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TelefileTelefile 2. Telefile Tax Shelters and Other Reportable Transactions Table of Contents Introduction Topics - This chapter discusses: Useful Items - You may want to see: Abusive Tax SheltersRules To Curb Abusive Tax Shelters Investor Reporting Penalties Whether To Invest Introduction Investments that yield tax benefits are sometimes called “tax shelters. Telefile ” In some cases, Congress has concluded that the loss of revenue is an acceptable side effect of special tax provisions designed to encourage taxpayers to make certain types of investments. Telefile In many cases, however, losses from tax shelters produce little or no benefit to society, or the tax benefits are exaggerated beyond those intended. Telefile Those cases are called “abusive tax shelters. Telefile ” An investment that is considered a tax shelter is subject to restrictions, including the requirement that it be disclosed, as discussed later. Telefile Topics - This chapter discusses: Abusive Tax Shelters , Rules To Curb Abusive Tax Shelters , Investor Reporting , Penalties , and Whether To Invest . Telefile Useful Items - You may want to see: Publication 538 Accounting Periods and Methods 556 Examination of Returns, Appeal Rights, and Claims for Refund 561 Determining the Value of Donated Property 925 Passive Activity and At-Risk Rules Form (and Instructions) 8275 Disclosure Statement 8275-R Regulation Disclosure Statement 8283 Noncash Charitable Contributions 8886 Reportable Transaction Disclosure Statement See chapter 5, How To Get Tax Help , for information about getting these publications and forms. Telefile Abusive Tax Shelters Abusive tax shelters are marketing schemes involving artificial transactions with little or no economic reality. Telefile They often make use of unrealistic allocations, inflated appraisals, losses in connection with nonrecourse loans, mismatching of income and deductions, financing techniques that do not conform to standard commercial business practices, or mischaracterization of the substance of the transaction. Telefile Despite appearances to the contrary, the taxpayer generally risks little. Telefile Abusive tax shelters commonly involve package deals designed from the start to generate losses, deductions, or credits that will be far more than present or future investment. Telefile Or, they may promise investors from the start that future inflated appraisals will enable them, for example, to reap charitable contribution deductions based on those appraisals. Telefile (But see the appraisal requirements discussed under Rules To Curb Abusive Tax Shelters , later. Telefile ) They are commonly marketed in terms of the ratio of tax deductions allegedly available to each dollar invested. Telefile This ratio (or “write-off”) is frequently said to be several times greater than one-to-one. Telefile Because there are many abusive tax shelters, it is not possible to list all the factors you should consider in determining whether an offering is an abusive tax shelter. Telefile However, you should ask the following questions, which might provide a clue to the abusive nature of the plan. Telefile Do the tax benefits far outweigh the economic benefits? Is this a transaction you would seriously consider, apart from the tax benefits, if you hoped to make a profit? Do shelter assets really exist and, if so, are they insured for less than their purchase price? Is there a nontax justification for the way profits and losses are allocated to partners? Do the facts and supporting documents make economic sense? In that connection, are there sales and resales of the tax shelter property at ever increasing prices? Does the investment plan involve a gimmick, device, or sham to hide the economic reality of the transaction? Does the promoter offer to backdate documents after the close of the year? Are you instructed to backdate checks covering your investment? Is your debt a real debt or are you assured by the promoter that you will never have to pay it? Does this transaction involve laundering United States source income through foreign corporations incorporated in a tax haven and owned by United States shareholders? Rules To Curb Abusive Tax Shelters Congress has enacted a series of income tax laws designed to halt the growth of abusive tax shelters. Telefile These provisions include the following. Telefile Disclosure of reportable transactions. Telefile You must disclose information for each reportable transaction in which you participate. Telefile See Reportable Transaction Disclosure Statement , later. Telefile Material advisors with respect to any reportable transaction must disclose information about the transaction on Form 8918, Material Advisor Disclosure Statement. Telefile To determine whether you are a material advisor to a transaction, see the Instructions for Form 8918. Telefile Material advisors will receive a reportable transaction number for the disclosed reportable transaction. Telefile They must provide this number to all persons to whom they acted as a material advisor. Telefile They must provide the number at the time the transaction is entered into. Telefile If they do not have the number at that time, they must provide it within 60 days from the date the number is mailed to them. Telefile For information on penalties for failure to disclose and failure to maintain lists, see Internal Revenue Code sections 6707, 6707A, and 6708. Telefile Requirement to maintain list. Telefile Material advisors must maintain a list of persons to whom they provide material aid, assistance, or advice on any reportable transaction. Telefile The list must be available for