American Taxation AssociationFebruary 27th, 2004Denver, Colorado

SOX 404Tax Shelter Disclosure Regulations

Sarbanes-Oxley 404 – Tax Role

Robert Lund –Director-Tax Services

Executive Summary of SOX 404

Annual report must contain a report from management on internal control that:

– States management’s responsibility for establishing and maintaining an adequate internal control structure and procedures for financial reporting, and

– Contain management’s assessment, as of the end of the fiscal year of the effectiveness of the internal control structure and procedures for financial reporting

Executive Summary of S-O 404

External auditor must attest to and report on management's assertion concerning its assessment of internal control

Effective Date The Act does not impose a deadline for the creation of rules to

implement §404. If adopted, would apply to companies whose fiscal years end on or after June 15, 2004. ( Who Knows ?)

Internal Control

•Focus is on reliability of financial reporting

•Committee of Sponsoring Organizations (COSO) of the Treadway Commission provides detailed internal control criteria and defines five components of internal control:

Internal Control, continued

Control Environment ‒ The control environment sets the tone of an organization, influencing the control consciousness of its people

Risk Assessment ‒ Every entity faces a variety of risks from external and internal sources that must be assessed both at the entity and the activity level

Control Activities ‒ These policies & procedures help ensure management directives are carried out

Information and Communication

‒ Pertinent information must be identified, captured and communicated in a form and timeframe that supports all other control components

Monitoring ‒ Internal control systems need to be monitored – a process that assesses the quality of the system’s performance over time

Management’s Assessment of Effectiveness Should:

Cover each of the five components of internal control and include: An inventory and documentation of significant controls

consistent with management’s assertion (see next slide) An evaluation of the design effectiveness of controls An evaluation of the operating effectiveness of controls based

on testing or other procedures

Include documentation of the results of the evaluation

Provide for communication of findings to the auditor or to others, if applicable

Management: Supporting the Evaluation

Determining which controls are significant: Controls that address significant classes of transactions,

account balances, disclosures and related assertions Consider likelihood that control failure could cause

misstatements and the potential magnitude

Management: Supporting the Evaluation

Should include: Fraud programs and controls Controls on which other controls are dependent (e.g., general

controls) Controls over significant non-routine transactions, journal

entries, and accounts involving judgments and estimates Controls over closing process and preparing F/S

Management: Evaluating Operating Effectiveness

Procedures must be sufficient to verify operating effectiveness: testing of controls by internal audit or others under the direction

of management use of service organization reports self-assessment processes

Inquiry alone is not adequate

Procedures performed and controls and locations selected are affected by risk assessment and monitoring processes

All significant controls and locations must be evaluated annually

Auditor’s Consideration of Management’s Evaluation

Inadequate documentation of controls may result in a significant deficiency or a material weakness

Absence of sufficient evidence to support assertion constitutes a material weakness

Tax Involvement with Section 404

Significant Transactions and Activities Tax is often a significant activity subject to significant financial

risk and substantial disclosure considerations

Tax Involvement with Section 404

Significant Activities and Risk Tax is based on self-assessment

– Unlike typical accounts payable Tax functions are often decentralized Estimates and judgments are often utilized in tax reserve

analysis computations.

Tax Integration with S-O 404

Scope and Depth of Tax Transactions Tax impacts nearly every line on the income statement and

balance sheet

Customs duties

Transfer pricing issues

Tax is Embedded in Every Aspect of Business

PROFIT AND LOSS ACCOUNT

Sales X

Purchases (X)

Manufacturing (X)

Overheads (X)

Financing (X)

Profit X

Tax charge X

Profit after tax X

BALANCE SHEET

Tangible assets X

Intangible assets X

Net current assets X

X

Capital X

Reserves X

Funding debt X

X

VAT and sales taxes

Cross border issues

Location of activities

Treasury

Foreign exchange

Funding

Location and exploitation of intellectual property

Cross border issues

Profit repatriation flows

Monetising tax assets

Trade debts

Liabilities

Property taxes

Employee taxes

International executive taxation

Tax considerations may impact areas of S-O 404 attest and advisory services

Tax Integration with S-O 404

Tax Subject Matter Requirement Tax content knowledge is necessary to evaluate tax-related

internal controls Broad Range of Taxes (Income/Sales)

