Risk Indicators
High Likelihood of Occurrence
Non-routine
Non-systematic
Subjective



Estimates
Assumptions
Interpretation
Complex
High Magnitude of Error
Significant Class of
Transaction
Misstatement is material to
financial statements
I. Obtain background information and high-level
understanding of tax functions
•Financial statements
•Organization charts (legal entity and corporate personnel)
•Internal memoranda & tax correspondence files
•Income tax provision workpapers
•Prior year’s income tax returns and workpapers
•Tax audit history and reports
•History of significant transactions (M&A, change of control, etc.)
II. Obtain general understanding of current control
environment and process
• Review tax department policies and procedures manuals
• Review tax workpaper and tax research documentation: (look for process
standards, work-flow tracking, documentation, etc.)
• Walk-through tax process and control procedures
• Management letter comments by audit firm concerning tax
• History of audit adjustments to tax accounts
• Internal audit review of tax functions
• Standard forms / checklists / dockets / workpaper formats used by tax
department
• Forms for requesting and approving checks or electronic tax payments
• Reporting structure - business unit or financial accounting
• Identify and review systems for which tax department has responsibility
III. Determine which tax segments and functions constitute
significant control risks
• Significant class of transaction
• Strategic business risks
• Tax department functions that aggregate to material risk

i.e., support to operating units or HR for sales & use tax, payroll tax , etc.
• Consider degree to which tax functions are non-routine, nonsystematic or subjective
• Consider level of complexity
• Consider materiality to financial statements
• Quantitative analysis

Account balances: current taxes payable/receivable, deferred tax assets &
liabilities, valuation allowance, effective tax rate, etc.

Comparison of change from prior years
IV. Identify Relevant Locations for Significant Segments
•Consider significant lines of business.
•Consider significant decentralized tax functions.
•Consider significant tax jurisdictions.
Possible Scoping Results Example
High
VAT
C&B
Income
Sales
Property
Payroll
Customs
Excise
Low
Likelihood of Occurrence
Are you Done? : Questions to ask
Have we identified all of the tax processes that have
significant risk to the financial statements?
Does the documentation of the tax process adequately
represent and provide an understanding of the underlying
tax process?
Have we identified all of the significant risk to the financial
statements inherent in the tax process?
Do the identified and designed controls adequately mitigate
the identified significant risk to the financial statements?
What We’re Seeing in the Marketplace
What We're Seeing in the Marketplace
Realities




Executives everywhere recognize the need for
improved corporate governance and more transparent
financial reporting
Organizations are clearly focused on meeting the
compliance requirements established by the SarbanesOxley Act of 2002
Non-SEC organizations are adopting similar measures
as “best practice standards”
Foreign registrants are feeling additional pressure from
similar initiatives in other countries
What We're Seeing in the Marketplace:
Realities




A paradox – while boosting investor confidence, many
CFOs claim they aren’t seeing return on investment
Compliance is perceived as:
– Expensive
– Diverting attention from the core business
– Overburdening limited resources to complete the
labor-intensive project
A “one-time” project approach for initial compliance –
versus focus on an ongoing, sustainable compliance
process
Sarbanes-Oxley is not the “Y2K” of accounting – there
will always be financial reporting requirements
associated with Sarbanes-Oxley and future regulations
What We're Seeing in the Marketplace:
Challenges
Internal





External
Satisfying management’s
Changing regulations
need for a high level of

Sarbanes-Oxley
confidence to support

PCAOB
assertions

AICPA
Creating a sustainable

SEC (including
compliance process
accelerated filer
Considering all sections of
requirements)
Sarbanes-Oxley

Others
Integrating all internal control
The COSO-ERM Framework
activities
is evolving
Achieving return on the
compliance investment
What We're Seeing in the Marketplace:
Research Findings




