current developments in tax shelters l.
Download
Skip this Video
Loading SlideShow in 5 Seconds..
CURRENT DEVELOPMENTS IN TAX SHELTERS PowerPoint Presentation
Download Presentation
CURRENT DEVELOPMENTS IN TAX SHELTERS

Loading in 2 Seconds...

play fullscreen
1 / 101

CURRENT DEVELOPMENTS IN TAX SHELTERS - PowerPoint PPT Presentation


  • 253 Views
  • Uploaded on

CURRENT DEVELOPMENTS IN TAX SHELTERS. By Matthew D. Lerner and Jean Baxley. Current Developments in Tax Shelters Overview. Recent Tax Shelter Cases What Taxpayers and Their Advisors Need to Know About the American Jobs Creation Act Revisions to Circular 230

loader
I am the owner, or an agent authorized to act on behalf of the owner, of the copyrighted work described.
capcha
Download Presentation

PowerPoint Slideshow about 'CURRENT DEVELOPMENTS IN TAX SHELTERS' - Albert_Lan


An Image/Link below is provided (as is) to download presentation

Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author.While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server.


- - - - - - - - - - - - - - - - - - - - - - - - - - E N D - - - - - - - - - - - - - - - - - - - - - - - - - -
Presentation Transcript
current developments in tax shelters

CURRENT DEVELOPMENTS IN TAX SHELTERS

By Matthew D. Lerner and Jean Baxley

current developments in tax shelters overview
Current Developments in Tax SheltersOverview
  • Recent Tax Shelter Cases
  • What Taxpayers and Their Advisors Need to Know About the American Jobs Creation Act
  • Revisions to Circular 230
  • IRS Requests for Tax Accrual Workpapers
  • Recent Developments in Privilege
slide3
RECENT

TAX SHELTER CASES

recent tax shelter cases long term capital holdings v united states facts
Recent Tax Shelter Cases:Long-Term Capital Holdings v. United StatesFacts
  • Onslow Trading and Commercial (“OTC”), a U.K. company, engaged in lease stripping transactions involving the sale and leasing of computers (CHIPS) and long-haul truck tractors (TRIPS). OTC received tax-free prepayments of rent, which it had a future obligation to pay to third parties.
  • OTC contributed its leasehold interests, the lease payment obligations, and the prepaid rent collections to U.S. corporations in exchange for preferred stock, thereby purportedly giving the preferred stock a high basis (due to the contributed rent collections) and low value (due to the contributed lease payment obligations).
recent tax shelter cases long term capital holdings v united states facts continued
Recent Tax Shelter Cases:Long-Term Capital Holdings v. United StatesFacts (continued)
  • At the same time, a U.K. entity controlled by the owners of Long-Term Capital Management (“LTCM”), i.e. LTCM-U.K., made a $5 million recourse loan to OTC.
  • A foreign bank made a loan to LTCM.
  • LTCM contributed the loan proceeds to Long Term Capital Partners LP (“LTCP”), a U.S. limited partnership, in exchange for a partnership interest in LTCP.
  • OTC contributed the high basis preferred stock received in the CHIPS and TRIPS transactions (and a portion of the proceeds from the LTCM-U.K. loan) to LTCP in exchange for a partnership interest in LTCP.
recent tax shelter cases long term capital holdings v united states facts continued6
Recent Tax Shelter Cases:Long-Term Capital Holdings v. United StatesFacts (continued)
  • LTCP contributed the preferred stock (and the proceeds from both loans) to P, a hedge fund.
  • OTC sold its interest in LTCP to LTCM via the exercise of a put option.
  • P sold the preferred stock, for which it claimed basis of just over $100 million, for approximately $1 million in cash to affiliates of Merrill Lynch, thereby triggering the built-in losses.
recent tax shelter cases long term capital holdings v united states facts continued7
Recent Tax Shelter Cases:Long-Term Capital Holdings v. United StatesFacts (continued)

3

GE

Loan

CHIPS

OTC(U.K.)

LTCM(U.S.)

Loan

UBS

1

LTCP P/S Int.

3

NB

4

TRIPS

3

LoanProceeds

3

Leasehold Interests, Lease Obligations &Prepaid Rent Collections

2

PreferredStock

PreferredStock & LoanProceeds

LTCP(U.S.)

U.S.Corp.

3

LoanProceeds

3

PreferredStock & LoanProceeds

P(CaymanIslands)