Tax Areas Requiring Internal Controls

Income Tax Sales & Use Taxes Property Tax Payroll Tax

Tax Incentives, Holidays, &

Credits

Non-US Income Tax

International Executive

TaxExcise Taxes

Transfer Pricing FAS109 VAT

Comp & Benefits Customs Unclaimed

Property

The tax function extends beyond income tax; non-income tax areasmay account for a disproportionately large share of the risk

Significance

There is no formula to “calculate” significance, however, there are general guidelines:

Quantitative factors: Value of transactions Volume of transactions

Qualitative factors: Risk of significant misstatement of a financial statement

element in the absence of internal controls.

Management ultimately decides significant controls.

Risk Indicators

High Likelihood of Occurrence

Non-routine

Non-systematic

Subjective Estimates Assumptions Interpretation

Complex

High Magnitude of Error

Significant Class of Transaction

Misstatement is material to financial statements

I. Obtain background information and high-level understanding of tax functions

•Financial statements

•Organization charts (legal entity and corporate personnel)

•Internal memoranda & tax correspondence files

•Income tax provision workpapers

•Prior year’s income tax returns and workpapers

•Tax audit history and reports

•History of significant transactions (M&A, change of control, etc.)

II. Obtain general understanding of current control environment and process

• Review tax department policies and procedures manuals

• Review tax workpaper and tax research documentation: (look for process standards, work-flow tracking, documentation, etc.)

• Walk-through tax process and control procedures

• Management letter comments by audit firm concerning tax

• History of audit adjustments to tax accounts

• Internal audit review of tax functions

• Standard forms / checklists / dockets / workpaper formats used by tax department

• Forms for requesting and approving checks or electronic tax payments

• Reporting structure - business unit or financial accounting

• Identify and review systems for which tax department has responsibility

III. Determine which tax segments and functions constitute significant control risks

• Significant class of transaction

• Strategic business risks

• Tax department functions that aggregate to material risk i.e., support to operating units or HR for sales & use tax, payroll tax , etc.

• Consider degree to which tax functions are non-routine, non-systematic or subjective

• Consider level of complexity

• Consider materiality to financial statements

• Quantitative analysis Account balances: current taxes payable/receivable, deferred tax assets &

liabilities, valuation allowance, effective tax rate, etc.

Comparison of change from prior years

IV. Identify Relevant Locations for Significant Segments

•Consider significant lines of business.

•Consider significant decentralized tax functions.

•Consider significant tax jurisdictions.

Possible Scoping Results Example

VAT

Sales

C&B

Income

High

Property

CustomsPayroll

Excise

Low

Likelihood of Occurrence

Mag

nitu

de

o f

Er r

o r

Are you Done? : Questions to ask

Have we identified all of the tax processes that have significant risk to the financial statements?

Does the documentation of the tax process adequately represent and provide an understanding of the underlying tax process?

Have we identified all of the significant risk to the financial statements inherent in the tax process?

Do the identified and designed controls adequately mitigate the identified significant risk to the financial statements?

What We’re Seeing in the Marketplace

What We're Seeing in the MarketplaceRealities

Executives everywhere recognize the need for improved corporate governance and more transparent financial reporting

Organizations are clearly focused on meeting the compliance requirements established by the Sarbanes-Oxley Act of 2002

Non-SEC organizations are adopting similar measures as “best practice standards”

Foreign registrants are feeling additional pressure from similar initiatives in other countries

What We're Seeing in the Marketplace: Realities

A paradox – while boosting investor confidence, many CFOs claim they aren’t seeing return on investment

Compliance is perceived as:– Expensive– Diverting attention from the core business– Overburdening limited resources to complete the

labor-intensive project A “one-time” project approach for initial compliance –

versus focus on an ongoing, sustainable compliance process

Sarbanes-Oxley is not the “Y2K” of accounting – there will always be financial reporting requirements associated with Sarbanes-Oxley and future regulations

