IRS treats protective disclosures inconsistently.

In shaping the reportable transaction disclosure rules, Treasury provided a way for taxpayers who are uncertain about whether to report a particular transaction to file a "protective" disclosure. In this way (or so it seems), taxpayers can lodge their uncertainty on Form 8886, Reportable Transaction Disclosure Statement. Regs. Sec. 1.6011-4(f)(2) expressly provides:

Protective disclosures. If a taxpayer is uncertain whether a transaction must be disclosed under this section, the taxpayer may disclose the transaction in accordance with the requirements of this section, and indicate on the disclosure statement that the taxpayer is uncertain whether the transaction is required to be disclosed under this section and that the disclosure statement is being filed on a protective basis.

Until December 2005, taxpayers used to indicate in writing at the top of Form 8886 that they were filing a protective disclosure. Now they check a box that was added to the form. As a matter of tax administration, the new procedure assists the IRS in easily identifying protective disclosures, particularly if the underlying tax return is e-filed. Yet, even when a taxpayer identifies a disclosure as protective, what is the practical effect of a protective filing? Are these disclosures treated any differently from nonprotective disclosures?

Revised Form 8886

In December 2005, the IRS revised Form 8886 and its instructions. It now asks taxpayers for more detailed information than it had apparently been receiving with prior versions of the form. Perhaps the most significant change is a prohibition banning taxpayers from stating on Form 8886 that further information will be "available upon request." Rather, taxpayers must now provide all required information with the original form. The instructions to the new form expressly specify that stating "available upon request" will subject taxpayers to penalties for failing to disclose (taxpayers must also now answer all questions on the face of the form, and only use additional sheets of paper as continuation sheets).

For protective disclosures, taxpayers must give as much detailed information as they would for nonprotective disclosures. Indeed, the only difference between a protective filing and a nonprotective filing is the checkbox. Yet, a protective disclosure covers those scenarios which the taxpayer is uncertain about whether to disclose a transaction altogether. By definition, a protective disclosure filing requires uncertainty either about whether the (1) transaction's facts meet one of the reportable transaction categories or (2) regulations even require reporting the transaction at all. In the case of a protective disclosure, however, taxpayers must effectively provide the IRS with as much information about the transaction as they would for a nonprotective filing (and, indeed, taxpayers also have to file such protective disclosure forms with the Office of Tax Shelter Analysis). As a result, taxpayers are left wondering what the IRS is doing with the information filed on protective disclosures.

Tax Accrual Workpapers and Other Bountiful Requests

The Internal Revenue Manual (IRM) (July 12, 2004) sets forth the IRS's tax accrual workpaper request policy. Unless taxpayers participated in a listed transaction, the IRS generally should ask for workpapers only in "unusual circumstances" which may exist when, for example, it requires additional facts; see IRM Section 4.10.20.3.1. If a taxpayer has participated in listed transactions, however, the policy is expanded. For one disclosed listed transaction, the IRS will request workpapers pertaining to the transaction, and for one undisclosed listed transaction or multiple listed transactions (disclosed or undisclosed), it will generally ask for all workpapers pertaining to the tax year.

If a taxpayer has undisclosed listed transactions or nonprotective disclosed listed transactions, the policy is clear--the taxpayer might receive a request for all tax accrual workpapers pertaining to one transaction or to a given tax year. When a protective disclosure serves as the basis for applying the workpaper policy, however, it had been unclear (until recently) how the IRS would treat the "protective" designation.

A series of frequently asked questions (FAQs) released in July 2005 have added clarity to how the IRS will treat protective designations; see www.irs.gov/businesses/corporations/ article/0,,id= 146242,00.html. The FAQs address a situation in which a taxpayer has "preserve[d] the taxpayer's opportunity to assert that the transaction is not a listed transaction or substantially similar to a listed transaction" by filing a protective disclosure. The FAQs direct examiners to determine whether the transaction is in fact the same as, or substantially sinfilar to, a listed transaction. FAQ No. 2 provides what appears to be the IRS's first written guidance giving taxpayers a chance to explain why the transaction is not the same as, or substantially similar to, a listed transaction. While the FAQ does not exclude protective disclosures from the workpaper policy, it does give taxpayers an occasion to assert why the transaction should not be considered listed. This new guidance seems to be the IRS'S first formal procedure affording taxpayers the chance to explain why a transaction described in a protective disclosure is not reportable.