ML

5

PreferredStock

recent tax shelter cases long term capital holdings v united states arguments
Recent Tax Shelter Cases:Long-Term Capital Holdings v. United StatesArguments
  • The government argued that the transaction lacked economic substance, and was merely a tax ploy to create artificial capital losses.
  • The taxpayer argued that the transaction had economic substance, and offered proof that Long-Term expected to realize a pre-tax profit from the transaction.
recent tax shelter cases long term capital holdings v united states outcome
Recent Tax Shelter Cases:Long-Term Capital Holdings v. United StatesOutcome
  • The United States District Court for the District of Connecticut disallowed the claimed capital losses, holding that the transaction engaged in by OTC and the Long-Term entities lacked economic substance.
  • The court held in the alternative that the transaction should be recast under the step transaction doctrine and treated as a sale of preferred stock by OTC to the Long-Term entities, resulting in a downward adjustment to the stock basis.
slide10
Recent Tax Shelter Cases:Long-Term Capital Holdings v. United StatesEvidence of Lack of Economic Substance
  • The court treated the following facts as evidence of lack of economic substance:
    • The transactions were brought to Long-Term as a “tax product” rather than as an investment.
    • Long-Term’s purported primary business purpose of generating additional investment fees from the contribution of the preferred stock (and cash) to P was disingenuous.
    • There was no reasonable expectation of profit from the transaction.
    • Several “side agreements” provided hidden fees to the parties structuring the transactions.
    • Long-Term permitted OTC to make the contribution of preferred stock (and cash) in contravention of the taxpayer’s investing requirements.
recent tax shelter cases long term capital holdings v united states penalties
Recent Tax Shelter Cases:Long-Term Capital Holdings v. United StatesPenalties
  • The court upheld imposition of penalties, despite the legal opinion obtained by Long-Term from King & Spalding. Indeed, the court stated that Long-Term failed to satisfy its burden to establish the applicability of the reasonable cause defense since it could not prove it received King & Spalding’s written opinion prior to the filing of its return.
  • The court determined that the opinion included unreasonable factual assumptions (e.g., it was assumed that the taxpayer had a valid business purpose and reasonably expected to earn a material pre-tax profit), and that the opinion contained a “selective discussion of authority . . . which bolsters its appearance as an advocacy piece not a balanced reasoned opinion with the objective of guiding a client’s decisions.”
  • The court also concluded that the taxpayer tried to hide the loss on its tax return by combining lines of Schedule M-1, and that this demonstrated a “lack of good faith” for purposes of the reasonable cause exception.
  • The penalty issue is on appeal to the Second Circuit (Case No. 04-5687, filed October 22, 2004).
recent tax shelter cases black decker corporation v united states facts
Recent Tax Shelter Cases:Black & Decker Corporation v. United StatesFacts
  • The transaction was structured in similar fashion to the listed transaction described by the Internal Revenue Service (“IRS”) in Notice 2001-17, 2001-1 C.B. 730. The transaction involved the centralization of the management and administration of the taxpayer’s employee and retiree healthcare benefit plans in a separate subsidiary.
    • B&D and certain of its subsidiaries exchanged cash of approximately $561 million for stock in a separate subsidiary, Black & Decker Healthcare Management, Inc. (“BDHMI”), and the assumption by BDHMI of certain employee and retiree healthcare liabilities with a value of $560 million.
    • B&D and its subsidiaries later sold stock in BDHMI in an arm’s length sale to an independent third-party for $1 million.
    • B&D claimed a $560 million capital loss, based on the position that the cost basis of the BDHMI shares (i.e., $561 million) was unreduced by the contingent liabilities assumed by BDHMI.
recent tax shelter cases black decker corporation v united states arguments
Recent Tax Shelter Cases:Black & Decker Corporation v. United StatesArguments
  • The government argued that the transaction was merely a tax avoidance vehicle that must be disregarded for tax purposes.
  • B&D argued that the transaction had economic substance, that its basis in the BDHMI stock was $561 million, and that it realized a bona fide capital loss of $560 million on the sale of the BDHMI stock. B&D conceded, for purposes of the motion for summary judgment, that tax avoidance was its sole motivation for the transaction.
recent tax shelter cases black decker corporation v united states outcome
Recent Tax Shelter Cases:Black & Decker Corporation v. United StatesOutcome
  • The United States District Court for the District of Maryland granted summary judgment in favor of B&D and upheld B&D’s $560 million capital loss. The court held that the transaction “[could not] be disregarded as a sham” and concluded that the transaction had “very real economic implications” for the beneficiaries of B&D’s employee benefits programs, B&D, and BDHMI.
  • The court applied the Fourth Circuit’s sham transaction doctrine. In support of its analysis, the court reasoned that "a corporation and its transactions are objectively reasonable, despite any tax-avoidance motive, so long as the corporation engages in bona fide economically-based business transactions."
slide15
Recent Tax Shelter Cases:Black & Decker Corporation v. United StatesEvidence of Objective Economic Substance
  • The court found the following facts as evidence of the objective economic substance of B&D’s transaction:
    • BDHMI assumed the responsibility for the management, servicing, and administration of plaintiff's employee and retiree health plans;
    • BDHMI considered and proposed numerous healthcare cost containment strategies since its inception, many of which have been implemented by B&D;
    • BDHMI has always maintained salaried employees; and
    • BDHMI became responsible for paying the healthcare claims of B&D’s employees and such claims are paid with BDHMI’s assets.
recent tax shelter cases coltec industries inc v united states facts
Recent Tax Shelter Cases:Coltec Industries, Inc. v. United StatesFacts
  • The transaction was structured in similar fashion to the transaction at issue in Black & Decker.
  • Coltec and its subsidiary, Garlock, transferred cash, stock of a related company, and an intercompany note to a newly-created subsidiary, Garrison, in exchange for Garrison’s assumption of contingent asbestos litigation liabilities valued at $371 million and Garrison stock. Garrison was formed for the purpose of managing the contingent asbestos liabilities.
recent tax shelter cases coltec industries inc v united states facts continued
Recent Tax Shelter Cases:Coltec Industries, Inc. v. United StatesFacts (continued)
  • Coltec then sold the Garrison stock received by Garlock in the exchange to Nationsbank and First Union to establish the market price of the stock for subsequent sales to service providers. These sales included “put” and “call” rights exercisable after five years; the options were never exercised, and have expired.
  • Coltec claimed $370 million in capital losses from these stock sales.
  • Two years later, Coltec sold additional stock in Garrison to a select group of lawyers involved in defending its asbestos claims to provide these lawyers an additional performance incentive.
recent tax shelter cases coltec industries inc v united states arguments
Recent Tax Shelter Cases:Coltec Industries, Inc. v. United StatesArguments
  • The government argued that: (1) Garrison’s assumption of the liabilities reduced Garlock’s basis in the Garrison stock because the principal purpose for Garrison’s assumption of the liabilities was not a bona fide non-tax business purpose; (2) no sale of the Garrison stock occurred because the put and call options negated any transfer of beneficial ownership to the banks; and (3) the transactions lacked economic substance.
  • Coltec argued that: (1) the Code did not require a reduction in Garlock’s basis in the Garrison stock for the contingent liabilities transferred to Garrison; (2) Garlock’s transfer of Garrison stock to the banks was a sale; (3) no separate business purpose was required for the sale of Garrison stock to the banks; and (4) the transactions had economic substance and were not shams because the Garrison transaction had a legitimate business purpose.
recent tax shelter cases coltec industries inc v united states outcome
Recent Tax Shelter Cases:Coltec Industries, Inc. v. United StatesOutcome
  • The Court of Federal Claims upheld Coltec’s $370 million capital loss, holding that Coltec had satisfied all of the statutory requirements for claiming a capital loss from the stock sale (including the tests of section 357(b)).
  • The court declined to apply the economic substance doctrine so as to “trump” Coltec’s compliance with the Code. Citing Gitlitz v. Commissioner, 531 U.S. 206 (2000), and United States v. Bynum, 408 U.S. 125 (1972).
  • The court determined that Coltec’s basis in the Garrison stock that was sold to Nationsbank and First Union should not be reduced by the amount of the contingent asbestos liabilities transferred to the subsidiary.
recent tax shelter cases coltec industries inc v united states outcome20
Recent Tax Shelter Cases:Coltec Industries, Inc. v. United StatesOutcome
  • The court held that contingent liabilities are not “liabilities” for purposes of reducing basis under section 358(d).
  • The court stated that even if section 358(d) applied to the liabilities, section 357(c)(3) would preclude the liabilities from reducing basis because they “would give rise to a deduction.” The court relied upon the analysis of section 357(c)(3) in Black & Decker, which concluded that there was no authority to limit the application of section 357(c)(3) only to situations where the liabilities would give rise to a deduction to the transferee (as opposed to the transferor).
  • The court also held that section 357(b) did not apply to reduce Coltec’s basis in the Garrison stock, because there was a valid business purpose for the assumption of the liabilities. In determining that there was a valid business purpose, the court relied upon the testimony of Coltec employees as to the non-tax purposes of the transaction.
recent tax shelter cases tifd iii e inc castle harbour v united states facts
Recent Tax Shelter Cases:TIFD-III-E, Inc. (“Castle Harbour”) v. United StatesFacts
  • In the early 1990’s, General Electric Capital Corporation (“GECC”) sought to reduce the risk associated with its aircraft leasing business.
  • GECC formed a limited liability company (“LLC”), Summer Street, that was owned by three of its subsidiaries, TIFD III-E, TIFD III-M, and GE Capital AG. GECC, through the subsidiaries, contributed the following to Summer Street: aircraft worth $530 million, subject to $258 million nonrecourse debt (net $272 million); $22 million in receivables; $296 million in cash; and 100% of the stock of another of its subsidiaries, TIFD VI (valued at $0).
  • TIFD III-E, TIFD III-M, and GE Capital AG sold interests in Summer Street worth $50 million to two foreign banks, ING Bank and Rabo Merchant Bank (collectively, the “Banks”). This sale constituted a sale of 100% of GE Capital AG’s interest in Summer Street. The Banks contributed an additional $67.5 million to Summer Street, bringing their total investment to $117.5 million.
recent tax shelter cases tifd iii e inc castle harbour v united states facts continued
Recent Tax Shelter Cases:TIFD-III-E, Inc. (“Castle Harbour”) v. United StatesFacts (continued)
  • Summer Street’s name was then changed to Castle Harbour - I LLC (“Castle Harbour”).
  • As a result of these transactions, TIFD III-E and TIFD III-M owned a combined interest in Castle Harbour of approximately 82 percent, and the Banks owned a combined interest of approximately 18 percent.
  • Under the terms of the partnership agreement, 98 percent of the “operating income” of the partnership was allocated to the Banks. Operating income was comprised of income less expenses. Depreciation of the airplanes and certain guaranteed payments to the GE entities were treated as expenses that reduced operating income; repayments of principal on the airplane debt were not.Since the aircraft owned by Castle Harbour had already been fully depreciated for tax purposes prior to their contribution to the partnership, only “book” depreciation significantly reduced operating income.
recent tax shelter cases tifd iii e inc castle harbour v united states facts continued23