What We're Seeing in the Marketplace: Challenges

Internal External

Satisfying management’s need for a high level of confidence to support assertions

Creating a sustainable compliance process

Considering all sections of Sarbanes-Oxley

Integrating all internal control activities

Achieving return on the compliance investment

Changing regulations Sarbanes-Oxley PCAOB AICPA SEC (including

accelerated filer requirements)

Others

The COSO-ERM Framework is evolving

What We're Seeing in the Marketplace:Research Findings

In November 2003, we commissioned a survey of 175 chief executive officers and chief financial offers at top U.S. companies – key findings from the survey include:

A majority (68%) believe SOX has boosted investor confidence in corporate America

70% rank SOX 404 compliance as a high or higher priority relative to other major business issues

Nearly all (97%) report being on or ahead of schedule with SOX readiness - however, only 31% had completed more than 50% of their SOX 404 preparation as of the survey date

Respondents report the most difficulty overall with documentation and testing of internal controls

2 8

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What We're Seeing in the Marketplace:A Forward Look

Companies are focusing on the regulatory demands and how to meet compliance deadlines - in documenting ICFR, they are amassing large amounts of information about their business processes, risks and controls

Some senior executives have begun to look beyond immediate compliance efforts to leverage into long-term business value – others will follow

Leading companies are beginning to extract value from the heightened control environment by using compliance efforts as a foundation to:– Strengthen, streamline and automate internal controls– Increase an enterprise-wide understanding of all risks – operational,

financial reporting and compliance – and how to control them– Improve and redesign business processes while maintaining

appropriate awareness and control of risks

What We're Seeing in the Marketplace:Risk & Performance Optimization

 

 

Operational Controls

Compliance Controls

 ICFR

ControlEvaluation

and Attestation

Process Improvementand Control Integrations

Re-architecture of Risk and

Control Reporting

Real TimePerformanceand ControlReporting

BusinessInfo-StructureOn Demand

Process Transformation

CO

NT

RO

LS

IM

PR

OV

EM

EN

T

PROCESS IMPROVEMENT

Risk & Performance Optimization

In leading edge companies, ICFR control documentation and evaluation is being leveraged as a foundation for risk and performance optimization

Tax Shelter Disclosure

Darice Henritze –Partner – International Tax Services

Treasury “Shelter” Regulations

Under § 6011, § 6111 and § 6112February 28, 2000 — original temporary and proposed regulations issued August 11, 2000 — revised temporary and proposed regulations issued August 2, 2001 – further revised temporary and proposed regulations issued March 20, 2002 — Treasury announced “simplified” initiative June 14, 2002 – further revised temporary and proposed regulations issuedOctober 17, 2002 – further revised temporary and proposed regulations issuedFebruary 28, 2003 – final regulations issuedDecember 29, 2003 – final regulations amended

Under § 6662 and § 6664December 31, 2002 – proposed regulations issuedDecember 29, 2003 – final regulations issued

Final Section 6011 Disclosure Regulations

Effective Dates

Generally effective for transactions entered into on or after February 28, 2003

For transactions entered into on or after January 1, 2003 and before February 28, 2003, taxpayers may apply either the final regulations or the October 2002 temporary regulations

For transactions entered into before January 1, 2003, see the temporary regulations in effect at that time

Conditions of confidentiality – Transactions entered into on or after December 29, 2003 (may be applied retroactively by taxpayers)

Taxpayers

Applies to ALL “TAXPAYERS” (means any “person” described in § 7701(a)(1), including S corporations and consolidated groups)Also includes, e.g., partners and S corporation shareholdersSpecial Rules– Reporting Shareholders of Certain Foreign Corporations

NOT JUST FOR INCOME TAXES

IRS can identify transactions entered into on or after January 1, 2003, as “listed transactions” for estate, gift, employment taxes; pension and exempt organization excise taxes

Definition of “Transaction”

“Includes all the factual elements relevant to the expected tax treatment of any investment, entity, plan, or arrangement, and includes any series of steps carried out as part of the plan.”