In November 2003, we
commissioned a survey of 175
chief executive officers and chief
financial offers at top U.S.
companies – key findings from the
survey include:
A majority (68%) believe SOX has
boosted investor confidence in
corporate America
70% rank SOX 404 compliance as
a high or higher priority relative to
other major business issues
Nearly all (97%) report being on or
ahead of schedule with SOX
readiness - however, only 31% had
completed more than 50% of their
SOX 404 preparation as of the
survey date
Respondents report the most
difficulty overall with documentation
and testing of internal controls
Respondents Report The Most Difficulty Overall With The
Documentation And Testing Of Internal Controls
80%
60%
50%
44%
40%
29%
29%
28%
19%
21%
10%
10%
7%
7%
Testing of Internal
Controls
Planning
Gap Analysis
Remediation
23%
34%
20%
16%
21%
0%
Documentation
Extremely Difficult (5)
Somewhat Difficult (4)
For each of the following, how difficult are you finding it to comply with SOX 404? Please use a 1 to 5 scale where 1 means “not
at all difficult” and 5 means “Extremely difficult”.
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28
What We're Seeing in the Marketplace:
A Forward Look



Companies are focusing on the regulatory demands and how to meet
compliance deadlines - in documenting ICFR, they are amassing large
amounts of information about their business processes, risks and
controls
Some senior executives have begun to look beyond immediate
compliance efforts to leverage into long-term business value – others will
follow
Leading companies are beginning to extract value from the heightened
control environment by using compliance efforts as a foundation to:
– Strengthen, streamline and automate internal controls
– Increase an enterprise-wide understanding of all risks – operational,
financial reporting and compliance – and how to control them
– Improve and redesign business processes while maintaining
appropriate awareness and control of risks
What We're Seeing in the Marketplace:
CONTROLS
IMPROVEMENT
Risk & Performance Optimization
Real Time
Performance
and Control
Reporting
Re-architecture
of Risk and
Control
Reporting
Compliance
Controls
Operational
Controls
ICFR
Control
Evaluation
and Attestation
Risk & Performance
Optimization
In leading edge companies,
ICFR control documentation
and evaluation is being
leveraged as a foundation
for risk and performance
optimization
Business
Info-Structure
On Demand
Process
Transformation
Process
Improvement
and Control
Integrations
PROCESS IMPROVEMENT
Tax Shelter Disclosure
Darice Henritze –
Partner – International Tax Services
Treasury “Shelter” Regulations
Under § 6011, § 6111 and § 6112
February 28, 2000 — original temporary and proposed regulations issued
August 11, 2000 — revised temporary and proposed regulations issued
August 2, 2001 – further revised temporary and proposed regulations issued
March 20, 2002 — Treasury announced “simplified” initiative
June 14, 2002 – further revised temporary and proposed regulations issued
October 17, 2002 – further revised temporary and proposed regulations issued
February 28, 2003 – final regulations issued
December 29, 2003 – final regulations amended
Under § 6662 and § 6664
December 31, 2002 – proposed regulations issued
December 29, 2003 – final regulations issued
Final Section 6011 Disclosure Regulations
Effective Dates
Generally effective for transactions entered into on or after February
28, 2003
For transactions entered into on or after January 1, 2003 and before
February 28, 2003, taxpayers may apply either the final regulations
or the October 2002 temporary regulations
For transactions entered into before January 1, 2003, see the
temporary regulations in effect at that time
Conditions of confidentiality – Transactions entered into on or after
December 29, 2003 (may be applied retroactively by taxpayers)
Taxpayers
Applies to ALL “TAXPAYERS” (means any “person”
described in § 7701(a)(1), including S corporations
and consolidated groups)
Also includes, e.g., partners and S corporation
shareholders
Special Rules– Reporting Shareholders of Certain
Foreign Corporations
NOT JUST FOR INCOME TAXES
IRS can identify transactions entered into on or after January
1, 2003, as “listed transactions” for estate, gift, employment
taxes; pension and exempt organization excise taxes
Definition of “Transaction”
“Includes all the factual elements relevant to the expected
tax treatment of any investment, entity, plan, or
arrangement, and includes any series of steps carried out
as part of the plan.”
Reportable Transactions
Listed, or substantially similar, transaction
Conditions of confidentiality
Contractual protection
Section 165 loss
Significant book/tax difference
Brief asset holding period
Listed Transactions
Currently 31 listed transactions identified in IRS notices and
other published guidance