Recent Tax Shelter Cases:TIFD-III-E, Inc. (“Castle Harbour”) v. United StatesFacts (continued)
  • “Disposition gains and losses” from sales or distributions of assets were allocated as follows: (1) they offset prior disposition losses/gains and/or prior operating income/loss; (2) 90 percent of the remainder of any gain or loss was allocated to the Banks, subject to a specified limit of approximately $3 million; and (3) if the limit was reached, then 99 percent of the balance was allocated to the GE entities, and one percent was allocated to the Banks.
  • In each year, a substantial part of the income received by the Banks was used to “buy down” portions of the Banks’ interests, thus decreasing their capital accounts. The goal of GE and the Banks was to liquidate the Banks’ interests in Castle Harbour over eight-years.
  • The expectation of the parties was that the Banks would earn an internal rate of return of just over 9%.
  • The partnership allocations reduced GECC’s tax liability with respect to operating income by $62.2 million over the life of the partnership.
recent tax shelter cases tifd iii e inc castle harbour v united states arguments
Recent Tax Shelter Cases:TIFD-III-E, Inc. (“Castle Harbour”) v. United StatesArguments
  • The government argued that the allocation of Castle Harbour’s income to the Banks should be disallowed on three grounds: (1) the overall transaction lacked “economic substance; (2) the Banks should be treated as lenders, not partners, for tax purposes and, therefore, partnership income could not be allocated to them; and (3) the manner in which the partnership income was allocated violated the “overall tax effect” rule of section 704(b).
  • GECC maintained that Castle Harbour was a real partnership, established for legitimate, non-tax business reasons.
recent tax shelter cases tifd iii e inc castle harbour v united states outcome
Recent Tax Shelter Cases:TIFD-III-E, Inc. (“Castle Harbour”) v. United StatesOutcome
  • The United States District Court for the District of Connecticut granted judgment in favor of the taxpayer for $62.2 million.
  • The court held in favor of the taxpayer on each of the arguments raised by the government, concluding that although the transaction “sheltered a great deal of income from taxes” it was “legally permissible.”
  • The court found that the formation of the partnership had “economic substance” under the Second Circuit Court of Appeals’ sham transaction standard, because it had real non-tax economic effects and a non-tax business purpose.
  • The court held that GECC had a legitimate business purpose for the transaction -- to raise additional capital, and to demonstrate to investors, rating agencies, and GECC senior management that it could raise capital on its aging aircraft.
recent tax shelter cases tifd iii e inc castle harbour v united states outcome continued
Recent Tax Shelter Cases:TIFD-III-E, Inc. (“Castle Harbour”) v. United StatesOutcome (continued)
  • The Banks contributed substantial amounts of cash to the partnership, which was used to purchase aircraft and retire debt, thus establishing a real economic effect to the transaction.
  • The court declined to decide whether to apply the economic substance test advanced by the taxpayer, i.e. that if the transaction had either a subjective business purpose or an objective economic effect, the transaction should be respected for tax purposes, or the test advocated by the government, i.e. a “flexible” standard where both factors should be considered but neither factor is dispositive. Instead, the court determined that the transaction had both a non-tax economic effect and a non-tax business motivation and so would pass the economic sham test under either approach.
slide27
Recent Tax Shelter Cases:TIFD-III-E, Inc. (“Castle Harbour”) v. United StatesEvidence of Economic Substance
  • Castle Harbour received an “economically real, up-front payment of $117 million” from the Banks;
  • The Banks participated in the “economically real” upside potential of the aircraft leasing business, despite provisions in the operating agreement that apparently guaranteed them a certain minimum level of return on their investment;
  • The arrangement allowed GECC to retire some of its commercial paper, thus reducing its debt-to-equity ratio.
recent tax shelter cases santa monica pictures v commissioner facts
Recent Tax Shelter Cases:Santa Monica Pictures v. CommissionerFacts
  • After Metro-Goldwyn Mayer (“MGM”) was sold to the highest bidder, two individuals and their related entities (collectively, the “Ackerman Group”) attempted to acquire MGM’s parent company, Santa Monica Holding Corporation (“SMHC”), which was owned by the creditors of MGM, the Credit Lyonnais group (“CL Group”).
    • SMHC had no valuable assets, and owed approximately $1 billion to the CL Group. CL Group also owned stock in SMHC. CL Group’s tax basis in the SMHC debt was approximately $1 billion, and its basis in the SMHC stock was approximately $665 million.
  • The Ackerman Group (AG) formed an LLC, SMP. The CL Group contributed the SMHC debt and the SMHC stock to SMP in exchange for preferred interests in SMP and $5 million cash. The CL Group acquired a put right, exercisable within five years, with respect to its SMP interests. The put required the AG to purchase the CL Group’s interest for $5 million, and the parties entered into a deposit account agreement that required the $5 million purchase price to be placed in a blocked account to be released when the put was exercised.
recent tax shelter cases santa monica pictures v commissioner facts continued
Recent Tax Shelter Cases:Santa Monica Pictures v. CommissionerFacts (continued)
  • At the earliest opportunity, i.e., just three weeks after the CL Group made its contribution to SMP, the CL Group exercised its put rights and received $5 million from the AG for its interest in SMP.
  • Under the partnership rules, the AG claimed a $1 billion basis in the SMHC debt held by SMP, and claimed a basis of $665 million in the SMHC stock.
  • In 1997, SMP sold $150 million of the almost $1 billion debt it held to TroMetro, an LLC formed by a long-time associate of one of the individuals who controlled the AG, for approximately $2.5 million. SMP claimed a loss of approximately $147.5 million on the sale on its 1997 return.
  • In 1998, SMP sold another $81 million of the debt it held to TroMetro for $1.4 million (i.e., cash of $150,000 and a TroMetro note). SMP claimed a loss of approximately $80 million on the sale on its 1998 tax return.
recent tax shelter cases santa monica pictures v commissioner facts continued30
Recent Tax Shelter Cases:Santa Monica Pictures v. CommissionerFacts (continued)
  • TroMetro and SMHC entered into a distribution agreement with respect to the film library held by SMHC. SMHC reported no income from this arrangement.
  • One of the individuals who controlled the AG was on the board of directors of Imperial Bank (“Imperial”). In 1997, Imperial realized significant capital gains from the sale of two of its financial services companies; it was looking for losses to offset these gains.
  • In November of 1997 the AG formed Corona Film Finance Fund, LLC (“Corona”). SMP contributed $250,000 cash and a $79 million receivable in exchange for a 99% interest in Corona.
  • On December 15, 1997, Imperial purchased a 79% interest in Corona from SMP for $1.25 million, and Imperial’s agreement to pay SMP a fee of 20% of the tax losses received from Corona. SMP claimed a capital loss of $62 million on the sale of the Corona interest to Imperial on its 1997 tax return.
recent tax shelter cases santa monica pictures v commissioner facts continued31
Recent Tax Shelter Cases:Santa Monica Pictures v. CommissionerFacts (continued)
  • On December 23, 1997, Imperial purchased an additional 14.65% interest in Corona from SMP for approximately $200,000. SMP claimed a capital loss of $11.6 million on the sale of the second Corona interest to Imperial on its 1997 tax return.
  • Also in December of 1997, Corona sold the $79 million receivable contributed by SMP to TroMetro for $1.1 million (i.e., $120,000 cash and a note). Corona reported a loss of $78 million on its return for 1997. Approximately $74 million of this loss flowed through to Imperial; $4 million flowed through to SMP and its owners.
  • In accordance with the original agreement between Imperial and SMP and as a result of the $74 million loss realized by Imperial, Imperial contributed $14.5 million cash (i.e., approximately 25% of the amount of the tax loss) to Corona; SMP then received the cash.
recent tax shelter cases santa monica pictures v commissioner arguments
Recent Tax Shelter Cases:Santa Monica Pictures v. CommissionerArguments
  • The government argued that under substance over form principles, i.e. the economic substance and the step transaction doctrines, the transactions should be recast as direct sales of the high basis, low value assets (i.e., the receivables and the SMHC stock) by the CL Group to the AG, resulting in no transfer of built-in losses to SMP and no flow-through of those losses to the Ackerman Group.
    • The government argued in the alternative that, if the form of the transaction was respected, the capital losses would still be disallowed because SMP’s tax basis in the SMHC receivables was zero, because the receivables were worthless at the time they were contributed to SMP by the CL Group.
    • The government did not challenge the status of SMP and Corona as bona fide partnerships.
  • The taxpayer argued that SMP succeeded to the CL Group’s high bases in the receivables and the SMHC stock when those assets were contributed to SMP, and that subsequent transfers of the receivables generated real losses. The taxpayer argued that the form of the transactions should be respected, because the parties had valid, non-tax business reasons for engaging in the transactions.
recent tax shelter cases santa monica pictures v commissioner outcome
Recent Tax Shelter Cases:Santa Monica Pictures v. CommissionerOutcome
  • The Tax Court disallowed the capital losses claimed on the sales of receivables, holding that SMP and Corona never had any basis in the receivables. The court concluded that: (1) the contribution to SMP of receivables and SMHC stock by the CL Group lacked economic substance and cannot be respected for tax purposes; (2) SMP obtained no basis in the receivables contributed by the CL Group because the receivables were worthless or did not represent bona fide indebtedness; and (3) the Corona transaction lacked economic substance.
  • The court concluded that the “exclusive purpose” for the formation of SMP was to transfer to the AG “enormous” tax attributes associated with the high-basis, low value receivables and SMHC stock.
recent tax shelter cases santa monica pictures v commissioner outcome continued
Recent Tax Shelter Cases:Santa Monica Pictures v. CommissionerOutcome (continued)
  • The court concluded, based on “economic realities,” that the CL Group entities did not become partners in SMP, but sold their high-basis, low value assets to the AG for $10 million.
  • In analyzing the objective economic substance of the transaction, the court found that the put right the CL Group obtained, and the CL Group’s exercise of that right on the earliest date possible, negated any economic significance that “might otherwise have attached” to the CL Group’s joining SMP.
  • In analyzing the objective economic substance of the transaction, the court found that the AG’s up-front payment of $5 million to the CL Group for its contribution of assets (i.e., receivables and SMHC stock) to SMP and the additional $5 million promised upon exercise of the put option far exceeded the value of the contributed assets, and that the AG had no reasonable expectation of recouping the $10 million.
recent tax shelter cases santa monica pictures v commissioner outcome continued35
Recent Tax Shelter Cases:Santa Monica Pictures v. CommissionerOutcome (continued)
  • The court assigned minimal value to the SMHC stock contributed by the CL Group, concluded that certain securities owned by SMHC (the “Carolco securities”) had no value; and concluded that unused net operating losses of SMHC had little or no value.
  • With respect to the government’s step transaction arguments under the “end result” and “interdependence” tests, the court stated: “[w]hether this contention is viewed as an alternative argument, or merely as a particularization of [the government’s] substance over form argument, the results are identical: We disregard the [CL Group’s] purported contribution to SMP.” Nonetheless, “for the sake of completeness,” the court went through a step transaction analysis and concluded that the CL Group’s contributions of SMHC receivables and SMHC stock to SMP and the AG’s purchase of the CL Group’s interest in SMP three weeks later should be recast as (1) direct sales of the SMHC receivables and SMHC stock from the CL Group to the AG, followed by (2) the AG’s contribution of the SMHC assets to SMP.