Reportable Transactions

Listed, or substantially similar, transaction

Conditions of confidentiality

Contractual protection

Section 165 loss

Significant book/tax difference

Brief asset holding period

Listed Transactions

Currently 31 listed transactions identified in IRS notices and other published guidance

Rev. Rul. 2004-4 Issued January 23, 2004 Notice 2004-8 Issued December 31, 2003 Notice 2003-81 Issued December 4, 2003 Notice 2003-77 Issued November 19, 2003 and clarified

December 1, 2003

Notice 2003-76: Listed transactions as of November 15, 2003

“Substantially similar” Same or similar types of tax consequences, and either factually

similar or based on same or similar tax strategy Broadly construed in favor of disclosure

Listed Transactions

Rev. Rul. 2004-4 – Prohibited Allocations of Securities in an S Corporation Notice 2004-8 – Abusive Roth IRA TransactionsNotice 2003-81 - Tax Avoidance Using Offsetting Foreign Currency Option ContractsNotice 2003-77 – Transfers to Trusts to Provide for the Satisfaction of Contested

LiabilitiesNotice 2003-55 — Lease Strips and Other Stripping Transactions (superseding Notice

95-53)Notice 2003-54 — Common Trust Fund StraddleNotice 2003-47 — Transfers of Compensatory Stock Options to Related PersonsNotice 2003-24 — Welfare Benefit FundNotice 2003-22 — Offshore Deferred Compensation ArrangementsRevenue Ruling 2003-6 — Certain S Corporation ESOPs

Listed Transactions (continued)

Notice 2002-70 – Certain Reinsurance Arrangements Notice 2002-65 – Passthrough Entity Straddle Tax Shelter Revenue Ruling 2002-46 – § 401k Accelerators Notice 2002-50 – Partnership Straddle Tax ShelterNotice 2002-35 – Notional Principal ContractsNotice 2001-21 – Inflated Basis “CARDS” TransactionsNotice 2001-45 – § 302 Basis-Shifting TransactionsNotice 2001-17 – Certain § 351 Transactions  Notice 2001-16 – Intermediary TransactionsNotice 2000-61 – Guam TrustNotice 2000-60 – Certain Stock Compensation TransactionsNotice 2000-44 – Inflated Partnership Basis TransactionsRevenue Ruling 2000-12 – Debt Straddles

Listed Transactions (continued)

Treasury Regulation § 1.7701(1)-3 – Fast Pay or Step-Down Preferred Transactions

Notice 99-59 – BOSS Transactions Revenue Ruling 99-14 – Lease-In /Lease-Out or LILO Transactions Treasury Regulation § 1.643(a)-8 – Certain Distributions from Charitable

Remainder Trusts ASA Investerings Partnership v. Commissioner -- Transactions similar to

those described in the ASA Investerings litigation and in ACM Partnership v. Commissioner, 157 F.3d 231 (3rd Cir. 1998)

Notice 98-5, part II – Foreign Tax Credit Transactions Notice 95-34 – Certain Trusts Purported to be Multiple Employer Welfare

Benefit Funds Exempted from the Limits of § 419 and § 419A Revenue Ruling 90-105 – Certain Accelerated Deductions for

Contributions to a Qualified Cash or Deferred Arrangement or Matching Contributions to a Defined Contribution Plan

Listed Transactions:Participants

Taxpayer’s tax return reflects tax consequences or a tax strategy described in IRS guidance identifying the transaction as “listed,” or

Taxpayer knows or has reason to know that taxpayer’s tax benefits are derived directly or indirectly from tax consequences or a tax strategy described in IRS guidance identifying the transaction as “listed”

Conditions of ConfidentialityTransactions prior to December 29, 2003

Generally facts and circumstances testSituations where treated as confidential

Taxpayer’s disclosure of tax treatment or tax structure of transaction is limited by understanding or agreement with or for the benefit of anyone who provides oral or written statement to the taxpayer concerning potential tax consequences of the transaction