Rev. Rul. 2004-4 Issued January 23, 2004

Notice 2004-8 Issued December 31, 2003

Notice 2003-81 Issued December 4, 2003
Notice 2003-77 Issued November 19, 2003 and clarified
December 1, 2003

Notice 2003-76: Listed transactions as of November 15, 2003
“Substantially similar”


Same or similar types of tax consequences, and either factually
similar or based on same or similar tax strategy
Broadly construed in favor of disclosure
Listed Transactions
Rev. Rul. 2004-4 – Prohibited Allocations of Securities in an S Corporation
Notice 2004-8 – Abusive Roth IRA Transactions
Notice 2003-81 - Tax Avoidance Using Offsetting Foreign Currency Option Contracts
Notice 2003-77 – Transfers to Trusts to Provide for the Satisfaction of Contested
Liabilities
Notice 2003-55 — Lease Strips and Other Stripping Transactions (superseding Notice
95-53)
Notice 2003-54 — Common Trust Fund Straddle
Notice 2003-47 — Transfers of Compensatory Stock Options to Related Persons
Notice 2003-24 — Welfare Benefit Fund
Notice 2003-22 — Offshore Deferred Compensation Arrangements
Revenue Ruling 2003-6 — Certain S Corporation ESOPs
Listed Transactions (continued)
Notice 2002-70 – Certain Reinsurance Arrangements
Notice 2002-65 – Passthrough Entity Straddle Tax Shelter
Revenue Ruling 2002-46 – § 401k Accelerators
Notice 2002-50 – Partnership Straddle Tax Shelter
Notice 2002-35 – Notional Principal Contracts
Notice 2001-21 – Inflated Basis “CARDS” Transactions
Notice 2001-45 – § 302 Basis-Shifting Transactions
Notice 2001-17 – Certain § 351 Transactions
Notice 2001-16 – Intermediary Transactions
Notice 2000-61 – Guam Trust
Notice 2000-60 – Certain Stock Compensation Transactions
Notice 2000-44 – Inflated Partnership Basis Transactions
Revenue Ruling 2000-12 – Debt Straddles
Listed Transactions (continued)
Treasury Regulation § 1.7701(1)-3 – Fast Pay or Step-Down Preferred
Transactions
Notice 99-59 – BOSS Transactions
Revenue Ruling 99-14 – Lease-In /Lease-Out or LILO Transactions
Treasury Regulation § 1.643(a)-8 – Certain Distributions from
Charitable Remainder Trusts
ASA Investerings Partnership v. Commissioner -- Transactions similar
to those described in the ASA Investerings litigation and in ACM
Partnership v. Commissioner, 157 F.3d 231 (3rd Cir. 1998)
Notice 98-5, part II – Foreign Tax Credit Transactions
Notice 95-34 – Certain Trusts Purported to be Multiple Employer
Welfare Benefit Funds Exempted from the Limits of § 419 and §
419A
Revenue Ruling 90-105 – Certain Accelerated Deductions for
Contributions to a Qualified Cash or Deferred Arrangement or
Matching Contributions to a Defined Contribution Plan
Listed Transactions:
Participants
Taxpayer’s tax return reflects tax consequences or a tax
strategy described in IRS guidance identifying the transaction as
“listed,” or
Taxpayer knows or has reason to know that taxpayer’s tax
benefits are derived directly or indirectly from tax consequences
or a tax strategy described in IRS guidance identifying the
transaction as “listed”
Conditions of Confidentiality
Transactions prior to December 29, 2003
Generally facts and circumstances test
Situations where treated as confidential


Taxpayer’s disclosure of tax treatment or tax structure of
transaction is limited by understanding or agreement with
or for the benefit of anyone who provides oral or written
statement to the taxpayer concerning potential tax
consequences of the transaction
Taxpayer knows or has reason to know that taxpayer’s
use or disclosure of information is otherwise restricted for
the benefit of any person other than taxpayer who
provides a statement concerning potential tax
consequences — e.g., transaction is claimed to be
proprietary or exclusive
Conditions of Confidentiality:
Transactions Prior to December 29, 2003
Presumption of non-confidentiality if express written
authorization is provided from every person who
makes a statement to the taxpayer as to the
potential tax consequences:

“The taxpayer (and each employee, representative, or
other agent of the taxpayer) may disclose to any and all
persons, without limitation of any kind, the tax treatment
and tax structure of the transaction and all materials of
any kind (including opinions or other tax analyses) that
are provided to the taxpayer relating to such tax
treatment and tax structure.”
Conditions of Confidentiality
Transactions on or after December 29, 2003
New definition for conditions of confidentiality
Advisor who is paid the minimum fee places a limitation
on disclosure by the taxpayer of the tax treatment or tax
structure of transaction and the limitation protects the
confidentiality of the advisor’s tax strategies
 Proprietary or exclusive assertion is not a limitation on
disclosure if the advisor confirms that the taxpayer may
disclose the tax treatment or tax structure
May be applied retroactively by taxpayer to transactions entered
into on or after January 1, 2003

Conditions of Confidentiality
Transactions on or after December 29, 2003
Minimum fee


$250,000 if taxpayer is a corporation (or a partnership or trust in
which all partners, owners or beneficiaries are corporations)
$50,000 for all other taxpayers
Determining minimum fee



Includes all fees for a tax strategy or for services for advice
(whether or not tax advice) or for the implementation of a
transaction
Very broad, includes services to analyze, implement, and
document the transaction and services to prepare returns if fees
are excessive. . .BUT
Does NOT include an amount paid to an advisor in that person’s
capacity as a party to the transaction
Contractual Protection
Facts and circumstances determination –
Taxpayer or a related party (section 267(b) or 707(b))
has the right to a full or partial refund of fees if all or a
portion of tax consequences are not sustained, or
Fees are contingent on taxpayer’s realization of tax
benefits from the transaction
Contractual Protection:
Exceptions
Party has a right to terminate transaction upon the happening of
an event affecting taxation
Refundable or contingent fees: if statement concerning
potential tax consequences is made only after the taxpayer
has entered into the transaction and reported consequences
of the transaction on a filed tax return, and person making
statement has not previously received fees from the taxpayer
relating to the transaction
Section 165 Loss
Corporations: $10M in one tax year, or $20M in tax year
transaction entered into and 5 succeeding tax years
Partnerships with only corporate partners:
$10M / $20M
Other Partnerships: $2M / $4M
S Corporations, Individuals & Trusts:
$2 M / $4 M
Individuals & Trusts: $50,000 for section 988 foreign currency
transaction losses
Section 165 Loss (continued)
A section 165 loss includes


Any amount deductible under section 165
Any deduction treated by the Code as resulting from a sale or
other disposition
– A loss resulting from the sale or exchange of a
partnership interest under section 741
– A loss resulting from a section 988 transaction
Section 165 Loss (continued)
Do not take into account offsetting gains, or other
income or limitations (such as capital loss
limitations)
However, section 165 loss is adjusted for salvage
value and any insurance or other compensation
received
Section 165 Loss:
Some Exceptions: Rev. Proc. 2003-24
Sale of a capital asset with a “qualifying basis” that is not an interest
in a passthrough entity, is not part of a straddle, and has not
been separated from any portion of income it generates

Qualifying basis = cash, § 358, § 1014, § 1015 (if donor had
qualifying basis), or § 1031(d)
Mark-to-market losses, provided taxpayer computes loss using a
qualifying basis
Loss from hedging transaction or mixed straddle
Book/Tax Difference:
Taxpayers
Only applies to:
Taxpayers that are reporting companies under Securities
Exchange Act of 1934 (and related entities), or
Business entities with at least $250 million in gross assets for
book purposes at the end of the financial accounting period
ending with or within the entity’s tax year in which the
transaction occurs (assets of all related business entities are
aggregated)
Significant Book/Tax Difference
Book/tax difference from the transaction exceeds $10M on a
gross basis
Offsetting items are not netted for either tax or book purposes
Book income determined using U.S. GAAP for worldwide
income, unless the taxpayer, in the ordinary course of
business, consistently keeps books on another basis
Transactions only among members of consolidated group are
disregarded
If members of consolidated group, plus third party, participate
in the transaction, aggregate group items
Significant Book/Tax Difference:
Other Persons
Foreign Persons


