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Lessons learned about reportable transactions and implications for the 2004 filing seasons.

Introduction

Penalty provisions enacted as part of the American Jobs Creation Act of 2004 (AJCA) (1) have put sharp teeth into existing disclosure rules relating to reportable transactions. The Regulations' complexities associated with applying the final reportable transaction disclosure regulations, (2) the operational problems inherent to that process, and the sometimes vague guidance provided by the Internal Revenue Service (IRS) combine to make compliance with the rules problematic.

Many companies today are, in fact, struggling to define what constitutes a reportable transaction, identify such transactions, decide whether to report them, and document them appropriately. The time required to complete this onerous process has caught more than one tax executive by surprise.

Waiting too long and potentially being found in noncompliance with the regulations carries a hefty price tag. In addition to financial risks--substantial monetary penalties that may result from failure to make appropriate disclosures--companies may incur financial reporting and reputational risks. Moreover, being found noncompliant may create transparency risks with the IRS, since companies with multiple listed transactions may be subject to IRS's demands for access to all of their tax accrual workpapers.

The good news is that tax executives need not be caught flat-footed as they prepare their companies' 2004 corporate tax returns. Valuable lessons can be learned from the 2003 tax filing season. If planning begins now--defining, identifying, and deciding whether to disclose potentially reportable transactions--a tax executive can mitigate, if not eliminate, critical risks associated with reportable transaction disclosures.

This article discusses key technical and application issues, and process considerations with respect to the regulations that came to light through work with taxpayers during the 2003 tax filing season. It also covers the consequences and risks associated with noncompliance with the regulations. Finally, it offers suggestions for how to get ahead--and stay ahead--of the game with respect to the current tax filing season.

Analyzing the Regulations

Identifying What Constitutes a "Transaction"

The regulations require every taxpayer that has participated in a reportable transaction and that is required to file a tax return to attach a disclosure statement (Form 8886 (3) or Schedule M-3 (4)) to its tax return for each taxable year in which it participates in the reportable transaction. The regulations set forth six categories of reportable transactions:

* Listed transactions;

* Confidential transactions;

* Transactions with contractual protection;

* Significant loss transactions;

* Transactions with a significant book-tax difference; and

* Transactions involving a brief asset holding period.

One of the most fundamental concepts of applying the regulations, yet often the most difficult to apply, is determining what constitutes the transaction that is being analyzed for disclosure purposes. The term "transaction," for purposes of the regulations, "includes all of 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 a plan." (5) This definition of "transaction" can be especially difficult to apply because a taxpayer may be required to aggregate related transactions and treat them as a single transaction for purposes of applying the regulations.

The difficulty a taxpayer might encounter when identifying the transaction for purposes of the regulations is illustrated in the following example: Assume that a taxpayer factors its accounts receivable for the month of January. As a result of the discount rate used by the parties, the taxpayer has a $1 million dollar loss resulting from the factoring. Each month thereafter, the parties continue to factor the taxpayer's accounts receivable. At the end of the year, when the taxpayer is determining its transactions for purposes of the regulations, the question is whether the taxpayer has 12 separate transactions for the year as a result of factoring its accounts receivable (each month being a separate transaction) or if the taxpayer has a single transaction, as a result of having to aggregate the transactions. (6)

Last year, some taxpayers did not recognize that the definition of the term "transaction" could require them to aggregate transactions and treat them as a single transaction for purposes of the regulations.

Consider another example of the difficulty that taxpayers encounter in identifying a transaction: Assume that Corporation J is a calendar-year taxpayer that incurred seven abandonment losses during its 2004 tax year. Assume that none of the losses by itself is greater than $10 million. Corporation J would not have to disclose any of the seven abandonment losses as a significant loss transaction. Now assume that four of the abandonment losses resulted from Corporation J's plan to discontinue a line of business and that each abandonment loss equals $3 million. While no single abandonment loss exceeds $10 million, Corporation J may be required to treat these four abandonment losses as a single transaction, because they were incurred as part of a plan to discontinue a line of business. If Corporation J is required to aggregate these abandonment losses, the total of the abandonment losses from the transaction equals $12 million. Therefore, absent satisfying any exceptions to disclosure, the taxpayer would need to disclose these abandonment losses as a significant loss transaction.