Taxpayer knows or has reason to know that taxpayer’s use or disclosure of information is otherwise restricted for the benefit of any person other than taxpayer who provides a statement concerning potential tax consequences — e.g., transaction is claimed to be proprietary or exclusive

Conditions of Confidentiality:Transactions Prior to December 29, 2003

Presumption of non-confidentiality if express written authorization is provided from every person who makes a statement to the taxpayer as to the potential tax consequences: “The taxpayer (and each employee, representative, or

other agent of the taxpayer) may disclose to any and all persons, without limitation of any kind, the tax treatment and tax structure of the transaction and all materials of any kind (including opinions or other tax analyses) that are provided to the taxpayer relating to such tax treatment and tax structure.”

Conditions of ConfidentialityTransactions on or after December 29, 2003

New definition for conditions of confidentiality Advisor who is paid the minimum fee places a limitation

on disclosure by the taxpayer of the tax treatment or tax structure of transaction and the limitation protects the confidentiality of the advisor’s tax strategies

Proprietary or exclusive assertion is not a limitation on disclosure if the advisor confirms that the taxpayer may disclose the tax treatment or tax structure

May be applied retroactively by taxpayer to transactions entered into on or after January 1, 2003

Minimum fee $250,000 if taxpayer is a corporation (or a partnership or trust in

which all partners, owners or beneficiaries are corporations) $50,000 for all other taxpayers

Determining minimum fee Includes all fees for a tax strategy or for services for advice

(whether or not tax advice) or for the implementation of a transaction

Very broad, includes services to analyze, implement, and document the transaction and services to prepare returns if fees are excessive. . .BUT

Does NOTNOT include an amount paid to an advisor in that person’s capacity as a party to the transaction

Conditions of ConfidentialityTransactions on or after December 29, 2003

Contractual Protection

Facts and circumstances determination –

Taxpayer or a related party (section 267(b) or 707(b)) has the right to a full or partial refund of fees if all or a portion of tax consequences are not sustained, or

Fees are contingent on taxpayer’s realization of tax benefits from the transaction

Contractual Protection:Exceptions

Party has a right to terminate transaction upon the happening of an event affecting taxation

Refundable or contingent fees: if statement concerning potential tax consequences is made only after the taxpayer has entered into the transaction and reported consequences of the transaction on a filed tax return, and person making statement has not previously received fees from the taxpayer relating to the transaction

Section 165 Loss

Corporations: $10M in one tax year, or $20M in tax year transaction entered into and 5 succeeding tax years

Partnerships with only corporate partners:

$10M / $20M

Other Partnerships: $2M / $4M

S Corporations, Individuals & Trusts:

$2 M / $4 M

Individuals & Trusts: $50,000 for section 988 foreign currency transaction losses

Section 165 Loss (continued)

A section 165 loss includes Any amount deductible under section 165 Any deduction treated by the Code as resulting from a sale or

other disposition

– A loss resulting from the sale or exchange of a partnership interest under section 741

– A loss resulting from a section 988 transaction

Section 165 Loss (continued)

Do not take into account offsetting gains, or other income or limitations (such as capital loss limitations)

However, section 165 loss is adjusted for salvage value and any insurance or other compensation received

Section 165 Loss: Some Exceptions: Rev. Proc. 2003-24

Sale of a capital asset with a “qualifying basis” that is not an interest in a passthrough entity, is not part of a straddle, and has not been separated from any portion of income it generates

Qualifying basis = cash, § 358, § 1014, § 1015 (if donor had qualifying basis), or § 1031(d)

Mark-to-market losses, provided taxpayer computes loss using a qualifying basis

Loss from hedging transaction or mixed straddle

Book/Tax Difference: Taxpayers

Only applies to:

Taxpayers that are reporting companies under Securities Exchange Act of 1934 (and related entities), or

Business entities with at least $250 million in gross assets for book purposes at the end of the financial accounting period ending with or within the entity’s tax year in which the transaction occurs (assets of all related business entities are aggregated)

Significant Book/Tax Difference

Book/tax difference from the transaction exceeds $10M on a gross basis

Offsetting items are not netted for either tax or book purposes

Book income determined using U.S. GAAP for worldwide income, unless the taxpayer, in the ordinary course of business, consistently keeps books on another basis