Only U.S. assets taken into account in determining whether
gross asset test is met
Only transactions giving rise to Effectively Connected
Income (or losses, etc.) are taken into account
Disregarded Entity


Treat income, loss, etc. as items of owner
Disregard transactions between entity and owner
Partner

Items allocated to partner for tax purposes, but to entity for
book purposes, are treated as items of partner
Significant Book/Tax Difference:
Some Exceptions: Rev. Proc. 2003-25
Tax income or gain is reported before or without book income or
gain
Book loss or expense is reported before or without tax loss or
deduction
Depreciation, percentage depletion, cost depletion, and intangible
drilling costs
Capitalization and amortization under sections 195, 248, and 709
Brief Asset Holding Period
Asset held for 45 days or less, and
Transaction results in taxpayer claiming a tax credit
exceeding $250,000
Exception:

Transactions resulting in a foreign tax credit for taxes imposed
in respect of a dividend that are not disallowed under § 901(k).
Reporting Shareholders: Special
Participation Rules
“Reporting shareholder” means:



US shareholder under § 551(a) in a foreign personal holding
company under § 552 – Form 5471
US shareholder under § 951(b) in a controlled foreign
corporation under § 957 – Form 5471, or
10 percent shareholder of a qualified electing fund under § 1295
– Form 8621
Reporting Shareholders: Special
Participation Rules
Rules for listed transactions, loss transactions, and brief
asset holding period transactions:

Treat reporting shareholder as “participant” if the foreign
corporation would be treated as participating if it were a
domestic corporation filing a tax return that reflects the
items from the transaction
Does not need to have US tax benefits or consequences
Reporting Shareholders: Special
Participation Rules
Rules for conditions of confidentiality transactions and
contractual protection transactions

Treat reporting shareholder as “participant” if the foreign
corporation would be treated as participating if it were a
domestic corporation filing a tax return that reflects the
items from the transaction
Reportable transaction only if


Confidentiality – Limitation concerns U.S. federal income
tax treatment or structure
Contractual protection – Refund or contingent fees
based on U.S. federal income tax benefits or
consequences
Reporting Shareholders: Special
Participation Rules
For the book/tax difference reportable transaction:


Treat reporting shareholder as “participant” if the foreign
corporation would be treated as having a US $10 million
book/tax difference for an item from the transaction if it were a
domestic corporation and
The transaction reduces or eliminates an income inclusion that
would otherwise be required under section 551, 951, or 1293.
Exceptions to the Disclosure Regulations
“Angel list” transactions

Notice 2001-18
With the exception of listed transactions, the
disclosure regulations do not apply to regulated
investment companies (RICs)
When Disclosure Is Made
General Rule: File disclosure statement (Form 8886) with
tax return (or amended return for transactions entered
into on or after December 29, 2003) for each tax year
for which the taxpayer participates
Also send copy to Office of Tax Shelter Analysis (OTSA)
when Form 8886 first filed with return
Transaction becomes listed after return filed and before
statute of limitations closes for the final return that is
affected by the transaction: Attach Form 8886 to
taxpayer’s next filed tax return
Includes loss carrybacks
Document Retention
Retain copy of all documents and other records related to a
transaction subject to disclosure that are material to an
understanding of the tax treatment or tax structure of
the transaction including:

Marketing materials, written analysis used in decisionmaking, correspondence and agreements with advisors
and other parties, analysis of tax benefits, documents
concerning business purpose, internal e-mails
Retain these materials until the expiration of the statute of
limitations for the final tax year for which disclosure was
required
Office of Tax Shelter Analysis
Influence/Relationships
National Office Counsel
Director of Practice
LMSB Commissioner
LMSB Counsel
OTSA
OTSA Review
Committee
Issue
Technical
Advisers
5 Industry Directors
Guidance Coordinating
Committee
Published Guidance
Territory Managers
Team Managers
Audits
Senior Legal Counsel
Corp. Tax Shelters
Area Counsel
(includes tech. specialists)
Associate Area
Counsel for PFTG
Litigation Vehicles
--- = Coordination Functions
“Super” IDRs (Continued)
Requires taxpayer to describe any listed transactions
entered into during the year under examination
Requests, inter alia:


All legal opinions and memoranda provided by any party that
promoted, solicited, or recommended participation in the
transaction
All internal documents used by the taxpayer in its decision
making process
Announcement 2002-63
Guidelines regarding Tax Accrual Workpapers:





Generally, for tax returns filed after July 1, 2002 (but
before for listed, if not disclosed)
Listed and Disclosed — workpapers from transaction
2 or more Listed
all workpapers
Listed but not Disclosed
Chief Counsel Notice CC-2003-012
}
New Penalty Guidelines
If “listed” transaction — examiner MUST consider § 6662
and submit to Director of Field Operations (DFO)
If “other potentially abusive tax shelter” — must coordinate
with Office of Tax Shelter Analysis (OTSA )
If examiner considers § 6662 — DFO must approve
imposition of penalty
Section 1.6662-3 for Reportable
Transactions (Dec. 29, 2003)
Effective date: Returns filed after December 31, 2002, for
transactions entered into on or after January 1, 2003
Disregard of Regulation:

Disclosure under Reg. section 1.6011-4 also required
Position contrary to Rev. Rul. or Notice:



No realistic possibility test
Section 6662 disclosure required
Reg. section 1.6011-4 disclosure also required
Section 1.6664-4 for Reportable
Transactions (Dec. 29, 2003)
Effective Date: Returns filed after December 31, 2002, for
transactions entered into on or after January 1, 2003
Disregard of regulations:


To rely on opinion that the regulation is invalid, must have
section 6662 disclosure and must have disclosure under
Reg. section 1.6011-4
Failure to disclose a reportable transaction under Reg.
section 1.6011-4 is “strong indication” that the taxpayer
did not act in good faith for the portion of the
underpayment attributable to the reportable transaction,
which would bar relief under section 6664(c)
Proposed Legislative Changes
Background
Charity Aid Recovery and Empowerment (CARE) Act of 2002 (H.R. 7) – (June 18, 2002)
Tax Shelter Transparency Act – (June 18, 2002)
Small Business and Farm Economic Recovery Act (September 17, 2002)
Economic Recovery Act of 2003 (S. 414) – (Feb. 14, 2003)
CARE Act of 2003 (S. 476) – (Feb. 27, 2003)
Doggett Bill (H.R. 1555) – (April 2, 2003)
Jobs and Growth Reconciliation Tax Act of 2003 (S. 1054, previously S.2) — (May 8, 2003)
Current Bills
Tax Incentives Act of 2003 (S. 1149) — (May 23, 2003) — currently in the Senate
Working Families Tax Credit Act of 2003 (H.R. 2286) — (June 2, 2003) — currently in the House
Committee of Ways and Means
American Jobs Creation Act of 2003 (H.R. 2896) — (July 25, 2003) – currently in the House Committee
on Ways and Means
Jumpstart Our Business Strength “JOBS” Act (S. 1637) — (Chairman’s Mark October 1, 2003)
Tax Shelter Transparency and Enforcement Act (S. 1937) – Introduced in Senate Finance Committee
November 24, 2003
Tax Shelter Transparency and Enforcement Act (S. 1937) – Introduced in Senate Finance Committee
(November 24, 2003)
Highway Reauthorization and Excise Tax Simplification Act of 2004 — Senate Finance Committee
(February 2, 2004)
Tax Administration Good Government Act of 2004 — Senate Finance Committee (February 2, 2004)
Proposed Legislative Change (S. 1149)
New §6707A — Failure to Disclose Reportable Transaction
Penalty for large entity corporation may be $200,000 for
listed transaction and $100,000 for other reportable
transactions
Almost strict liability penalty
Discretion of OTSA to rescind:




Does not apply to failure to disclose listed transactions
Applies only to unintentional mistakes of fact
No rights to appeal OTSA’s decision
If rescinded, included in annual report from IRS to
Congress
Disclosed to SEC with new 6662A Accuracy Penalty
Slightly different version of penalty in H.R. 2896
Proposed Legislative Change (S. 1149 & H.R. 2896)
New Accuracy-Related Penalty for Reportable
Transaction Understatements (§6662A)
Increased Penalty for Undisclosed Reportable Transactions
— 30%