Defining "Substantially Similar" to a Listed Transaction

Listed transactions represent one of the most complex categories of reportable transactions that taxpayers are required to disclose. The regulations define a listed transaction as "a transaction that is the same as or substantially similar to one of the types of transactions that the IRS has determined to be a tax avoidance transaction and identified by notice, regulation, or other form of published guidance as a listed transaction." (7) The regulations define substantially similar as including "any transaction that is expected to obtain the same or similar types of tax consequences and that is either factually similar or based on the same or similar tax strategy." (8) The regulations further provide that the term "substantially similar" must be broadly construed in favor of disclosure. (9)

To date, the IRS has identified 31 listed transactions. (10) Many of these transactions are extremely complex and require many pages for the IRS to describe the type of transaction that is covered by the published guidance. (11) Accordingly, taxpayers must determine whether they have participated in any transaction that is expected to obtain the same or similar types of tax consequences as any of the 31 listed transactions and, if so, whether their transaction is either factually similar or based on the same or a similar tax strategy. To date, the IRS has issued relatively little, if any, guidance on what transactions might be considered substantially similar to any of the listed transactions, though there are two examples in the regulations. (12) In other words, the IRS has largely left it to taxpayers and, perhaps, ultimately the courts, to interpret the intent and meaning of "substantially similar" and to apply it to their transactions.

For example, many taxpayers who enter into Swap transactions have been struggling with determining whether disclosure of certain Swap transactions is required by Notice 2002-35. (13) In Notice 2002-35, the IRS stated that transactions involving the use of a notional principal contract to claim current deductions for periodic payments made by a taxpayer while disregarding the accrual of a right to receive offsetting payments in the future will be a listed transaction. Taxpayers, without any further guidance from the IRS, must determine whether their transactions are factually similar or based upon the "same or similar tax strategy" as the transactions described in Notice 2002-35.

Another example is the potentially broad application of Notice 2001-16, (14) whereby the IRS has designated as a listed transaction any transaction that involves the use of an intermediary to sell assets of a corporation. Without any guidance from the IRS, taxpayers must determine whether a transaction involving an intermediary may be "otherwise properly recharacterized," by the IRS or the courts and, as such, be substantially similar to the listed transaction. (15)

Determining the Applicability of the Exceptions to Disclosure

Taxpayers must also determine whether their transactions satisfy any of the exceptions to disclosure that have been provided for by the IRS. The IRS has issued Revenue Procedures that exclude certain transactions from individual categories of reportable transactions. (16) These exceptions--commonly referred to as "angel lists"--provide lists of transactions of the type that the IRS believes are not likely to have abusive characteristics. In practice, however, some of the items on these "angel lists" can be difficult to apply. Taxpayers must carefully read, analyze, and apply the exceptions to their particular facts.

For example, the "angel list" for significant book-tax differences provides that "[d]epreciation, depletion under section 612 of the Internal Revenue Code, and amortization relating solely to differences in methods, lives (for example, useful lives, recovery periods), or conventions ..." is not considered to be a significant book-tax difference. (17) Thus, taxpayers with book-tax differences attributable to depreciation, depletion, or amortization must determine whether those differences arise solely from differences in methods, lives or conventions (in which case the transaction would fall within the exception) or whether some part of the difference is attributable to a basis difference for book and tax purposes (in which case the transaction would not satisfy the exception and may require disclosure).

Another example is with respect to the contribution of property to charity. The "angel list" provides that book-tax differences arising from "[c]haritable contributions of cash or tangible property" are not considered to be a significant book-tax difference. (18) Taxpayers, when identifying their book-tax differences arising from charitable contributions, must therefore be certain to obtain sufficient information to determine the amount of the book-tax differences attributable to the contribution of tangible property--satisfying the exception in the "angel list"--and the amount of the book-tax differences attributable to the contribution of intangible property--ineligible for the exception.