Transactions only among members of consolidated group are disregarded

If members of consolidated group, plus third party, participate in the transaction, aggregate group items

Significant Book/Tax Difference:Other Persons

Foreign Persons Only U.S. assets taken into account in determining whether

gross asset test is met Only transactions giving rise to Effectively Connected

Income (or losses, etc.) are taken into account

Disregarded Entity Treat income, loss, etc. as items of owner Disregard transactions between entity and owner

Partner Items allocated to partner for tax purposes, but to entity for

book purposes, are treated as items of partner

Significant Book/Tax Difference:Some Exceptions: Rev. Proc. 2003-25

Tax income or gain is reported before or without book income or gain

Book loss or expense is reported before or without tax loss or deduction

Depreciation, percentage depletion, cost depletion, and intangible drilling costs

Capitalization and amortization under sections 195, 248, and 709

Brief Asset Holding Period

Asset held for 45 days or less, and

Transaction results in taxpayer claiming a tax credit exceeding $250,000

Exception: Transactions resulting in a foreign tax credit for taxes imposed

in respect of a dividend that are not disallowed under § 901(k).

Reporting Shareholders: Special Participation Rules

“Reporting shareholder” means: US shareholder under § 551(a) in a foreign personal holding

company under § 552 – Form 5471 US shareholder under § 951(b) in a controlled foreign

corporation under § 957 – Form 5471, or 10 percent shareholder of a qualified electing fund under § 1295

– Form 8621

Reporting Shareholders: Special Participation Rules

Rules for listed transactions, loss transactions, and brief asset holding period transactions:

Treat reporting shareholder as “participant” if the foreign corporation would be treated as participating if it were a domestic corporation filing a tax return that reflects the items from the transaction

Does not need to have US tax benefits or consequences

Reporting Shareholders: Special Participation Rules

Rules for conditions of confidentiality transactions and contractual protection transactions

Treat reporting shareholder as “participant” if the foreign corporation would be treated as participating if it were a domestic corporation filing a tax return that reflects the items from the transaction

Reportable transaction only if Confidentiality – Limitation concerns U.S. federal

income tax treatment or structure Contractual protection – Refund or contingent fees

based on U.S. federal income tax benefits or consequences

Reporting Shareholders: Special Participation Rules

For the book/tax difference reportable transaction: Treat reporting shareholder as “participant” if the foreign

corporation would be treated as having a US $10 million book/tax difference for an item from the transaction if it were a

domestic corporation and The transaction reduces or eliminates an income inclusion that

would otherwise be required under section 551, 951, or 1293.

“Angel list” transactions Notice 2001-18

With the exception of listed transactions, the disclosure regulations do not apply to regulated investment companies (RICs)

Exceptions to the Disclosure Regulations

When Disclosure Is Made

General Rule: File disclosure statement (Form 8886) with tax return (or amended return for transactions entered into on or after December 29, 2003) for each tax year for which the taxpayer participates

Also send copy to Office of Tax Shelter Analysis (OTSA) when Form 8886 first filed with return

Transaction becomes listed after return filed and before statute of limitations closes for the final return that is affected by the transaction: Attach Form 8886 to taxpayer’s next filed tax return

Includes loss carrybacks

Document Retention

Retain copy of all documents and other records related to a transaction subject to disclosure that are material to an understanding of the tax treatment or tax structure of the transaction including:

Marketing materials, written analysis used in decision-making, correspondence and agreements with advisors and other parties, analysis of tax benefits, documents concerning business purpose, internal e-mails

Retain these materials until the expiration of the statute of limitations for the final tax year for which disclosure was required

Office of Tax Shelter AnalysisInfluence/Relationships

Guidance CoordinatingCommittee

OTSA ReviewCommittee

Director of Practice

IssueTechnicalAdvisers

Published Guidance

--- = Coordination Functions

Litigation Vehicles

Associate AreaCounsel for PFTG

Area Counsel(includes tech. specialists)