No Section 6011 disclosure
Listed
 Strict Liability
Other
 Almost Strict Liability (OTSA’s discretion on
§6707A)
20% Penalty with Disclosure / Heightened Requirements



Disclosure — §6664(d) — substantial authority and MLTN
Penalty Based on an “Understatement” at highest rate
Opinion Letters Restricted
Proposed Legislative Change (S. 1149 & H.R. 2896)
Limited Reliance on Opinions of Tax Advisors for
Reportable Transaction Understatement Penalty
Cannot rely on opinion for reasonable belief if either:

Advisor = “material advisor” who either:
Participates (or is related to a person who
participates) in organization, management,
promotion, or sale of the transaction;
Is compensated by another material advisor; or
Has a contingent fee arrangement OR

Opinion is:
Based on unreasonable facts and assumptions;
Based on unreasonable reliance on reps; or
Doesn’t identify and consider all relevant facts
Proposed Legislative Change (was in S. 1054; but is not in
current Energy Bill; in H.R. 2286)
Substantial Understatement and Preparer Penalty
for Nonreportable Transactions
Accuracy Penalty – Non-Reportable Transaction

New Standards
 Thresholds for Corporations — Exceeds the lesser of (1)
the greater of 10% or $10,000 or (2) $10,000,000
 More Likely than Not
 Disclosure and Reasonable Basis
Preparer Penalty – Non-Reportable Transaction

New Standards
 More Likely than Not
 Disclosure and Reasonable Basis
 Amounts
Proposed Legislative Change (was in S. 1054; but is not in
current Energy Bill; in H.R. 2286)
Economic Substance & Other Related Provisions
Codifies economic substance:



Transaction changes taxpayer’s economic position in a meaningful way
Substantial non-tax purpose for entering into transaction
Transaction is a reasonable means of accomplishing that purpose
40% strict liability accuracy-related penalty (no economic substance) —
reduced to 20% if facts are adequately disclosed
Other provisions


No deduction on interest attributable to understatement related to reportable
transaction or noneconomic substance transaction
Non-disclosure of listed transaction – automatic 6-year statute on whole
return
California Tax Shelter Legislation
Disclosure by California taxpayer subject to California income or
franchise tax



Federal listed transaction entered into after February 28, 2000
Other federal reportable transactions
California-only transaction identified by the California Franchise
Tax Board
 California announced 2 listed transactions on
December 31, 2003
Registration by tax shelter organizer
List maintenance by tax shelter organizer, seller or material
advisor
California Tax Shelter Legislation
California Penalties

Adopted many proposed Federal legislative changes
– Failure to disclose reportable transaction
Listed transaction ($30,000)
Other reportable transaction ($15,000)
– Additional accuracy-penalties for reportable transaction
20 % (disclosed)
30 % (not disclosed)
- Noneconomic substance penalty
20 % (relevant facts disclosed)
40 % (relevant facts not disclosed)
- Interest enhanced penalty
Additional 100 % of interest due on deficiency
California Tax Shelter Legislation
Voluntary Compliance Initiative


Available until April 15, 2004
Applies to “abusive tax avoidance” transactions for tax years beginning before January 1, 2003
Voluntary Compliance Initiative without appeal




Must pay tax and interest
Waiver of all penalties
No criminal penalties
No claims for refund
Voluntary Compliance Initiative with appeal



Must pay tax and interest
Waiver of penalties except for accuracy-related penalties (20-40 %)
No criminal penalties
California collected $30 million in the first week
Ramifications for Noncompliance
Request by IRS for tax accrual work papers
Increased scrutiny from higher IRS officials
Mandatory consideration of accuracy-related penalties
Failure to disclose reportable transaction is “strong
indication” that taxpayer did not act in good faith, which
precludes relief under section 6664
Proposed legislation




Disclosure penalties
Accuracy-related penalties
Reporting to the Securities Exchange Commission
Statute of limitations on assessments extended