recent tax shelter cases santa monica pictures v commissioner outcome continued36
Recent Tax Shelter Cases:Santa Monica Pictures v. CommissionerOutcome (continued)
  • The court addressed the government’s alternative argument that SMP had a zero basis in the SMHC receivables contributed by the CL Group because those receivables were worthless, and held that the receivables were worthless and, thus, did not constitute a “contribution of property” to SMP.
  • The court addressed the government’s alternative argument that SMP had a zero basis in one of the SMHC receivables contributed by the CL group because that receivable did not arise out of a bona fide debtor/creditor relationship, and concluded that the debt was not bona fide debt.
  • The court concluded that, in light of the fact that SMP had a zero basis in the SMHC assets, the contribution of those assets to Corona was “devoid of business purpose and economic substance.”
  • The court rejected the government’s argument that the sales of receivables to TroMetro should be recast as sales by SMP of an option to receive an equity interest in SMHC. However, the court noted that this conclusion did “not ultimately affect [its] decision” because the court had already reached the conclusion (on other grounds) that SMP had no basis in the SMHC receivables.
recent tax shelter cases santa monica pictures v commissioner evidence of lack of business purpose
Recent Tax Shelter Cases:Santa Monica Pictures v. CommissionerEvidence of Lack of Business Purpose
  • The CL Group had no intention of producing/distributing films with the AG; the AG had no experience in running a film distribution business; the CL Group contributed the film assets to SMHC and knew they were of little value; and the parties did not actively negotiate over the particulars re: the film business.
  • The AG was clearly interested in the tax attributes the CL Group had in the MGM companies, and its due diligence activities were focused almost entirely on obtaining assurances regarding the CL Group’s high basis in the receivables and the SMHC stock.
  • The AG faxed a Wall Street Journal article to its counsel that described a transaction similar to the proposed transaction, with a note that the article “gives good support for our business purpose for doing the deal.”
recent tax shelter cases santa monica pictures v commissioner misstatement and negligence penalties
Recent Tax Shelter Cases:Santa Monica Pictures v. CommissionerMisstatement and Negligence Penalties
  • The court sustained the section 6662(h) penalty for gross valuation misstatements, based on its determination that SMP had a zero basis in the receivables contributed by the CL Group, concluding that SMP’s and Corona’s claimed basis was “infinitely more than 400 percent of the amount” that the court determined to be the correct basis in the receivables.
  • The court also sustained the section 6662(a)(1) negligence penalty, observing that the principal of the AG who “personally engineered the plan to transfer built-in losses” was a “highly educated, sophisticated tax attorney” who had worked at a major law firm, at the Tax Court, and at Treasury.
recent tax shelter cases santa monica pictures v commissioner substantial understatement penalty
Recent Tax Shelter Cases:Santa Monica Pictures v. CommissionerSubstantial Understatement Penalty
  • The court sustained the section 6662(a)(2) substantial understatement penalty, holding that the taxpayer “cited no substantial authority” for its position.
  • The court held that the transaction at issue was a “tax shelter” for purposes of section 6662(d)(2)(C)(iii) since it concluded that the transaction between the CL Group and the AG lacked economic substance and, thus, that the taxpayer must demonstrate “reasonable belief” to prevail.
  • The court concluded that none of the opinions purportedly relied upon by the taxpayer reached a more likely than not conclusion, and that the taxpayer did not reasonably rely on such opinions.
recent tax shelter cases santa monica pictures v commissioner substantial understatement penalty40
Recent Tax Shelter Cases:Santa Monica Pictures v. CommissionerSubstantial Understatement Penalty
  • The court analyzed separately each piece of advice the taxpayer claimed to have relied upon, which included eight legal and accounting memoranda, and determined that none of the memoranda provided reasonable cause.
  • The court’s complaints with the opinions were that they:
    • misrepresented the facts of the actual transactions;
    • assumed certain incorrect facts, e.g. that there was a business purpose for the transactions, that the taxpayer knew were untrue;
    • were based on “dubious” appraisals of assets; and
    • analyzed legal issues that were irrelevant to the case.
slide41
WHAT TAXPAYERS AND THEIR ADVISORS NEED TO KNOW ABOUT THE AMERICAN JOBS CREATION ACT (“AJCA”)
american jobs creation act ajca disclosure penalties section 6707a
American Jobs Creation Act (AJCA) Disclosure Penalties Section 6707A
  • New section 6707A imposes a penalty for failing to disclose a tax shelter transaction.
  • The amount of the penalty is $10,000 for individuals, and $50,000 for all other taxpayers for “reportable” transactions; and $100,000 for individuals and $200,000 all other taxpayers for “listed” transactions.
  • Treasury has the authority to define “reportable” and “listed” transactions in regulations under section 6011.
  • The penalty applies to any taxpayer who participates in a reportable transaction. A taxpayer is a participant in a reportable transaction if his tax return reflects the tax benefit of the reportable transaction.
  • The section 6707A penalty applies regardless of whether the reportable transaction results in an understatement of tax.
american jobs creation act ajca disclosure penalties section 6707a continued
American Jobs Creation Act (AJCA) Disclosure Penalties Section 6707A (continued)
  • The section 6707A penalty, effective for returns and statements the due date for which is after October 22, 2004, applies in addition to any accuracy-related penalties.
  • The section 6707A penalty cannot be waived for failing to report a “listed” transaction,” but the taxpayer can argue that the transaction was not a “substantially similar” transaction.
  • However, Notice 2005-11 grants the IRS authority to rescind the penalty for failing to disclose a “reportable” transaction (other than a listed transaction) based upon: (1) Whether the taxpayer has a history of complying with the tax laws; (2) Whether the violation is due to an unintentional mistake of fact; and (3) Whether imposing the penalty would be against “equity and good conscience”
  • There is no judicial review of the Commissioner’s determination whether to rescind the section 6707A penalty.
american jobs creation act ajca disclosure penalties section 6707a continued44
American Jobs Creation Act (AJCA) Disclosure Penalties Section 6707A (continued)
  • Certain taxpayers have to disclose the payment of certain penalties to the Securities and Exchange Commission (“SEC”).
  • The penalties which trigger this new reporting obligation are the section 6707A penalty for failure to disclose, the section 6662A penalty for an understatement attributable to an undisclosed listed transaction or undisclosed reportable avoidance transaction, and the 40 percent penalty under section 6662 for gross valuation misstatements if the 30 percent penalty under section 6662A would have applied.
  • Note that the failure to make the disclosure to the SEC as just described is itself treated as a failure to include information with respect to a listed transaction for which the penalty under section 6707A applies.
american jobs creation act ajca disclosure penalties section 6707a continued45
American Jobs Creation Act (AJCA) Disclosure Penalties Section 6707A (continued)
  • Reportable transactions include six different types of transactions.
    • Listed Transactions;
    • Confidential Transactions for which the taxpayer has paid an advisor a minimum fee (i.e., $250,000 for corporations, and $50,000 for other taxpayers);
    • Transactions with Contractual Protection;
    • Loss Transactions - A transaction that results in a loss of $10 million or more in a single taxable year for corporations, or $20 million or more in multiple years;
    • Transactions with a Significant Book-Tax Difference - Transactions with a book-tax difference of more than $10 million on a gross basis in any taxable year are considered “significant” for these purposes; and
    • Transactions Involving a Brief Asset Holding Period - Transactions are reportable if there is a tax credit claimed that exceeds $250,000, and the asset giving rise to the credit is held for 45 days or less.
american jobs creation act ajca disclosure penalties section 6707a continued46
American Jobs Creation Act (AJCA) Disclosure Penalties Section 6707A (continued)
  • The two types of reportable transactions that most large corporations will face are loss transactions and transactions involving significant book-tax differences.
  • For tax years ending on or after December 31, 2004, if a corporate taxpayer is required to file the new Schedule M-3, the reporting of book-tax differences is deemed to be satisfied by the filing of that completed schedule.
  • If the Schedule M-3 is filed with the return, it does not also have to be filed with OTSA.
  • If, however, the transaction has significant book-tax differences and falls within another category of reportable transactions (for example, it is substantially similar to a listed transaction or involves a substantial loss), then it would not only be reported on Schedule M-3, but would have to be reported on a Form 8886 filed with the return. A copy of the Form 8886 would then have to be filed with OTSA.
american jobs creation act ajca accuracy related penalties section 6662a
American Jobs Creation Act (AJCA) Accuracy- Related Penalties Section 6662A
  • In general, section 6662A provides that a 20-percent accuracy-related penalty may be imposed on any reportable transaction understatement.
  • A “reportable transaction understatement” means:
    • The amount of the increase in taxable income which results from a difference between the proper tax treatment of an item and the taxpayer’s treatment of such item (as shown on the taxpayer’s return), multiplied by the highest rate of tax imposed by section 1 (section 11 for corporations); plus
    • The amount of decrease in the aggregate amount of credits determined under subtitle A which results from a difference between the taxpayer’s treatment of an item to which section 6662A applies (as shown on the taxpayer’s return) and the proper tax treatment of such item.
american jobs creation act ajca accuracy related penalties section 6662a continued
American Jobs Creation Act (AJCA) Accuracy- Related Penalties Section 6662A (continued)
  • Section 6662A applies to any listed transaction and any reportable transaction (other than a listed transaction) if a significant purpose of such transaction is the avoidance or evasion of Federal income tax.
  • The section 6662A penalty applies to any increase in taxable income resulting from certain reportable transactions regardless of the amount of the unreported tax liability. This means that it applies even if the taxpayer is in a net operating loss position.
  • The amount of the section 6662A penalty is 30 percent, rather than 20 percent, if the taxpayer does not adequately disclose the relevant facts affecting the tax treatment of the item giving rise to the understatement.
american jobs creation act ajca accuracy related penalties section 6662a continued49
American Jobs Creation Act (AJCA) Accuracy- Related Penalties Section 6662A (continued)
  • The reasonable cause and good faith defense is not available with respect to the 30-percent penalty.
  • Tax treatment on an amended return or a supplement to a return is not taken into account if the amended return or the supplement is filed after the earlier of the date the taxpayer is first contacted by the IRS regarding an examination of the return, or any other date specified by the Secretary.
  • In general, the section 6662A accuracy-related penalty does not apply to any portion of a reportable transaction understatement if, pursuant to section 6664(d), it is shown that there was reasonable cause and the taxpayer acted in good faith.
american jobs creation act ajca accuracy related penalties section 6662a continued50
American Jobs Creation Act (AJCA) Accuracy- Related Penalties Section 6662A (continued)
  • The reasonable cause and good faith exception does not apply unless:
    • The relevant facts affecting the tax treatment of the item are adequately disclosed;
    • There is or was “substantial authority” for such treatment; and
    • The taxpayer reasonably believed that such treatment was more likely than not the proper treatment. Section 6664(d)(2).
  • Under section 6664(d)(2), the requirement to disclose adequately under section 6011 will be treated as satisfied even if the taxpayer did not in fact disclose if the section 6707A penalty is rescinded.
american jobs creation act ajca accuracy related penalties section 6662a continued51
American Jobs Creation Act (AJCA) Accuracy- Related Penalties Section 6662A (continued)
  • The opinion of a tax advisor may not be relied upon to establish reasonable belief if either the tax advisor or the opinion is disqualified.
  • A tax advisor is a disqualified tax advisor if:
    • The advisor is a material advisor and participates in the organization, management, promotion, or sale of the transaction, or is related to any person who so participates;
    • The advisor is compensated directly or indirectly by a material advisor with respect to the transaction;
    • The advisor has a fee arrangement with respect to the transaction which is contingent on the intended tax benefits from the transaction being sustained; or
  • By regulations, the advisor has a disqualifying financial interest in the transaction.
american jobs creation act ajca accuracy related penalties section 6662a continued52
American Jobs Creation Act (AJCA) Accuracy- Related Penalties Section 6662A (continued)
  • An opinion is a disqualified opinion if:
    • The opinion is based on unreasonable factual or legal assumptions (including assumptions about future events);
    • The opinion unreasonably relies on representations, statements, findings, or agreements of the taxpayer or any other person;
    • The opinion does not identify and consider all relevant facts; or
    • The opinion fails to meet other requirements prescribed by the Secretary.
american jobs creation act ajca accuracy related penalties notice 2005 12
American Jobs Creation Act (AJCA) Accuracy- Related Penalties Notice 2005-12
  • Notice 2005-12 provides interim guidance on implementing section 6662A and the revisions to sections 6662 and 6664.
    • For purposes of determining whether the 30 percent penalty applies, the taxpayer will be treated as disclosing the relevant facts affecting the tax treatment of the item under section 6011 if the taxpayer filed a disclosure statement under Treas. Reg. § 1.6011-4(d), is deemed to have satisfied its disclosure obligation under Rev. Proc. 2004-45, 2004-31 I.R.B. 140, or satisfies the requirements set forth in any other published guidance regarding disclosure under section 6011.
    • For purposes of determining the amount of any reportable transaction understatement, the IRS will not take into account amended returns filed after the dates specified in Treas. Reg. §1.6664-2(c)(3) and Notice 2004-38, 2004-21 I.R.B. 949, which are dates after which a taxpayer may not file a “qualified amended return”.
american jobs creation act ajca accuracy related penalties notice 2005 12 continued
American Jobs Creation Act (AJCA) Accuracy- Related Penalties Notice 2005-12 (continued)
  • Notice 2005-12 also provides interim guidance on when a material advisor is a disqualified tax advisor.
    • A material advisor participates in the “organization” of a transaction if the advisor devises, creates, investigates, or initiates the transaction or tax strategy; devises the business or financial plans for the transaction or tax strategy; carries out those plans through negotiations or transactions with others; or performs acts related to the development or establishment of the transaction.
    • A material advisor participates in the “management” of a transaction if the material advisor is involved in the decision-making process regarding any business activity with respect to the transaction.
    • A material advisor participates in the “promotion or sale” of a transaction if the material advisor is involved in the marketing of the transaction, including soliciting taxpayers to enter into a transaction or tax strategy; placing an advertisement for the transaction; or instructing or advising others in the marketing of the transaction.
american jobs creation act ajca accuracy related penalties notice 2005 12 continued55
American Jobs Creation Act (AJCA) Accuracy- Related Penalties Notice 2005-12 (continued)
  • Notice 2005-12 provides that a tax advisor, including a material advisor, will not be treated as participating in the organization, management, promotion, or sale of a transaction if the advisor’s only involvement in the transaction is rendering an opinion regarding the tax consequences of the transaction.
  • Notice 2005-12 also defines when a tax advisor will have a disqualified compensation arrangement. Until further guidance, a tax advisor is treated as a disqualified tax advisor if the tax advisor has a referral fee or fee-sharing arrangement by which the advisor is compensated directly or indirectly by a material advisor. This rule applies regardless of whether or not the tax advisor is a material advisor.
  • An arrangement is a disqualified compensation arrangement if there is an agreement or understanding (oral or written) with a material advisor of a reportable transaction pursuant to which the tax advisor is expected to render a favorable opinion regarding the tax treatment of the transaction to any person referred by the material advisor.
american jobs creation act ajca material advisor rules changes
American Jobs Creation Act (AJCA) Material Advisor Rules - Changes
  • The AJCA made the following changes to the rules applicable to “material advisors”:
    • Section 6111(a) was amended to require each material advisor with respect to a reportable transaction to make a return (in such form as the Secretary may prescribe) setting forth information identifying and describing the transaction; information describing any potential tax benefits expected to result from the transaction; and such other information as the Secretary may prescribe.
    • Section 6111(b) defines a material advisor as
      • Any person who provides any material aid, assistance, or advice with respect to organizing, managing, promoting, selling, implementing, insuring, or carrying out any reportable transaction; and
      • Who directly or indirectly derives gross income in excess of the threshold amount (or such other amount as may be prescribed by the Secretary) for such advice or assistance. (The threshold amounts are $50,000 in the case of a reportable transaction substantially all of the tax benefits from which are provided to natural persons, and $250,000 in any other case).
american jobs creation act ajca material advisor rules
American Jobs Creation Act (AJCA) Material Advisor Rules
  • Section 6111(c) confers authority to issue regulations which provide:
    • That only one person shall be required to satisfy the section 6111 requirements in cases in which two or more persons would otherwise be required to meet such requirements;
    • Exemptions from the requirements of the section; and
    • Such rules as may be necessary or appropriate to carry out the purposes of the section.
  • Section 6112 provides that each material advisor with respect to any reportable transaction is required to maintain a list identifying each person with respect to whom such advisor acted as a material advisor with respect to such transaction; and containing such other information as the Secretary may by regulations require.
  • Section 6708 provides a penalty of $10,000 per day, which is applicable to a material advisor who fails to provide the list that is required to be maintained under section 6112 within the prescribed time frame.
american jobs creation act ajca material advisor rules guidance
American Jobs Creation Act (AJCA) Material Advisor Rules - Guidance
  • Notice 2004-80 provides interim guidance regarding disclosures by a material advisor and the maintenance of lists by material advisors.
  • Notice 2005-17 provides an extension of the transition relief outlined in Notice 2004-80.
  • Notice 2005-22 provides additional interim guidance to material advisors, including advice regarding, among other things:
    • How to complete IRS Form 8264, and when it must be filed; and
    • Determining the point at which an advisor becomes a “material advisor.”
american jobs creation act ajca section 6501 c 10
American Jobs Creation Act (AJCA) Section 6501(c)(10)
  • New section 6501(c)(10) changes the statute of limitations for listed transactions by providing that if a taxpayer fails to include on any return or statement for any taxable year any information with respect to a listed transaction which is required under section 6011, the time for assessment of any tax imposed with respect to such transaction shall not expire before the date which is 1 year after the earlier of:
    • the date on which the taxpayer furnishes the required information to the Secretary, or
    • the date that a material advisor provides required information relating to such transaction with respect to such taxpayer.
  • New section 6501(c)(10) focuses on disclosure. The statute of limitations is only extended if: (1) the taxpayer has not disclosed the transaction under section 6011; and (2) the material advisor has failed to fulfill its disclosure obligation.
  • Revenue Procedure 2005-26 provides additional guidance on section 6501(c)(10).
american jobs creation act ajca section 6404 g
American Jobs Creation Act (AJCA) Section 6404(g)
  • The AJCA amended the circumstances under which interest which otherwise would have been suspended by operation of section 6404(g) is not suspended.
  • In general, section 6404(g) provides that, in certain circumstances, where the Secretary does not provide a notice to the taxpayer specifically stating the taxpayer’s liability and the basis for the liability before the close of the 18 month period beginning on the later of the date on which the return is filed or the due date of the return without regard to extensions, the Secretary suspends the imposition of interest (and other additional amounts) related to the suspension period.
  • Prior to the changes in the AJCA, interest would be suspended on certain listed transactions if they were not otherwise in a category defined in section 6404(g)(2).
american jobs creation act ajca section 6404 g continued
American Jobs Creation Act (AJCA) Section 6404(g) (continued)
  • The AJCA provides that, under section 6404(g)(2)(D) and (E), any interest, penalty, addition to tax, or additional amount will not be suspended for amounts:
    • with respect to any gross misstatement;
    • with respect to any reportable transaction where section 6664(d)(2)(A) is not met; and
    • with respect to any listed transaction (as defined in section 6707A(c)).
american jobs creation act ajca section 163 m
American Jobs Creation Act (AJCA) Section 163(m)
  • Effective for taxable years ending after October 22, 2004, newly-enacted section 163(m) disallows a deduction for any interest payable on an underpayment attributable to a reportable transaction as defined by section 6662A(b) if the requirements of section 6664(d)(2)(A) are not met.
  • Thus, no interest would be deductible on that part of an underpayment attributable to a listed transaction or a reportable tax avoidance transaction unless reasonable cause can be proved.
  • Reasonable cause for this purpose requires all relevant facts to have been disclosed in accordance with the regulations under section 6011, that there be substantial authority for the treatment of the transaction, and that the taxpayer reasonably believes that the treatment was more likely than not proper.
  • This disallowance covers interest on the deficiency, interest on any interest payable, and interest on any penalty.
american jobs creation act ajca changes to section 7525
American Jobs Creation Act (AJCA)Changes to Section 7525
  • The AJCA limits the scope of the section 7525 tax practitioner-client privilege for communications regarding tax shelters.
  • In general, the change in the AJCA broadens the scope of the limitation in section 7525(b) from communications between a federally authorized tax practitioner and a “director, shareholder, officer, or employee, agent, or representative of a corporation” (emphasis added) to “(A) any person, (B), any director, officer, employee, agent or representative of that person, or (C) any other person holding a capital or profits interest in the person” where the communication is in connection with the promotion of the direct or indirect participation of the person in any tax shelter (as defined in section 6662(d)(2)(C)(ii)).
slide64
REVISIONS TO