inspection by the IRS, and the information required to be included on the list generally must be kept for 7 years. Telefile See Regulations section 301. Telefile 6112-1 for more information (including what information is required to be included on the list). Telefile Confidentiality privilege. Telefile The confidentiality privilege between you and a federally authorized tax practitioner does not apply to written communications made after October 21, 2004, regarding the promotion of your direct or indirect participation in any tax shelter. Telefile Appraisal requirement for donated property. Telefile If you claim a deduction of more than $5,000 for an item or group of similar items of donated property, you generally must get a qualified appraisal from a qualified appraiser and complete and attach section B of Form 8283 to your return. Telefile If you claim a deduction of more than $500,000 for the donated property, you generally must attach the qualified appraisal to your return. Telefile If you file electronically, see Form 8453, U. Telefile S. Telefile Individual Income Tax Transmittal for an IRS e-file Return, and its instructions. Telefile For more information about appraisals, including exceptions, see Publication 561. Telefile Passive activity loss and credit limits. Telefile The passive activity loss and credit rules limit the amount of losses and credits that can be claimed from passive activities and limit the amount that can offset nonpassive income, such as certain portfolio income from investments. Telefile For more detailed information about determining and reporting income, losses, and credits from passive activities, see Publication 925. Telefile Interest on penalties. Telefile If you are assessed an accuracy-related or civil fraud penalty (as discussed under Penalties , later), interest will be imposed on the amount of the penalty from the due date of the return (including any extensions) to the date you pay the penalty. Telefile Accounting method restriction. Telefile Tax shelters generally cannot use the cash method of accounting. Telefile Uniform capitalization rules. Telefile The uniform capitalization rules generally apply to producing property or acquiring it for resale. Telefile Under those rules, the direct cost and part of the indirect cost of the property must be capitalized or included in inventory. Telefile For more information, see Publication 538. Telefile Denial of deduction for interest on an underpayment due to a reportable transaction. Telefile You cannot deduct any interest you paid or accrued on any part of an underpayment of tax due to an understatement arising from a reportable transaction (discussed later) if the relevant facts affecting the tax treatment of the item are not adequately disclosed. Telefile This rule applies to reportable transactions entered into in tax years beginning after October 22, 2004. Telefile Authority for Disallowance of Tax Benefits The IRS has published guidance concluding that the claimed tax benefits of various abusive tax shelters should be disallowed. Telefile The guidance is the conclusion of the IRS on how the law is applied to a particular set of facts. Telefile Guidance is published in the Internal Revenue Bulletin for taxpayers' information and also for use by IRS officials. Telefile So, if your return is examined and an abusive tax shelter is identified and challenged, published guidance dealing with that type of shelter, which disallows certain claimed tax shelter benefits, could serve as the basis for the examining official's challenge of the tax benefits you claimed. Telefile In such a case, the examiner will not compromise even if you or your representative believes you have authority for the positions taken on your tax return. Telefile The courts have generally been unsympathetic to taxpayers involved in abusive tax shelter schemes and have ruled in favor of the IRS in the majority of the cases in which these shelters have been challenged. Telefile Investor Reporting You may be required to file a reportable transaction disclosure statement. Telefile Reportable Transaction Disclosure Statement Use Form 8886 to disclose information for each reportable transaction (discussed later) in which you participated. Telefile Generally, you must attach Form 8886 to your return for each tax year in which you participated in the transaction. Telefile Under certain circumstances, a transaction must be disclosed within 90 days of the transaction being identified as a listed transaction or a transaction of interest (discussed later). Telefile In addition, for the first year Form 8886 is attached to your return, you must send a copy of the form to: Internal Revenue Service OTSA Mail Stop 4915 1973 North Rulon White Blvd. Telefile Ogden, UT 84404 If you file your return electronically, the copy sent to OTSA must show exactly the same information, word for word, provided with the electronically filed return and it must be provided on the official IRS Form 8886 or an exact copy of the form. Telefile If you use a computer-generated or substitute Form 8886, it must be an exact copy of the official IRS form. Telefile If you fail to file Form 8886 as required or fail to include any required information on the form, you may have to pay a penalty. Telefile See Penalty for failure to disclose a reportable transaction , later under Penalties. Telefile The following discussion briefly describes reportable transactions. Telefile For more details, see the Instructions for Form 8886. Telefile Reportable transaction. Telefile A reportable transaction is any of the following. Telefile A listed transaction. Telefile A confidential transaction. Telefile A transaction