Applying the Regulations to International Transactions

One aspect of the regulations that surprises many taxpayers is the broad applicability of the rules to transactions entered into by non-U.S. taxpayers. (19) The regulations apply both to non-U.S. entities (i.e., foreign corporations and foreign partnerships) that file U.S. tax returns and to foreign entities (i.e., controlled foreign corporations) for which the U.S. parent corporation is considered to be a "reporting shareholder." (20)

The obligation to disclose the reportable transaction of a controlled foreign corporation falls upon the reporting shareholder. The reporting shareholder must disclose the reportable transactions of its non-U.S. entities. Accordingly, U.S. corporations with international operations conducted by non-U.S. entities must analyze not only the transactions entered into by the U.S. taxpayer, but also the transactions entered into by each of its foreign corporations in order to determine whether a transaction has satisfied one or more of the six categories of reportable transactions. A hypothetical determination needs to be made by the reporting shareholder of whether a transaction would be disclosable by a foreign corporation if it were treated as a domestic corporation filing a U.S. tax return. (21)

With respect to significant book-tax difference transactions, the analysis is slightly different. A reporting shareholder participates in a transaction with a significant book-tax difference if the foreign corporation would be considered to participate under the regulations if it were a domestic corporation and the transaction also eliminates or reduces an income inclusion that otherwise would have been required under section 551,951, or 193 of the Internal Revenue Code. (22)

U.S. tax directors, therefore, must determine (or have someone report to them) whether transactions conducted by their foreign entities would constitute a reportable transaction if conducted by a U.S. corporation. This analysis will require applying U.S. tax principles to the foreign entities' transactions. For example, it is irrelevant if a transaction conducted in a foreign jurisdiction would have been treated, under local law, as a reduction in equity. If, under U.S. principles, the transaction would be treated as resulting in a $10 million or greater loss under section 165, then absent the transaction satisfying one of the exceptions in the angel lists, the reporting shareholder must disclose the transaction.

The broad reach of the regulations, combined with the logistical problems of gathering the necessary information domestically and internationally, along with the technical difficulties of analyzing them, makes the application of these rules in an international context particularly difficult.

Understanding the Interaction of the Schedule M-3 and the Regulations

The regulations require certain taxpayers that participate in a transaction with a significant book-tax difference to disclose their participation in the transaction. A transaction with a significant book-tax difference is defined as a transaction where the amount for tax purposes of any item or items of income, gain, expense, or loss from the transaction differs by more than $10 million on a gross basis from the amount of the item or items for book purposes in any taxable year. (23)

For tax years ending on or after December 31, 2004, any domestic corporation--including a U.S. consolidated tax group consisting of a U.S. parent corporation and additional includible corporations listed on Form 851, Affiliations Schedule--required to file a Form 1120 that reports total consolidated assets on Schedule L at the end of the corporation's tax year in an amount that equals or exceeds $10 million must complete and file a Schedule M-3. A corporation that files a Schedule M-3 (in accordance with the instructions for the form) with its timely-filed original tax return (including extensions) is deemed to satisfy the regulations solely for transactions with significant book-tax differences for that taxable year. (24)

It is important to note that if a taxpayer's transaction is a reportable transaction as a result of satisfying more than one of the categories of reportable transaction, the completion and filing of Schedule M-3 only satisfies the taxpayer's disclosure of the significant book-tax difference aspect of the transaction. The taxpayer is still required to separately disclose on Form 8886 the other aspects of the transaction that may result in it being a reportable transaction. For example, assume a transaction resulting in a significant book-tax difference also meets the requirement of a significant loss transaction. The taxpayer's completion of Schedule M-3 reflecting the book-tax difference will not satisfy the taxpayer's requirement to disclose the transaction as a significant loss transaction. The taxpayer must also complete a Form 8886 to report the significant loss transaction.

While the Schedule M-3 can satisfy a taxpayer's requirement to disclose significant book-tax difference transactions, taxpayers must not ignore other specific requirements of the regulations. For example, the instructions to the Schedule M-3 direct a taxpayer to aggregate similar types of book-tax difference transactions and enter the net number on the Schedule M-3. The regulations require, however, that the taxpayer first identify the transaction, then determine which items of income, gain, expense or loss result from the transaction, and then disclose the transaction if the book-tax difference for all items resulting from the transaction exceeds $10 million.

What does this mean for a taxpayer with a significant book-tax difference transaction? If a revenue agent issues an Information Document Request (IDR) requesting the taxpayer to provide a list of all transactions resulting in significant book-tax differences for the tax year under examination, the taxpayer must be in a position to identify those transactions with items resulting in significant book-tax differences. The aggregated numbers contained in the Schedule M-3 will not allow the taxpayer to identify such transactions in order to respond to the IDR. Furthermore, the taxpayer must comply with the record retention requirements contained in the regulations for these significant book-tax difference transactions, which can differ significantly from the taxpayer's normal record retention procedures. (25)

Implementing an Effective Compliance Process

In order to identify the transactions that require disclosure and contend with the complexities of the regulations, a taxpayer must have an effective and efficient process in place. Each company will need to determine the best process for their needs.

