by Roger Russell
The newly revised proposed and temporary regulations governing tax shelter disclosure and registration, which went into effect on Jan. 1, 2003, cover a broader range of taxpayers than the old regulations, and could pose special problems for smaller and midsized businesses.
"The overall intent of the regs is to make it easier for the Internal Revenue Service to pursue sophisticated shelters, instead of trying to audit companies and finding arrangements that it considers to be borderline or abusive," said Bob Trinz, editor of RIA’s Federal Taxes Weekly Alert, a Thomson business. "Given current IRS assets, it was like trying to find a needle in a haystack with just the audit method available to discover tax shelters."
William V. Marino, assistant professor of accounting at York College of the City University of New York agreed. "The three main requirements of the regs - disclosure, registration and list maintenance - will help the IRS in its business of stemming the loss of revenue from abusive tax shelters," he said.
The regulations, in their fifth incarnation in less than three years, require taxpayers to disclose, and promoters to maintain customer lists for, six
reportable transaction categories. Trinz said that a number of the reportable transaction categories have generated controversy.
"There’s some opposition to the confidentiality provision," he said. This provision affects transactions offered taxpayers under conditions of confidentiality, unless a presumption is satisfied regarding written authorization to disclose. "The IRS will be pressured to make this provision clearer," said Trinz.
"However," he said, "the big guns have concentrated on the book tax disclosure requirements." These are transactions where the treatment for federal income tax differs by more than $10 million from the treatment of the item for book purposes in any tax year.
The regulations have also come under fire for their potential harmful effect on small and midsized businesses. In comments to the IRS, Grant Thornton singled out the "contractual protection" provision and the "time of providing disclosure" provision.
"These amendments went to a more objective standard for most of the tests," said David Auclair, senior manager of Grant Thornton’s Federal Tax Solutions Group. "That can be both good and bad. Although they give a more certain standard, they can sweep in transactions that you would think would not be covered."
"One of the bright-line tests is in the contractual protection provisions," he said. "These are inserted into fee arrangements to protect the taxpayer against the possibility that the intended tax consequences will not be sustained. But under the regs, if the benefit the taxpayer receives is, in any way, guaranteed, it will be a reportable transaction."
The problem with including such an arrangement as a reportable transaction is that "it can apply to a plain-vanilla transaction, such as filing an amended return to claim a refund," said Auclair. "Mid-market companies have traditionally used contingent fee arrangements for these things, and they shouldn’t be considered tax shelters. There’s a stigma in being involved with a tax shelter transaction, so companies will be inhibited from pursuing some of these perfectly legitimate transactions."
The solution, said Auclair, is to modify the requirement so it does not apply to transactions where there is a substantive IRS review. "They should use the same standard that they set in Circular 230, which governs practice before the IRS," he said. "These specifically allow contingent fees if, at the time of the transaction, the practitioner reasonably anticipates that the benefits will receive substantive review by the IRS."
Grant Thornton is also concerned about the so-called "time of providing disclosure" provision of the regulations. This provision requires the disclosure of reportable transactions, even in the event that the transaction becomes reportable after federal tax returns have been filed for the years in which the transaction affects the taxpayer’s tax liability.
"This is not a new provision - it was in the earlier versions of these regs," said Auclair. "We commented on it because we believe that mid-market companies are more likely to become the innocent victims of these rules." He added that the provision places an undue burden on middle-market companies with small internal staffs, and may penalize them for a failure of organizational memory. "It’s not fair for small companies that have fewer people in the tax department," he said.
"When one of them leaves, they take that organizational memory with them. It amounts to asking all of the newer employees to pore over returns going back years - it places an undue burden on them."
There are currently a number of bills pending in Congress, which, if passed, would impose stiff penalties on companies that fail to disclose a reportable transaction. Moreover, the regs apply to any transaction entered into after Feb. 28, 2000, that becomes a reportable transaction after 2002.
Auclair suggests that the IRS use the same period of limitations that they have to assess tax for a particular transaction. "It’s normally a three-year period with certain exceptions," he said. "There’s no purpose for a transaction to be covered by these regs where the IRS couldn’t impose a tax on it due to the limitations period."
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