Senior Legal CounselCorp. Tax Shelters

LMSB Counsel

National Office Counsel

Audits

Territory ManagersTeam Managers

5 Industry Directors

OTSA

LMSB Commissioner

Requires taxpayer to describe any listed transactions entered into during the year under examination

Requests, inter alia: All legal opinions and memoranda provided by any party that

promoted, solicited, or recommended participation in the transaction

All internal documents used by the taxpayer in its decision making process

“Super” IDRs (Continued)

Announcement 2002-63

Guidelines regarding Tax Accrual Workpapers: Generally, for tax returns filed after July 1, 2002 (but

before for listed, if not disclosed) Listed and Disclosed — workpapers from transaction 2 or more Listed Listed but not Disclosed Chief Counsel Notice CC-2003-012

all workpapers }

New Penalty Guidelines

If “listed” transaction — examiner MUST consider § 6662 and submit to Director of Field Operations (DFO)

If “other potentially abusive tax shelter” — must coordinate with Office of Tax Shelter Analysis (OTSA )

If examiner considers § 6662 — DFO must approve imposition of penalty

Section 1.6662-3 for Reportable Transactions (Dec. 29, 2003)

Effective date: Returns filed after December 31, 2002, for transactions entered into on or after January 1, 2003

Disregard of Regulation: Disclosure under Reg. section 1.6011-4 also required

Position contrary to Rev. Rul. or Notice: No realistic possibility test Section 6662 disclosure required Reg. section 1.6011-4 disclosure also required

Section 1.6664-4 for Reportable Transactions (Dec. 29, 2003)

Effective Date: Returns filed after December 31, 2002, for transactions entered into on or after January 1, 2003

Disregard of regulations: To rely on opinion that the regulation is invalid, must have

section 6662 disclosure and must have disclosure under Reg. section 1.6011-4

Failure to disclose a reportable transaction under Reg. section 1.6011-4 is “strong indication” that the taxpayer did not act in good faith for the portion of the underpayment attributable to the reportable transaction, which would bar relief under section 6664(c)

Proposed Legislative Changes

BackgroundCharity Aid Recovery and Empowerment (CARE) Act of 2002 (H.R. 7) – (June 18, 2002)

Tax Shelter Transparency Act – (June 18, 2002)

Small Business and Farm Economic Recovery Act (September 17, 2002)

Economic Recovery Act of 2003 (S. 414) – (Feb. 14, 2003)

CARE Act of 2003 (S. 476) – (Feb. 27, 2003)

Doggett Bill (H.R. 1555) – (April 2, 2003)

Jobs and Growth Reconciliation Tax Act of 2003 (S. 1054, previously S.2) — (May 8, 2003)

Current BillsTax Incentives Act of 2003 (S. 1149) — (May 23, 2003) — currently in the Senate

Working Families Tax Credit Act of 2003 (H.R. 2286) — (June 2, 2003) — currently in the House Committee of Ways and Means

American Jobs Creation Act of 2003 (H.R. 2896) — (July 25, 2003) – currently in the House Committee on Ways and Means

Jumpstart Our Business Strength “JOBS” Act (S. 1637) — (Chairman’s Mark October 1, 2003)

Tax Shelter Transparency and Enforcement Act (S. 1937) – Introduced in Senate Finance Committee November 24, 2003

Tax Shelter Transparency and Enforcement Act (S. 1937) – Introduced in Senate Finance Committee (November 24, 2003)

Highway Reauthorization and Excise Tax Simplification Act of 2004 — Senate Finance Committee (February 2, 2004)

Tax Administration Good Government Act of 2004 — Senate Finance Committee (February 2, 2004)

Proposed Legislative Change (S. 1149)New §6707A — Failure to Disclose Reportable Transaction

Penalty for large entity corporation may be $200,000 for listed transaction and $100,000 for other reportable transactions

Almost strict liability penaltyDiscretion of OTSA to rescind:

Does not apply to failure to disclose listed transactions Applies only to unintentional mistakes of fact No rights to appeal OTSA’s decision If rescinded, included in annual report from IRS to