CIRCULAR 230

revisions to circular 230 background
Revisions to Circular 230Background
  • On December 17, 2004, the U.S. Department of the Treasury (“Treasury”) and the IRS published final regulations amending Circular 230. These regulations were promulgated, in large part, with the purpose of curbing the promotion of abusive tax shelters. The regulations were revised on May 18, 2005, to respond to certain comments by practitioners. 70 Fed. Reg. 28,824 (May 19, 2005). The regulations provide ethical standards applicable to practitioners (i.e. attorneys, certified public accountants, enrolled agents, and enrolled actuaries) who provide written tax advice concerning one or more federal tax issues. A practitioner’s failure to comply with these regulations could result in the imposition of sanctions, which may include censure (public reprimand), suspension, disbarment, and/or monetary penalties.
revisions to circular 230 applicability
Revisions to Circular 230Applicability
  • The new regulations govern all written tax advice, including electronic communications, concerning one or more federal tax issues. “Written tax advice” means written advice concerning one or more federal tax issues. A “federal tax issue” is a question concerning the federal tax treatment of an item of income, gain, loss, deduction, or credit, the existence or absence of a taxable transfer of property, or the value of property for federal tax purposes.
  • Written tax advice is subject to one of two sets of rules -- the “covered opinion” rules contained in section § 10.35, or the “other written advice” rules contained in section § 10.37. The rules applicable to “covered opinions” are more stringent than the rules applicable to “other written advice.”
revisions to circular 230 overview of provisions
Revisions to Circular 230Overview of Provisions
  • Best Practices - Broadly drafted aspirational standards.
  • Covered Opinions - Detailed rules applicable to written tax advice on one or more federal tax issues arising from: (1) a listed transaction; (2) a plan or arrangement the principal purpose of which is the avoidance or evasion of federal tax; or (3) a plan or arrangement a significant purpose of which is the avoidance or evasion of federal tax, if the written advice is: (a) a reliance opinion (with a more likely than not, or stronger, conclusion); (b) a marketed opinion; (c) subject to conditions of confidentiality; or (d) subject to contractual protection (emphasis added).
  • Other Written Advice - Rules applicable to written advice that does not qualify as a “covered opinion.”
revisions to circular 230 best practices section 10 33
Revisions to Circular 230Best Practices (Section 10.33)
  • The Best Practices standards are aspirational in nature. Best practices include the following:
    • Complying with the standards of practice provided in other sections of Circular 230.
    • Communicating clearly with the client regarding the terms of the engagement, including the form and scope of the advice to be rendered.
    • Establishing the facts, determining which facts are relevant, evaluating the reasonableness of any assumptions or representations, relating the applicable law (including potentially applicable judicial doctrines) to the relevant facts, and arriving at a conclusion supported by the law and the facts.
    • Advising the client regarding the import of the conclusions reached, including, for example, whether a taxpayer may avoid accuracy-related penalties under the Code if a taxpayer acts in reliance on the advice.
    • Acting fairly and with integrity in practice before the IRS.
    • Tax advisors in supervisory roles within a tax practice are encouraged to take reasonable steps to ensure that the tax practice’s procedures are consistent with these best practices.
revisions to circular 230 covered opinions section 10 35
Revisions to Circular 230 Covered Opinions (Section 10.35)
  • The standards of § 10.35 apply to “Covered Opinions.” Under the regulations, a covered opinion is written advice, including electronic communications, concerning one or more federal tax issues arising from:
    • A transaction that is a “listed transaction” (or a transaction that is “substantially similar” to a listed transaction) at the time the advice is rendered.
    • A partnership or other entity, investment plan or arrangement, or any other plan or arrangement the principal purpose of which is the avoidance or evasion of federal tax.
    • A partnership or other entity, investment plan or arrangement, or any other plan or arrangement a significant purpose of which is the avoidance or evasion of federal tax, if the advice also constitutes a “reliance opinion,” a “marketed opinion,” is subject to conditions of confidentiality, or is subject to contractual protection.
revisions to circular 230 reliance opinions subject to section 10 35
Revisions to Circular 230 –Reliance Opinions Subject to Section 10.35
  • A “reliance opinion” is advice that concludes at a confidence level of at least more likely than not (a greater than 50 percent likelihood) that one or more significant federal tax issues would be resolved in the taxpayer’s favor. A federal tax issue is “significant” if the IRS has a reasonable basis for a successful challenge and its resolution could have a significant impact, whether beneficial or adverse and under any reasonably foreseeable circumstance, on the overall federal tax treatment of the transaction(s) or matter(s) addressed in the opinion.
  • Note that advice that would otherwise constitute a reliance opinion is not treated as such if: (1) it does not concern a listed transaction; (2) it does not concern a partnership, entity, plan, or arrangement the principal purpose of which is the avoidance or evasion of tax; and (3) the practitioner prominently discloses in the written advice that it was not intended or written by the practitioner to be used, and that it cannot be used by the taxpayer, for the purpose of avoiding penalties that may be imposed by the IRS.
revisions to circular 230 marketed opinions subject to section 10 35
Revisions to Circular 230 –Marketed OpinionsSubject to Section 10.35
  • A “marketed opinion” is advice the practitioner knows or has reason to know will be used or referred to by a person other than the practitioner (or a person who is a member of, associated with, or employed by the practitioner’s firm) in promoting, marketing or recommending a partnership or other entity, investment plan or arrangement to one or more taxpayer(s). § 10.35(b)(5).
  • Advice that would otherwise constitute a marketed opinion is not treated as such if: (1) it does not concern a listed transaction; (2) it does not concern a partnership, entity, plan, or arrangement the principal purpose of which is the avoidance or evasion of tax; and (3) the practitioner prominently discloses in the written advice that: (a) the advice was not intended or written by the practitioner to be used, and that it cannot be used by the taxpayer, for the purpose of avoiding penalties that may be imposed on the taxpayer by the IRS; (b) the advice was written to support the promotion or marketing of the transaction(s) or matter(s) addressed by the written advice; and (c) the taxpayer should seek advice based on the taxpayer’s particular circumstances from an independent tax advisor.
revisions to circular 230 exceptions to the definition of a covered opinion
Revisions to Circular 230Exceptions to the Definition of a “Covered Opinion”
  • The covered opinion rules do not apply to the following types of written tax advice:
    • Preliminary Advice – The practitioner reasonably expects to provide subsequent written advice to the client that satisfies the “covered opinion” requirements.
    • Specified Types of Advice - Advice (other than advice with respect to a listed transaction, or a transaction with the principal purpose of tax avoidance or evasion) that concerns the qualification of a qualified plan; a state or local bond opinion; and advice included in documents required to be filed with the SEC.
    • Post-Filing Advice - Post-filing advice is advice prepared for and provided to a taxpayer, solely for use by that taxpayer, after the taxpayer has filed a return reflecting the benefits of the transaction.
revisions to circular 230 exceptions to the definition of a covered opinion continued
Revisions to Circular 230Exceptions to the Definition of a “Covered Opinion” (continued)
  • In-House Advice - A covered opinion does not include written advice provided to an employer by an employee practitioner that concerns the employer's tax liability.
  • Negative Advice - Negative advice is written advice that does not resolve a Federal tax issue in the taxpayer’s favor, unless the advice reaches a conclusion favorable to the taxpayer at any confidence level, e.g. not frivolous. §10.35(b)(2)(ii)(E).
  • Certain Advice Containing Prominent Disclosures - Advice that otherwise qualifies as a reliance opinion or marketed opinion is not a covered opinion if it contains appropriate, prominent disclosures as described in the regulations.
revisions to circular 230 standards applicable to covered opinions overview
Revisions to Circular 230Standards Applicable to Covered OpinionsOverview
  • If written advice is subject to the covered opinion rules, the practitioner providing the advice must
    • consider all relevant facts,
    • relate the law to the facts,
    • evaluate the significant federal tax issues, and
    • provide a conclusion.
revisions to circular 230 standards applicable to covered opinions factual matters
Revisions to Circular 230Standards Applicable to Covered OpinionsFactual Matters
  • The practitioner must use reasonable efforts to identify and ascertain the facts. The opinion must identify and consider all facts the practitioner determines to be relevant.
  • The opinion must not be based on any “unreasonable” factual assumptions.
  • The opinion must not be based on any “unreasonable factual representations, statements or findings” of the taxpayer or any other person.
  • The opinion may not rely on a factual representation that a transaction has a business purpose if the representation does not include a specific description of the business purpose or if the practitioner knows or should know that the representation is incorrect or incomplete.