Protective Material Advisor Forms

Advisors who are required under Sec. 6111 to file information returns reporting their role as a "material advisor" must do so on Form 8264, Application for Registration of a Tax Shelter; see Notice 2004-80. The confidential corporate tax shelter regulations under former Sec. 6111 provide for filing a protective Form 8264 when the taxpayer "is uncertain whether the transaction is required to be registered as a confidential corporate tax shelter"; see Regs. Sec. 301.6111-2(b)(5). While the regulations have not been amended to reflect the changes made to Sec. 6111 by the American Jobs Creation Act of 2004, material advisors continue to file protective Forms 8264. The IRS, however, does not appear to treat such protective filings differently from nonprotective filings in the case of material advisor forms.

Consider, for example, a material advisor who files a protective Form 8264 for a transaction that might have reportable-transaction characteristics. Because of the uncertainty, however, the advisor files the form on a protective basis. Once the IRS receives a Form 8264--whether protective or nonprotective--the IRS computer system may, in some instances, send the advisor a request for an investor list under Sec. 6112. The IRS's system does not appear to discriminate between protective filings or nonprotective filings when it comes to investor list requests. When a list request letter is sent, it is often based merely on receiving Form 8264.

There is no written guidance directing the IRS to afford material advisors an opportunity to assert a transaction described in a protective Form 8264 is not, in fact, reportable--either prior or subsequent to the mailing of a list request. The IRS may be taking the position that a list request in these cases is merely an automatic function of its computer system responding to the filing of Form 8264.

Material advisor information returns even present issues unique to disclosures made by taxpayers on Form 8886. While a taxpayer's disclosure can trigger an examination based on its content, a material advisor's reporting can trigger a list request under Sec. 6112. An examiner may consider the protective nature of a disclosure or a change in circumstances after a taxpayer's disclosure is filed. In the case of material advisor disclosures, however, the IRS has no written guidance and may in fact be unwilling to recognize a protective designation or a change in IRS guidance. There may be instances, however, in which a transaction that might have been reported on Form 8264 protectively--or not protectively--has become delisted or otherwise excepted from disclosure by, for example, a revised revenue procedure (e.g., so-called angel lists) or other IRS notice. If there is an outstanding list request or the IRS has already received information required under Sec. 6112, there is no written guidance as to whether the IRS should either withdraw the list request or return the information to the advisor. It is likely that in these cases, the IRS would simply stand behind the initial request. The IRS's stance may result in unjust consequences to an advisor, particularly if any IRS guidance is retroactive in effect; see Notice 2006-16. This might occur, for example, when a material advisor files a protective Form 8264 to report the advisor's role in a transaction that later becomes expressly excepted from disclosure and reporting under Notice 2002-35. The IRS has no policies in force to effectively defuse the already-filed protective Form 8264.

Conclusion

Taxpayers and advisors filing disclosures on a protective basis do so because of the uncertainty as to whether the transaction is reportable under Sec. 6011. While the IRS'S treatment of such protective filings is unclear in most cases, the IRS has taken a position in applying its tax accrual workpaper policy that respects disclosures filed and designated as "protective." For material advisors, however, the IRS has not adopted formal guidance allowing advisors to assert a transaction reported on a protective basis is, in fact, not reportable. These divergent policies are examples of the continued uncertainty that surrounds the" IRS's treatment of protective disclosures.

Editor's note: Mr. Miller is a member of the AICPA Tax Division's Practice & Procedures Committee. Ms. Stiff and Mr. Keenan are members of that Committee. For further information about this column, contact Mr. Miller at [e-mail].

FROM TODD SIMMENS, CPA, J.D., LL.M., ERNST & YOUNG LLP, WASHINGTON, DC METROPARK, NJ