Committing the Necessary Resources

Compliance with the regulations is a detailed process that requires extensive time and resources to evaluate the potential transactions that may require disclosure. As such, it is important for taxpayers to begin the process early. Training, requesting information from various business units/functions, evaluating the responses from these business units, determining whether to disclose a particular transaction, filling out the necessary forms, and ensuring adequate record retention all take time. To exacerbate the problem, most companies do not have excess personnel to devote to these tasks. The personnel who are tasked with identifying reportable transactions must perform the necessary work in between their multitude of other tasks.

Furthermore, a substantial time commitment is required to keep current on the changes and updates issued by the IRS with regard to reportable transactions and the regulations. These changes need to be communicated to the people responsible for identifying these transactions. Additional training may need to be provided for significant updates to the regulations. Because of the significant time required to comply with the regulations, it is recommended that tax departments should start the process of identifying transactions early to ensure they mitigate the risks of nondisclosure. Tax departments also should consider evaluating transactions throughout the tax year as they enter into them.

Communicating with the Proper Parties

Under the regulations, ordinary course of business transactions may be required to be disclosed to the IRS, regardless of whether there was any tax planning done with respect to the transaction or whether the transaction could in any way be considered a tax shelter or potentially abusive transaction. For example, business transactions entered into by the Legal, Human Resources, Treasury, or other departments within a company may need to be disclosed. Often, because of the broad reach of the regulations, and there having been no tax planning involved in many transactions, the tax department may find that it must obtain information from personnel in other departments and business units. With respect to those transactions, the tax department will want to establish and document a process for retrieving and assembling information about potentially reportable transactions. The tax department should consider designing a communication process that does not require others within the company to become an expert in the regulations, but rather encourages a more open flow of information to the tax department about potentially reportable transactions.

With the passage of the AJCA, the government established a single definition of the types of transactions that taxpayers and material advisors must disclose and for which material advisors must keep lists of clients ("advisees"). (26) Now that the taxpayer and material advisor disclosure rules, as well as the list maintenance provision, utilize the same definition of reportable transaction, the government has more than one source to obtain information about reportable transactions. The IRS is likely to obtain information on reportable transactions much earlier as a result of material advisors disclosing transactions in accordance with section 6111. With this information, the IRS can quickly move to obtain from the material advisors their section 6112 list of clients in order to identify taxpayers who participated in the reportable transaction and who, potentially, failed to disclose their participation in the transaction.

Similarly, the IRS can utilize the disclosure of a reportable transaction by a taxpayer to identify material advisors that may have failed to disclose the reportable transaction and to obtain material advisors' investor lists to discover non-disclosing taxpayers. This "web of disclosure" means that it is unlikely that taxpayers failing to disclose reportable transactions can avoid detection by the IRS.

To ensure compliance with the regulations, the tax department will want to effectively communicate with its advisors. The interaction between the taxpayer and material advisor reportable transaction disclosure rules and the material advisor list maintenance rules means the IRS will be receiving more information than ever about reportable transactions. This will increase the likelihood that taxpayers who fail to properly disclose these transactions will be identified by the IRS. To avoid any potential penalties, the tax department should consider communicating with its advisers to ascertain if these advisors have disclosed a transaction for which it provided assistance to the company or if the advisor has put the company's name on an investor list.

Developing an Effective Record Retention Policy

Under the regulations, taxpayers must retain a copy of all documents and other records related to a transaction subject to disclosure under the regulations that are material to an understanding of the tax treatment or tax structure of the transaction. (27) The documents must be retained until the expiration of the statute of limitations applicable to the final taxable year for which disclosure of the transaction was required. (28) The documents that must be retained include the following: marketing materials related to the transaction; written analyses used in decision-making related to the transaction; correspondence and agreements between the taxpayer and any adviser, lender, or other party to the reportable transaction that relate to the transaction; documents discussing, referring to, or demonstrating the purported or claimed tax benefits arising from the reportable transaction; and documents, if any, referring to the business purposes for the reportable transaction. (29) Since this document retention requirement is in addition to any document retention requirements of section 6001, taxpayers must specifically identify the additional documentation and ensure that it is properly retained for the required time period.