with contractual protection. Telefile A loss transaction. Telefile A transaction of interest entered into after November 1, 2006. Telefile Note. Telefile Transactions with a brief asset holding period were removed from the definition of reportable transaction for transactions entered into after August 2, 2007. Telefile Listed transaction. Telefile A listed transaction is the same as, or substantially similar to, one of the types of transactions the IRS has determined to be a tax-avoidance transaction. Telefile These transactions have been identified in notices, regulations, and other published guidance issued by the IRS. Telefile For a list of existing guidance, see Notice 2009-59 in Internal Revenue Bulletin 2009-31, available at www. Telefile irs. Telefile gov/irb/2009-31_IRB/ar07. Telefile html. Telefile Confidential transaction. Telefile A confidential transaction is offered to you under conditions of confidentiality and for which you have paid an advisor a minimum fee. Telefile A transaction is offered under conditions of confidentiality if the advisor who is paid the fee places a limit on your disclosure of the tax treatment or tax structure of the transaction and the limit protects the confidentiality of the advisor's tax strategies. Telefile The transaction is treated as confidential even if the conditions of confidentiality are not legally binding on you. Telefile Transaction with contractual protection. Telefile Generally, a transaction with contractual protection is one in which you or a related party has the right to a full or partial refund of fees if all or part of the intended tax consequences of the transaction are not sustained, or a transaction for which the fees are contingent on your realizing the tax benefits from the transaction. Telefile For information on exceptions, see Revenue Procedure 2007-20 in Internal Revenue Bulletin 2007-7, available at www. Telefile irs. Telefile gov/irb/2007-07_IRB/ar15. Telefile html. Telefile Loss transaction. Telefile For individuals, a loss transaction is one that results in a deductible loss if the gross amount of the loss is at least $2 million in a single tax year or $4 million in any combination of tax years. Telefile A loss from a foreign currency transaction under Internal Revenue Code section 988 is a loss transaction if the gross amount of the loss is at least $50,000 in a single tax year, whether or not the loss flows through from an S corporation or partnership. Telefile Certain losses (such as losses from casualties, thefts, and condemnations) are excepted from this category and do not have to be reported on Form 8886. Telefile For information on other exceptions, see Revenue Procedure 2004-66 in Internal Revenue Bulletin 2004-50, as modified and superseded by Revenue Procedure 2013-11, (or future published guidance) available at www. Telefile irs. Telefile gov/irb/2004-50_IRB/ar11. Telefile html. Telefile Transaction of interest. Telefile A transaction of interest is a transaction entered into after November 1, 2006, that is the same as, or substantially similar to, one of the types of transactions that the IRS has identified by notice, regulation, or other form of published guidance as a transaction of interest. Telefile The IRS has identified the following transactions of interest. Telefile “Toggling” grantor trusts as described in Notice 2007-73, 2007-36 I. Telefile R. Telefile B. Telefile 545, available at www. Telefile irs. Telefile gov/irb/2007-36_IRB/ar20. Telefile html. Telefile Certain transactions involving contributions of a successor member interest in a limited liability company as described in Notice 2007-72, 2007-36 I. Telefile R. Telefile B. Telefile 544, available at www. Telefile irs. Telefile gov/irb/2007-36_IRB/ar19. Telefile html. Telefile Certain transactions involving the sale or other disposition of all interests in a charitable remainder trust and claiming little or no taxable gain as described in Notice 2008-99, 2008-47 I. Telefile R. Telefile B. Telefile 1194, available at www. Telefile irs. Telefile gov/irb/2008-47_IRB/ar11. Telefile html. Telefile Certain transactions involving a U. Telefile S. Telefile taxpayer owning controlled foreign corporations (CFCs) that hold stock of a lower-tier CFC through a domestic partnership to avoid reporting income as described in Notice 2009-7, 2009-3 I. Telefile R. Telefile B. Telefile 312, available at www. Telefile irs. Telefile gov/irb/2009-03_IRB/ar10. Telefile html. Telefile For updates to this list, go to www. Telefile irs. Telefile gov/Businesses/Corporations/Abusive-Tax-Shelters-and-Transactions. Telefile Penalties Investing in an abusive tax shelter may lead to substantial expenses. Telefile First, the promoter generally charges a substantial fee. Telefile If your return is examined by the IRS and a tax deficiency is determined, you will be faced with payment of more tax, interest on the underpayment, possibly a 20%, 30%, or even 40% accuracy-related penalty, or a 75% civil fraud penalty. Telefile You may also be subject to the penalty for failure to pay tax. Telefile These penalties are explained in the following paragraphs. Telefile Accuracy-related penalties. Telefile An accuracy-related penalty of 20% can be imposed for underpayments of tax due to: Negligence or disregard of rules or regulations, Substantial understatement of tax, Substantial valuation misstatement (increased to 40% for gross valuation misstatement), Transaction lacking economic substance (increased to 40% for undisclosed transaction lacking economic substance), or Undisclosed foreign financial asset understatement (40% in all cases). Telefile Except for a transaction lacking economic