Accuracy-related penalty defenses.

Proposed regulations (REG-126016-01) would limit the defenses available when an accuracy-related penalty is imposed on (1) the failure to disclose reportable transactions or (2) a return position based on an invalid regulation.

Under Sec. 6662, a 20% accuracy-related penalty applies to underpayments attributable to negligence or disregard of rules or regulations and to substantial understatements of income tax. Sec. 6664(c) allows taxpayers to avoid the penalty it they can establish, among other things, that they had reasonable cause for underpaying and had acted in good faith.

Temp. Regs. Sec. 1.6011-4T requires taxpayers to disclose reportable transactions on their returns. The IRS believes that taxpayers have improperly relied on opinions or advice issued by tax advisers to establish reasonable cause and good faith as a basis for avoiding the accuracy-related penalty, even when the opinion or advice relates to a reportable transaction that the taxpayer should have disclosed (but did not) under Temp. Regs. Sec. 1.6011-4T. It further believes that taxpayers have improperly relied on opinions or advice that a regulation is invalid without disclosing this position on their returns.

Under the proposed rules, the adequate-disclosure exception to the accuracy-related penalty for underpayments of tax attributable to negligence or disregard of rules or regulations would not apply to underpayments relating to a reportable transaction unless the transaction is disclosed under Temp. Regs.

Sec. 1.6011-4T. Further, according to Prop. Regs. Sec. 1.6662-3(a), if a position relates to a reportable transaction and is contrary to a revenue ruling or notice (other than a notice of proposed rulemaking), a taxpayer could not rely on the fact that the position had a realistic possibility of being sustained on the merits as a defense to the penalty. Instead, he or she would have to satisfy the Regs. Sec. 1.6662-3(c)(1) adequate-disclosure exception, including the disclosure of the reportable transaction under Temp. Regs. Sec, 1.6011-4T.

Prop. Regs. Sec. 1.6664-4(c) would clarify and modify the standards for (and limits on) the use of opinions and advice to satisfy the reasonable-cause and good-faith exception under Sec. 6664(c) as a defense to the penalty (e.g., by making it clear that a taxpayer's education, sophistication and business experience would be relevant in determining whether his or her reliance on the opinion or advice was reasonable and made in good faith).

Prop. Regs. Sec. 1.6664-4(c) states that a taxpayer cannot rely on an opinion or advice to satisfy the reasonable-cause and good-faith exception if he or she has not disclosed a (1) reportable transaction or (2) position based on a regulation being invalid.

The regulations would apply to returns filed after Dec. 30, 2002 for transactions entered into after 2002.

The IRS says it will rigorously apply the existing Regs. Sec. 1.6664-4(c) facts-and-circumstances standard regarding a taxpayer's reasonable reliance in good faith on advice from a tax professional. Regardless of when a taxpayer entered into a transaction, the IRS may consider his or her failure to disclose a reportable transaction or a position that a regulation is invalid as a factor in determining whether the taxpayer has met the reasonable-cause and good-faith exception.