Consequences of Failing to Comply

Applying the regulations is complex and could be costly. The risk of not complying, however, is greater this year than at any time in the past. Failure to disclose reportable transactions could result in penalties, financial reporting disclosure, risks to the taxpayer's reputation, greater transparency through the IRS's access to the taxpayer's tax accrual workpapers, and limitations on the amount of time a taxpayer has to file a qualified amended return.

Penalty Risks

The AJCA created penalties for taxpayers who fail to disclose reportable transactions. For example, the AJCA established section 6707A of the Code, which imposes a penalty for taxpayers failing to disclose their participation in a reportable transaction as required under section 6011. Section 6707A imposes a $200,000 penalty for each listed transaction that a corporate taxpayer fails to disclose. This penalty cannot be abated. For each of the five other categories of reportable transactions, the IRS will impose a $50,000 penalty for each transaction that a corporate taxpayer fails to disclose. The Commissioner may rescind all or part of the penalty on non-listed transactions.

The AJCA also contains a new accuracy-related penalty on understatements with respect to reportable transactions. Under section 6662A, an understatement with respect to a properly disclosed listed transaction or reportable avoidance transaction would result in a 20-percent penalty. An understatement with respect to a listed transaction or reportable avoidance transaction that is not properly disclosed would result in a 30-percent penalty. Further, the AJCA institutes a more stringent "reasonable cause" exception as defense against this penalty; significantly, the exception is only available with respect to disclosed transactions.

Along with the new penalties, the IRS's attitude toward imposing penalties has changed. In the past, taxpayers were often able to trade penalties in exchange for their concessions on other issues. Recently, IRS Appeals issued guidance stating that it will no longer trade penalty issues and that the settlement of penalties should be based on the merits and the hazards surrounding each penalty issue standing alone. (30) Additionally, the Office of Chief Counsel issued guidance stating its attorneys must consider the hazards of litigation with respect to the underlying tax adjustments and include an analysis of the hazards of litigation in the settlement memorandum. (31) The Chief Counsel guidance noted that examination employees should consider, develop, and impose penalties where appropriate, with heightened scrutiny given to cases involving listed or deemed abusive transactions.

One example of the IRS's becoming more serious about imposing penalties is the IRS's recent settlement initiative for executive stock options, which included penalties as part of the settlement offer. (32) To participate in this initiative, taxpayers must agree to pay a penalty under section 6662 equal to 10 percent of the amount of underpayment attributable to the listed transaction unless the executive filed a disclosure under Announcement 2002-2. (33)

Financial Reporting and Reputational Risk

The AJCA implemented a new layer of transparency for companies that fail to disclose transactions. SEC reporting companies subject to a penalty for failing to disclose a listed transaction under section 6707A or subject to the new 30 percent accuracy-related penalty are required to include the imposition of such penalty in the reports they file with the SEC for the periods specified by the IRS. In today's environment, with the financial statements of public companies under close scrutiny, most companies wish to avoid such disclosure in order to protect their reputation in the eyes of investors and the consumer public.

In addition, failing to disclose a transaction may tarnish the company's reputation with the IRS. The discovery of an undisclosed transaction may cause serious damage to the taxpayer's relationship with the IRS examination team. Furthermore, many programs that are designed to facilitate the audit process, such as Limited Issue Focused Examination, limit participation solely to compliant taxpayers. (34)

Transparency with the IRS

Failing to disclose a transaction may require a company to make its books more transparent to the IRS. Announcement 2002-63 authorizes IRS field agents to request the tax accrual workpapers for taxpayers that fail to disclose one or more listed transactions. Whether the IRS gains access solely to those workpapers related to the listed transactions or all of the tax accrual workpapers depends upon the number of listed transactions and if the transactions were properly disclosed by the taxpayer.

Taxpayers may not want to provide access to these workpapers to the IRS, because they are a potential "roadmap" to the areas of greatest risk, as determined by the taxpayer. The taxpayer is essentially showing their hand to the IRS by providing these workpapers, because they may contain the taxpayer's evaluation of the merits of the issue. As a result, this may cause the taxpayer to lose any bargaining power with the IRS.