substance, this penalty will not be imposed if you can show you had reasonable cause for any understatement of tax and that you acted in good faith. Telefile Your failure to disclose a reportable transaction is a strong indication that you failed to act in good faith. Telefile If you are charged an accuracy-related penalty, interest will be imposed on the amount of the penalty from the due date of the return (including extensions) to the date you pay the penalty. Telefile The 20% penalties do not apply to any underpayment attributable to a reportable transaction understatement subject to an accuracy-related penalty (discussed later). Telefile Negligence or disregard of rules or regulations. Telefile The penalty for negligence or disregard of rules or regulations is imposed only on the part of the underpayment due to negligence or disregard of rules or regulations. Telefile The penalty will not be charged if you can show you had reasonable cause for understating your tax and that you acted in good faith. Telefile Negligence includes any failure to make a reasonable attempt to comply with the provisions of the Internal Revenue Code. Telefile It also includes any failure to keep adequate books and records. Telefile A return position that has a reasonable basis is not negligence. Telefile Disregard includes any careless, reckless, or intentional disregard of rules or regulations. Telefile The penalty for disregard of rules and regulations can be avoided if all the following are true. Telefile You keep adequate books and records. Telefile You have a reasonable basis for your position on the tax issue. Telefile You make an adequate disclosure of your position. Telefile Use Form 8275 to make your disclosure and attach it to your return. Telefile To disclose a position contrary to a regulation, use Form 8275-R. Telefile Use Form 8886 to disclose a reportable transaction (discussed earlier). Telefile Substantial understatement of tax. Telefile An understatement is considered to be substantial if it is more than the greater of: 10% of the tax required to be shown on the return, or $5,000. Telefile An “understatement” is the amount of tax required to be shown on your return for a tax year minus the amount of tax shown on the return, reduced by any rebates. Telefile The term “rebate” generally means a decrease in the tax shown on your original return as the result of your filing an amended return or claim for refund. Telefile For items other than tax shelters, you can file Form 8275 or Form 8275-R to disclose items that could cause a substantial understatement of income tax. Telefile In that way, you can avoid the substantial understatement penalty if you have a reasonable basis for your position on the tax issue. Telefile Disclosure of the tax shelter item on a tax return does not reduce the amount of the understatement. Telefile Also, the understatement penalty will not be imposed if you can show there was reasonable cause for the underpayment caused by the understatement and that you acted in good faith. Telefile An important factor in establishing reasonable cause and good faith will be the extent of your effort to determine your proper tax liability under the law. Telefile Substantial valuation misstatement. Telefile In general, you are liable for a 20% penalty for a substantial valuation misstatement if all the following are true. Telefile The value or adjusted basis of any property claimed on the return is 150% or more of the correct amount. Telefile You underpaid your tax by more than $5,000 because of the misstatement. Telefile You cannot establish that you had reasonable cause for the underpayment and that you acted in good faith. Telefile You may be assessed a penalty of 40% for a gross valuation misstatement. Telefile If you misstate the value or the adjusted basis of property by 200% or more of the amount determined to be correct, you will be assessed a penalty of 40%, instead of 20%, of the amount you underpaid because of the gross valuation misstatement. Telefile The penalty rate is also 40% if the property's correct value or adjusted basis is zero. Telefile Transaction lacking economic substance. Telefile The economic substance doctrine only applies to an individual that entered into a transaction in connection with a trade or business or an activity engaged in for the production of income. Telefile For transactions entered into after March 30, 2010, a transaction has economic substance for you as an individual taxpayer only if: The transaction changes your economic position in a meaningful way (apart from federal income tax effects), or You have a substantial purpose (apart from federal income tax effects) for entering into the transaction. Telefile For purposes of determining whether economic substance exists, a transaction's profit potential will only be taken into account if the present value of the reasonably expected pre-tax profit from the transaction is substantial compared to the present value of the expected net tax benefits that would be allowed if the transaction were respected. Telefile If any part of your underpayment is due to any disallowance of claimed tax benefits by reason of a transaction lacking economic substance or failing to meet the requirements of any similar rule of law, that part of your underpayment will be subject to the 20% accuracy-related penalty even if you had a reasonable cause and acted in good faith concerning that part. Telefile Additionally, the penalty increases to 40% if you do not adequately disclose on your return or in a statement attached to your return the relevant facts affecting the tax treatment of a transaction that lacks economic substance. Telefile