Congress

Disclosed to SEC with new 6662A Accuracy PenaltySlightly different version of penalty in H.R. 2896

Proposed Legislative Change (S. 1149 & H.R. 2896)New Accuracy-Related Penalty for Reportable Transaction Understatements (§6662A)

Increased Penalty for Undisclosed Reportable Transactions — 30% No Section 6011 disclosure

Listed Strict Liability

Other Almost Strict Liability (OTSA’s discretion on

§6707A)20% Penalty with Disclosure / Heightened Requirements

Disclosure — §6664(d) — substantial authority and MLTN Penalty Based on an “Understatement” at highest rate Opinion Letters Restricted

Proposed Legislative Change (S. 1149 & H.R. 2896) Limited Reliance on Opinions of Tax Advisors forReportable Transaction Understatement Penalty

Cannot rely on opinion for reasonable belief if either: Advisor = “material advisor” who either:

Participates (or is related to a person who participates) in organization, management, promotion, or sale of the transaction;

Is compensated by another material advisor; orHas a contingent fee arrangement OR

Opinion is:Based on unreasonable facts and assumptions;Based on unreasonable reliance on reps; orDoesn’t identify and consider all relevant facts

Proposed Legislative Change (was in S. 1054; but is not in current Energy Bill; in H.R. 2286)

Substantial Understatement and Preparer Penalty for Nonreportable Transactions

Accuracy Penalty – Non-Reportable Transaction New Standards

Thresholds for Corporations — Exceeds the lesser of (1) the greater of 10% or $10,000 or (2) $10,000,000

More Likely than NotDisclosure and Reasonable Basis

Preparer Penalty – Non-Reportable Transaction New Standards

More Likely than NotDisclosure and Reasonable BasisAmounts

Proposed Legislative Change (was in S. 1054; but is not in current Energy Bill; in H.R. 2286)

Economic Substance & Other Related Provisions

Codifies economic substance: Transaction changes taxpayer’s economic position in a meaningful way Substantial non-tax purpose for entering into transaction Transaction is a reasonable means of accomplishing that purpose

40% strict liability accuracy-related penalty (no economic substance) — reduced to 20% if facts are adequately disclosed

Other provisions No deduction on interest attributable to understatement related to reportable

transaction or noneconomic substance transaction Non-disclosure of listed transaction – automatic 6-year statute on whole

return

California Tax Shelter Legislation

Disclosure by California taxpayer subject to California income or franchise tax Federal listed transaction entered into after February 28, 2000 Other federal reportable transactions California-only transaction identified by the California Franchise

Tax Board

California announced 2 listed transactions on December 31, 2003

Registration by tax shelter organizer

List maintenance by tax shelter organizer, seller or material advisor

California Tax Shelter Legislation

California Penalties Adopted many proposed Federal legislative changes

– Failure to disclose reportable transaction

Listed transaction ($30,000)

Other reportable transaction ($15,000)

– Additional accuracy-penalties for reportable transaction20 % (disclosed)

30 % (not disclosed)- Noneconomic substance penalty

20 % (relevant facts disclosed) 40 % (relevant facts not disclosed)

- Interest enhanced penalty Additional 100 % of interest due on deficiency

California Tax Shelter Legislation

Voluntary Compliance Initiative Available until April 15, 2004 Applies to “abusive tax avoidance” transactions for tax years beginning before January 1, 2003

Voluntary Compliance Initiative without appeal Must pay tax and interest Waiver of all penalties No criminal penalties No claims for refund

Voluntary Compliance Initiative with appeal Must pay tax and interest Waiver of penalties except for accuracy-related penalties (20-40 %) No criminal penalties

California collected $30 million in the first week

Ramifications for Noncompliance

Request by IRS for tax accrual work papers

Increased scrutiny from higher IRS officials

Mandatory consideration of accuracy-related penalties

Failure to disclose reportable transaction is “strong indication” that taxpayer did not act in good faith, which precludes relief under section 6664

Proposed legislation Disclosure penalties Accuracy-related penalties Reporting to the Securities Exchange Commission Statute of limitations on assessments extended