Limitations on Filing Qualified Amended Returns

With the IRS's increased "web of disclosure" and heightened enforcement efforts through broad settlement initiatives, the time taxpayers have to file qualified amended returns and protect themselves against penalties may be shortened. Treas. Reg. [section] 1.6664-2(c)(3) provides that the amount reported on a "qualified amended return" will be treated as an amount shown as tax on the taxpayer's return for purposes of determining whether there is an underpayment of tax subject to an accuracy-related penalty. On March 1, 2005, the IRS issued temporary regulations regarding the time for filing a qualified amended return. (35) Generally, a taxpayer may file a qualified amended return at any time prior to being contacted by the IRS for an examination of the tax return. In the case of an undisclosed listed transaction for which a taxpayer claims any direct or indirect tax benefit on its return, the time for filing an amended return ends on the earlier of the date the taxpayer is contacted for examination or the date the IRS contacts a promoter, organizer, seller, or material adviser concerning the listed transaction. (36) The temporary regulations also state that the time for filing an amended return ends on the date the IRS announces a settlement initiative to compromise or waive penalties for a listed transaction. (37)

Conclusion

In light of the significant additional compliance burdens that the new regulations impose upon taxpayers and the severe financial and other risks that taxpayers face by incorrectly applying these complex rules, what steps can taxpayers take to get ahead of the curve? Experience teaches that it is never too early to begin this process. Taxpayers that wait until their tax returns are almost complete will find that it is extremely difficult for them to obtain, analyze, and report the appropriate information and will run a greater risk of inadvertently being subject to the risks of noncompliance discussed in this article.

The following are several steps that every taxpayer should consider taking now in order to be prepared to comply with the regulations:

1. Educate and train the appropriate people;

2. Devise a process that works within the constraints of the taxpayer's organization; and

3. Prepare for the possibility of an IRS examination.

The first step is to make sure that the proper people are appropriately educated with respect to both the technical and practical application of the regulations, as well as the harsh consequences for failing to properly disclose reportable transactions. Some individuals will need to have a greater "working knowledge" of the regulations, while others will merely need to know enough in order to be able to identify potential issues that need to be addressed further. As the rules change or as additional guidance is issued by the IRS or the courts, additional training may be necessary.

Given the limited resources that most taxpayers have for meeting their compliance burdens, an efficient process is essential to making the burdens of complying with the regulations more manageable and will reduce the risks of non-compliance with the Regulations. There is no "one size fits all" process that will work for all taxpayers. Rather, a process has to be tailored to the individual circumstances--organizational structure, management reporting, automation of systems, etc.--of each taxpayer. Such a process, however, should include methods for gathering, analyzing, reporting, and documenting the information.

Finally, every taxpayer needs to be prepared for the day that the IRS "walks in the door" and begins the examination of the taxpayer's 2003 and subsequent tax returns. There have already been cases where the IRS examination has included a review of the taxpayer's reportable transactions. Accordingly, a taxpayer should be able to demonstrate to the IRS that it took the disclosure rules seriously and employed a process that resulted in the appropriate disclosures being made to the IRS. The consequences of a taxpayer not being able to adequately demonstrate the sufficiency of its process may very well be an increased scrutiny by the IRS with the potential for financial and reputational damage to the taxpayer's position.

Planning and carrying out decisions relating to reportable transaction disclosure will take time--there is no question about it. The larger, more complex and far-reaching your operations are, the more time, effort and expense will likely be required to complete the process. With a firm understanding of the regulations, tax executives can mitigate their risks and even leverage compliance to their company's advantage.

(1) Public L. No. 108-357, 118 Stat 1418.

(2) Treas. Reg. [section] 1.6011-4.

(3) Reportable Transaction Disclosure Statement.

(4) The filing of Schedule M-3, Net Income (Loss) Reconciliation for Corporations With Total Assets of $10 Million or More, by certain taxpayers in accordance with Rev. Proc. 2004-45, 2004-31 I.R.B. 140, will satisfy the Treas. Reg. [section] 1.6011-4(b)(6) requirement to disclose transactions with a significant book-tax difference.

(5) Treas. Reg. [section] 1.6011-4(b)(1).