Relevant facts include any facts affecting the tax treatment of the transaction. Telefile Any excessive amount of an erroneous claim for an income tax refund or credit (other than a refund or credit related to the earned income credit) that results from a transaction found to be lacking economic substance will not be treated as having a reasonable basis and could be subject to a 20% penalty. Telefile Undisclosed foreign financial asset understatement. Telefile For tax years beginning after March 18, 2010, you may be liable for a 40% penalty for an understatement of your tax liability due to an undisclosed foreign financial asset. Telefile An undisclosed foreign financial asset is any asset for which an information return, required to be provided under Internal Revenue Code section 6038, 6038B, 6038D, 6046A, or 6048 for any taxable year, is not provided. Telefile The penalty applies to any part of an underpayment related to the following undisclosed foreign financial assets. Telefile Any foreign business you control, reportable on Form 5471, Information Return of U. Telefile S. Telefile Persons With Respect To Certain Foreign Corporations, or Form 8865, Return of U. Telefile S. Telefile Persons With Respect to Certain Foreign Partnerships. Telefile Certain transfers of property to a foreign corporation or partnership, reportable on Form 926, Return by a U. Telefile S. Telefile Transferor of Property to a Foreign Corporation, or certain distributions to a foreign person, reportable on Form 8865. Telefile Your ownership interest in certain foreign financial assets, temporarily reportable on Form 8275 or 8275-R. Telefile Instead of, or in addition to, Form 8275 or 8275-R, you may have to file Form 8938, Statement of Specified Foreign Financial Assets, with your tax return. Telefile See the Instructions for Form 8938 for details. Telefile Your acquisition, disposition, or substantial change in ownership interest in a foreign partnership, reportable on Form 8865. Telefile Creation or transfer of money or property to certain foreign trusts, reportable on Form 3520, Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts. Telefile Penalty for incorrect appraisals. Telefile The person who prepares an appraisal of the value of property may have to pay a penalty if: He or she knows, or reasonably should have known, that the appraisal would be used in connection with a return or claim for refund; and The claimed value of the property on a return or claim for refund based on that appraisal results in a substantial valuation misstatement or a gross valuation misstatement as discussed earlier. Telefile For details on the penalty amount and exceptions, see Publication 561. Telefile Penalty for failure to disclose a reportable transaction. Telefile If you fail to include any required information regarding a reportable transaction (discussed earlier) on a return or statement, you may have to pay a penalty of 75% of the decrease in tax shown on your return as a result of such transaction (or that would have resulted if the transaction were respected for federal tax purposes). Telefile For an individual, the minimum penalty is $5,000 and the maximum is $10,000 (or $100,000 for a listed transaction). Telefile This penalty is in addition to any other penalty that may be imposed. Telefile The IRS may rescind or abate the penalty for failing to disclose a reportable transaction under certain limited circumstances but cannot rescind the penalty for failing to disclose a listed transaction. Telefile For information on rescission, see Revenue Procedure 2007-21 in Internal Revenue Bulletin 2007-9 available at www. Telefile irs. Telefile gov/irb/2007-09_IRB/ar12. Telefile html. Telefile Accuracy-related penalty for a reportable transaction understatement. Telefile If you have a reportable transaction understatement, you may have to pay a penalty equal to 20% of the amount of that understatement. Telefile This applies to any item due to a listed transaction or other reportable transaction with a significant purpose of avoiding or evading federal income tax. Telefile The penalty is 30% rather than 20% for the part of any reportable transaction understatement if the transaction was not properly disclosed. Telefile You may not have to pay the 20% penalty if you meet the strengthened reasonable cause and good faith exception. Telefile The reasonable cause and good faith exception does not apply to any part of a reportable transaction understatement attributable to one or more transactions that lack economic substance. Telefile This penalty does not apply to the part of an understatement on which the fraud penalty, gross valuation misstatement penalty, or penalty for nondisclosure of noneconomic substance transactions is imposed. Telefile Civil fraud penalty. Telefile If any underpayment of tax on your return is due to fraud, a penalty of 75% of the underpayment will be added to your tax. Telefile Joint return. Telefile The fraud penalty on a joint return applies to a spouse only if some part of the underpayment is due to the fraud of that spouse. Telefile Failure to pay tax. Telefile If a deficiency is assessed and is not paid within 10 days of the demand for payment, an investor can be penalized with up to a 25% addition to tax if the failure to pay continues. Telefile Whether To Invest In light of the adverse tax consequences and the substantial amount of penalties and interest that will result if the claimed tax benefits are disallowed, you should consider tax shelter investments carefully and seek competent legal and financial advice. Telefile Prev Up Next Home More Online Publications
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