  • All factual representations, statements or findings of the taxpayer relied upon by the practitioner must be identified in a separate section.
revisions to circular 230 standards applicable to covered opinions relating the law to the facts
Revisions to Circular 230Standards Applicable to Covered OpinionsRelating the Law to the Facts
  • The opinion must relate the applicable law (including potentially applicable judicial doctrines) to the relevant facts.
  • The practitioner must not assume the favorable resolution of any significant federal tax issue, unless otherwise permitted in the regulations, or otherwise base an opinion on any unreasonable legal assumptions, representations, or conclusions.
  • The opinion must not contain internally inconsistent legal analyses or conclusions.
slide77
Revisions to Circular 230Standards Applicable to Covered OpinionsEvaluation of Significant Federal Tax Issues
  • The advice must provide a conclusion as to the likelihood that the taxpayer will prevail on the merits regarding each significant tax issue considered in the opinion. If the practitioner is unable to reach a conclusion regarding one or more significant federal tax issues, the opinion must state that the practitioner is unable to reach a conclusion regarding those issues.
  • A federal tax issue is “significant” if the IRS has a reasonable basis for a successful challenge and the resolution of the issue could have a significant impact on the overall federal tax treatment of the transactions or matters opined on. § 10.35(b)(3).
  • The opinion must describe the reasons for the conclusions, including the facts and analysis supporting the conclusions, or describe the reasons that the practitioner is unable to reach a conclusion as to one or more issues.
revisions to circular 230 evaluation of significant federal tax issues continued
Revisions to Circular 230Evaluation of Significant Federal Tax Issues (continued)
  • If a “more likely than not” conclusion is not reached with respect to a significant tax issue, the advice must prominently disclose that fact and state that the taxpayer may not use the advice to avoid penalties.
  • In evaluating the significant federal tax issues, the opinion must not take into account the possibility that a tax return will not be audited, that an issue will not be raised on audit, or that an issue will be resolved through settlement if raised.
revisions to circular 230 standards applicable to covered opinions providing an overall conclusion
Revisions to Circular 230Standards Applicable to Covered OpinionsProviding an Overall Conclusion
  • The advice must provide an overall confidence level as to the likelihood that the federal tax treatment of the matter(s) that is the subject of the advice is the proper treatment and the reasons for that conclusion.
  • If the practitioner is unable to reach an overall conclusion, the opinion must state that the practitioner is unable to reach an overall conclusion and describe the reasons for the inability to reach such a conclusion.
revisions to circular 230 standards applicable to covered opinions competence
Revisions to Circular 230Standards Applicable to Covered OpinionsCompetence
  • The opinion must be rendered by a practitioner who is knowledgeable in all of the aspects of federal tax law relevant to the opinion being rendered. A practitioner may rely on the opinion of another practitioner if the opinion identifies and states the conclusions reached in the opinion relied upon. A practitioner must not rely on the opinion of another practitioner if the practitioner knows or should know that the opinion should not be relied upon.
  • If a practitioner relies on the opinion of another practitioner, the relying practitioner must be satisfied that the combined analysis of the opinions and the overall conclusion satisfy the covered opinion requirements.
slide81
Revisions to Circular 230Standards Applicable to Covered OpinionsSpecial Rules for Marketed Opinions
  • If the advice is a marketed opinion, the advice must provide a conclusion at a confidence level of at least more likely than not with respect to each significant federal tax issue and with respect to the overall conclusion.
  • A marketed opinion must contain two prominent disclosures:
    • The advice was written to support the promotion or marketing of the transaction or matter addressed in the advice; and
    • The taxpayer should seek advice from an independent tax advisor.
  • If the confidence level for a marketed opinion does not reach more likely than not, the opinion may still be issued if, in addition to the two required, prominent disclosures set forth in the previous paragraph, the advice prominently discloses the following:
    • The advice was not intended or written to be used, and it cannot be used, for the purpose of avoiding penalties that may be imposed by the IRS.
slide82
Revisions to Circular 230Standards Applicable to Covered OpinionsSpecial Rules for Marketed Opinions (continued)
  • Note also that any covered opinion that fails to reach a more likely than not conclusion with respect to a significant federal tax issue must prominently disclose the following:
    • The opinion does not reach a conclusion at a confidence level of at least more likely than not with respect to one or more significant federal tax issues addressed in the opinion. With respect to those significant federal tax issues, the opinion was not written, and cannot be used by the taxpayer, for the purpose of avoiding penalties that may be imposed on the taxpayer.
slide83
Revisions to Circular 230Standards Applicable to Covered OpinionsSpecial Rules for Limited Scope Opinions
  • A practitioner may provide an opinion that considers less than all of the significant federal tax issues if:
    • the opinion is not an opinion with respect to a listed transaction or a transaction that has the principal purpose of tax avoidance or evasion;
    • the opinion is not a marketed opinion;
    • the practitioner and the taxpayer agree that the scope of the opinion and the taxpayer’s reliance on the opinion for purposes of avoiding penalties are limited to the federal tax issue(s) addressed in the opinion; and the opinion includes the following prominent disclosures:
      • the opinion is limited to the one or more federal tax issues addressed in the opinion;
      • additional issues may exist that could affect the treatment of the transaction or matter that is the subject of the opinion and the opinion does not consider any such issues; and
      • with respect to issues not addressed in the opinion, the opinion cannot be used for the purpose of avoiding penalties.
slide84
Revisions to Circular 230Standards Applicable to Covered OpinionsSpecial Rules for Limited Scope Opinions (continued)
  • A practitioner providing a limited scope opinion may make reasonable assumptions regarding the favorable resolution of a federal tax issue (an “assumed issue”).
  • Any assumed issues must be identified in a separate section of the opinion.
revisions to circular 230 standards applicable to covered opinions required disclosures
Revisions to Circular 230Standards Applicable to Covered OpinionsRequired Disclosures
  • All covered opinions must include the following disclosure if it applies:
    • The opinion must disclose the existence of any relationship between the practitioner (or firm) providing the opinion and a promoter of the transaction that is the subject of the covered opinion, including any compensation arrangement or referral agreement.
revisions to circular 230 standards applicable to covered opinions consistency with disclosures
Revisions to Circular 230Standards Applicable to Covered OpinionsConsistency with Disclosures
  • The advice contained in the covered opinion must not be contrary to or inconsistent with any required disclosure.
slide87
Revisions to Circular 230Section 10.36 -Procedures to Ensure Compliance With the Covered Opinion Rules
  • Section 10.36 provides that a practitioner who has principal authority and responsibility for overseeing a firm’s practice of providing federal tax advice must take reasonable steps to ensure that the firm has adequate procedures in effect for purposes of complying with § 10.35.
  • A practitioner who is responsible for establishing and maintaining compliance procedures is subject to discipline in two circumstances:
    • The practitioner through willfulness, recklessness, or gross incompetence, does not take reasonable steps to ensure compliance with the covered opinion rules, and one or more of the firm’s practitioners have engaged in a pattern or practice of failing to comply with the rules; or
    • The practitioner knows or should know of a pattern or practice of noncompliance with the covered opinion rules, and through willfulness, recklessness, or gross incompetence, fails to take prompt action to correct the noncompliance.
    • Note that the regulations do not provide definitions for “willfulness,” “recklessness,” or “gross incompetence,” or give concrete examples of practitioner conduct that would be considered willful, reckless, or grossly incompetent in this context.
revisions to circular 230 standards applicable to other written advice
Revisions to Circular 230Standards Applicable to “Other Written Advice”
  • The standards of Section 10.37 apply to written tax advice that does not constitute a “covered opinion.”
  • Section 10.37 states that a practitioner must not:
    • Base advice on unreasonable factual or legal assumptions (including assumptions as to future events);
    • Unreasonably rely upon representations, statements, findings or agreements of the taxpayer or any other person;
    • Fail to consider all relevant facts that the practitioner knows or should know; or
    • In evaluating a federal tax issue, take into account the possibility that a tax return will not be audited, that an issue will not be raised on audit, or than an issue will be resolved through settlement if raised.
revisions to circular 230 standards applicable to other written advice continued
Revisions to Circular 230Standards Applicable to “Other Written Advice” (continued)
  • All relevant facts and circumstances, including the scope of the engagement and the type and specificity of the advice sought by the taxpayer, will be considered in determining whether advice complies with this standard.