(6) After the 2003 tax filing season, the IRS revised the list of exceptions for significant loss transactions to provide that losses from certain factoring transactions conducted by the taxpayer with an unrelated party in the ordinary course of the taxpayer's business are not taken into account in determining whether a taxpayer has a significant loss transaction. See Rev. Proc. 2004-66, 2004-50 I.R.B. 966, modifying and superseding Rev. Proc. 2003-24, 2003-11 I.R.B. 599. Nonetheless, taxpayers are still faced with having to decide whether, and how to, aggregate their transactions for purposes of the regulations.

(7) Treas. Reg. [section] 1.6011-4(b)(2).

(8) Treas. Reg. [section] 1.6011-4(c)(4).

(9) Id.

(10) Notice 2004-67, 2004-41 I.R.B. 1, and Notice 2005-13, 2005-9 I.R.B. 1. See www.irs.gov for the most up-to-date list of listed transactions.

(11) See, e.g., Rev. Rul. 2002-69, 2002-2 C.B. 760 (LILO transactions); Notice 2003-24, 2003-1 C.B. 853 (Certain Collectively Bargained Welfare Funds).

(12) See Treas. Reg. [section] 1.6011-4(c)(4), Examples 1 and 2.

(13) 2002-1 C.B. 992.

(14) 2001-1 C.B. 730.

(15) Id.

(16) See Rev. Proc. 2004-65, I.R.B. 2004-50 (contractual protections exceptions); Rev. Proc. 2004-66, 2004-50 I.R.B. 966, modifying and superseding Rev. Proc. 2003-24, 2003-1 C.B. 599 (significant loss exceptions); Rev. Proc. 2004-67, 2004-50 I.R.B. 967, modifying and superseding Rev. Proc. 2003-25, 2003-1 C.B. 601 (significant book-tax differences exceptions); and Rev. Proc. 2004-68, I.R.B. 2004-50 (brief-asset holding period exceptions).

(17) Rev. Proc. 2004-67, [section] 4.02(3) (emphasis added).

(18) Id. [section] 4.02(9).

(19) For a thorough discussion of the application of the regulations to non-U.S. entities, see Michael Danilack, Application of the Final Reportable Transaction and List Maintenance Regulations to Transactions Conducted by Foreign Entities, 32 TAX MANAGEMENT INTERNATIONAL JOURNAL, No. 11 (November 14, 2003).

(20) See Treas. Reg. [section] 1.6011-4(c)(3)(i)(G)(2).

(21) Treas. Reg. [section] 1.6011-4(c)(3)(i)(G)(1).

(22) Id.

(23) Treas. Reg. [section] 1.6011-4(b)(6).

(24) Rev. Proc. 2004-45, [section] 4(1).

(25) See Treas. Reg. [section] 1.6011-4(g).

(26) Section 6111 requires that each material advisor with respect to any reportable transaction make a return setting forth information identifying and describing the transaction and any potential benefits expected to result from the transaction. A material advisor meets its section 6111 disclosure requirement by filing a Form 8264 by the last day of the month that follows the end of the calendar quarter in which the advisor becomes a material advisor. Notice 2005-22, I.R.B. 2005-12. Section 6112 and the applicable regulations require each material advisor with respect to any reportable transaction to maintain a list that identifies each person to whom the advisor acted as a material adviser with respect to the transaction and contains other information that the Secretary may require.

(27) Treas. Reg. [section] 1.6011-4(g).

(28) Id.

(29) Id.

(30) Appeals Notice dated June 21, 2004.

(31) CC-2004-036.

(32) Announcement 2005-19, I.R.B. 2005-11 (February 22, 2005).

(33) 2002-1 C.B. 304.

(34) For example, the Memorandum of Understanding for the Limited Issue Focused Examination program specifically states that the process will be terminated if an abusive tax shelter or listed transaction is not disclosed.

(35) REG-122847-04.

(36) Temp. Reg. [section] 1.6664-2T(c)(3)(ii).

(37) Temp. Reg. [section] 1.6664-2T(c)(3)(i)(E).

HOWARD J. BERMAN is a Director, Tax Controversy Services with Deloitte Tax LLP in New York, NY, JOHN R. KEENAN is a Director, Tax Controversy Services in Washington, D.C. and RONA FAUST is a Manager, Tax Controversy Services in Washington, D.C.
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