  • If the practitioner knows or has reason to know that the advice will be used or referred to by someone outside the practitioner’s firm in promoting, marketing or recommending to one or more taxpayers a partnership, entity, plan, or arrangement a significant purpose of which is the avoidance or evasion of federal tax, the practitioner’s conduct will be judged using a “heightened standard of care.”
revisions to circular 230 sanctions and penalties for noncompliance
Revisions to Circular 230Sanctions and Penalties for Noncompliance
  • Section 10.52 of the Circular 230 regulations provides that a practitioner may be sanctioned by censure (public reprimand), suspension, or disbarment, for willful violation of the regulations (other than § 10.33); or for recklessly or through gross incompetence violating, among others, the covered opinion provisions and other written advice requirements.
  • Monetary penalties against a practitioner who violates Circular 230 are permitted under section 822(a)(1) of the recently enacted AJCA. Such penalties may be imposed on firms and entities on behalf of which the practitioner may be acting if the firm or entity knew or reasonably should have known of the practitioner’s conduct. Any penalty imposed shall not exceed the gross income derived (or to be derived) from the conduct giving rise to the penalty and may be in addition to, or in lieu of, any suspension, disbarment, or censure of the practitioner. 31 U.S.C. § 330(b) (as amended by the AJCA). The new regulations do not address this recent change in the law.
irs requests for tax accrual workpapers contents of tax accrual workpapers
IRS Requests for Tax Accrual WorkpapersContents of Tax Accrual Workpapers
  • Tax accrual workpapers include documentation of the company’s analysis of tax contingencies and reserves reported on financial statements, including roll-forwards of changes to the reserves. The workpapers may include memoranda, analyses and schedules that reflect the company’s hazards-of-litigation determinations.
  • The workpapers may be prepared by company attorneys, company accountants, and other company personnel, and by outside legal or accounting advisers. The workpapers may be reviewed by or provided to various persons, both inside and outside the company.
irs requests for tax accrual workpapers irs s position re disclosure
IRS Requests for Tax Accrual WorkpapersIRS’s Position Re: Disclosure
  • In United States v. Arthur Young & Co., 465 U.S. 805 (1984), the Supreme Court held that tax accrual workpapers enjoy no special protection against disclosure to the IRS. Nevertheless, in Announcement 84-46, 1984-18 IRB 18, the IRS stated that it would demonstrate “administrative sensitivity” and generally would not request tax accrual workpapers. Until 2002, the IRS generally requested tax accrual workpapers only in unusual circumstances.
  • In 2002, responding to tax shelter developments, the IRS adopted a new tax accrual workpaper policy, under which workpapers will be requested from taxpayers that engage in “listed transactions.” The new policy was initially set forth in Announcement 2002-63, 2002-2 CB 72, was augmented in Large and Midsized Business (“LMSB”) Questions & Answers and in Chief Counsel Notice 2004-010, and was finally memorialized in Internal Revenue Manual section 4.10.20. The new policy is in keeping with the IRS’s emphasis on “transparency.”
irs requests for tax accrual workpapers irs s position re disclosure continued
IRS Requests for Tax Accrual WorkpapersIRS’s Position Re: Disclosure (continued)
  • Under the new guidelines, if a taxpayer engages in one listed transaction, and properly discloses that transaction, the IRS will request only the portion of the tax accrual workpapers concerning that transaction. However, the IRS will request all tax accrual workpapers if:
    • The listed transaction is not properly disclosed; or
    • The taxpayer engages in multiple listed transactions; or
    • There are reported financial irregularities regarding the taxpayer.
  • This new policy applies to tax returns filed after July 1, 2002 (some returns filed earlier also may trigger a request, if listed transactions were not disclosed).
irs requests for tax accrual workpapers asserted protections from disclosure
IRS Requests for Tax Accrual WorkpapersAsserted Protections From Disclosure
  • Taxpayers and the IRS have disagreed on whether certain protections apply to shield tax accrual workpapers from disclosure to the IRS. Taxpayers have asserted that the following protections apply to shield workpapers from disclosure to the IRS:
    • Attorney-Client Privilege – Protects confidential communications made by a client, or by a person seeking to be a client, to an attorney, or made by the attorney to the client outside the presence of third parties with an expectation of confidentiality for the purpose of securing legal services, unless the privilege has been waived.
    • Work Product Doctrine – Protects documents prepared “in anticipation of litigation” or for trial by or for another party, or by or for that other party’s representative. The doctrine protects mental impressions of, and facts gathered by, attorneys and other representatives. A document may be prepared “in anticipation of litigation” even though litigation is not currently ongoing or imminent. A document prepared for “dual” legal and business purposes may, or may not, be entitled to work product protection.
irs requests for tax accrual workpapers asserted protections from disclosure continued
IRS Requests for Tax Accrual WorkpapersAsserted Protections From Disclosure (continued)
  • Code Section 7525 Tax Practitioner-Client Privilege – Created by statute, protects not only communications between tax attorneys and clients, but between other tax practitioners and their clients. Applies to communications made after July 22, 1998, between “federally authorized tax practitioners” and clients.
    • The privilege applies in a manner similar to the attorney-client privilege.
    • The privilege does not apply to “tax shelter” transactions (i.e. transactions with a “significant” purpose of tax avoidance or evasion).
    • For communications prior to October 15, 2004, the privilege does not apply to “corporate” tax shelters. For communications after October 15, 2004, the privilege does not apply to any tax shelter.
    • The privilege does not apply to criminal matters. The privilege may only be asserted in matters before the IRS and in Federal tax litigation.
irs requests for tax accrual workpapers are tax accrual workpapers privileged
IRS Requests for Tax Accrual WorkpapersAre Tax Accrual Workpapers Privileged?
  • The IRS’s position is generally that tax accrual workpapers are not privileged.
  • In United States v. El Paso Co., 683 F. 2d 530 (5th Cir. 1982), the Fifth Circuit said it “would be reluctant to hold that a lawyer’s analysis of the soft spots in a tax return and his judgments on the outcome of litigation on it are not legal advice.” However, the court held that disclosure of workpapers to outside auditors waived any privilege. (The case was decided before the enactment of Code section 7525).
  • In United States v. Rockwell Int’l, 897 F. 2d 1255 (3d Cir. 1990), the Third Circuit held that the determination of whether a tax reserve analysis is protected by the attorney-client privilege is dependent on several factors: (1) does it represent legal advice, or business advice, of an attorney? (2) Who was involved in its preparation? (3) Who has control of the file? (4) Was it intended to be disclosed to third parties, such as an independent auditor? (5) Was it actually disclosed to a third party?
recent developments in privilege legal opinions
Recent Developments in PrivilegeLegal Opinions
  • In the context of legal opinions, the IRS has asserted that work product protection is waived when the taxpayer places advice “in issue,” e.g. offers a short opinion for penalty protection purposes. This view was rejected in Black and Decker v. United States, 219 F.R.D. 87 (D. Md. 2003), where the court refused to find a broad subject matter waiver and allowed the “long” tax opinion prepared by an accountant to remain protected.
  • The IRS has argued that documents (including legal advice) drafted by outside attorneys for an accounting firm client that promoted tax shelters are not protected by the attorney-client privilege because the law firm and the accounting firm were “co-promoters” of shelters and, thus, all communications were business advice, not legal advice. This position was rejected due to lack of proof in United States v. BDO Seidman, 2003-1 USTC ¶50,255(N.D. Ill.).
recent developments in privilege section 7525 privilege
Recent Developments in PrivilegeSection 7525 Privilege
  • In the tax shelter context, the IRS has asserted that the section 7525 privilege does not encompass an “identity” privilege for clients of an accounting firm who have engaged in potentially abusive tax shelters. This position was successfully asserted by the government in United States v. BDO Seidman, 337 F.3d 802 (7th Cir. 2003) and United States v. Arthur Andersen, 2003-2 USTC ¶50,624 (N.D. Ill. 2003).
  • Based upon one court’s analysis, tax opinion letters prepared by accountants may not be protected from disclosure by the accountant-client privilege. In United States v. KPMG, LLP, 237 F. Supp. 2d 35 (D.D.C. 2003), the court concluded that the tax opinion in issue, which was prepared by accountants, was not protected by the accountant-client privilege because the analysis in the opinion letter was “prepared in connection with preparation of a tax return” as the opinion related to a transaction to be disclosed on the taxpayer’s tax return. CompareKPMG with United States v. Adlman, 134 F.3d 1194 (2d Cir. 1998), where the Second Circuit held that certain tax opinion letters prepared by accountants may be protected from disclosure to the IRS by the work product doctrine.
circular 230 disclosure
Circular 230 Disclosure
  • Internal Revenue Service Circular 230 Disclosure: As provided for in Treasury regulations, advice (if any) relating to federal taxes that is contained in this communication (including attachments) is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to another party any plan or arrangement addressed herein.