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Penalty regulations address new reasonable basis disclosure standard.

Under pre-Revenue Reconciliation Act of 1993 (RRA) law, disclosure of a return position was considered adequate for purposes of avoiding (1) the negligence or disregard of rules or regulations component and (2) the substantial understatement of income tax component of the Sec. 6662 accuracy-related penalty, if the return position was not frivolous (i.e., not patently improper) and the position was disclosed in the manner provided by the Sec. 6662 regulations (e.g., disclosed on a Form 8275, Disclosure Statement); see Regs. Secs. 1.6662-3(c) and 1.6662-4(e).

The RRA raised the disclosure standard for taxpayers from not frivolous to reasonable basis. In the case of the substantial understatement of income tax component of the Sec. 6662 penalty, the disclosure standard was raised by Sec. 6662(d)(2)(B)(ii). In the case of the negligence or disregard of rules or regulations component of the Sec. 6662 penalty, the legislative history to the RRA states that the disclosure standard is similarly raised from nonfrivolous to reasonable basis; see H. Rep. No. 213, 103d Cong., 1st Sess. 669 (1993) (hereinafter, the Conference Report). Presumably, the disclosure standard for the negligence or disregard component was not raised by statute because there was no prior statutory adequate disclosure exception for the negligence or disregard component.

To provide guidance on the new reasonable basis disclosure standard, the IRS recently issued temporary (and proposed) regulations that address (1) the effect of the new reasonable basis disclosure standard on the negligence component of the Sec. 6662 penalty; (2) the definition of the reasonable basis standard; and (3) the effective dates of the RRA changes.

Effect of the new reasonable basis disclosure standard on negligence

Temp. Regs. Sec. 1.6662-7T(b) states that the penalty for negligence may no longer be avoided by disclosure. This follows from the fact that, by definition, a position that has a reasonable basis is not a negligent position; see Regs. Sec. 1.6662-3(b). Therefore, with the new reasonable basis disclosure standard, the adequate disclosure exception is no longer applicable to negligence (since a position that has a reasonable basis does not need to be disclosed). The adequate disclosure exception, however, continues to apply to the disregard of rules or regulations component of the Sec. 6662 penalty.

Definition of the reasonable basis standard

Prior to amendment by the temporary regulations, Regs. Sec. 1.6662-4(d)(2) provided that a return position that was arguable, but fairly unlikely to prevail in court, satisfied the reasonable basis standard. However, based on the following statement in the Conference Report (at 669), the Service has indicated in the preamble to the temporary regulations that a new definition of the reasonable basis standard will be provided in the final regulations.

The conferees intend that "reasonable basis" be a relatively high standard of tax reporting, that is, significantly higher than "not patently improper." This standard is not satisfied by a return position that is merely arguable or that is merely a colorable claim.

Although the temporary regulations do not currently provide a new definition of the reasonable basis standard, Temp. Regs. Sec. 1.6662-7T(d)(2) does provide, in accordance with the Conference Report, that the reasonable basis standard is significantly higher than the not frivolous standard (i.e., not patently improper). The IRS is seeking comments on how a new reasonable basis standard should be defined in the final regulations.

Effective dates of the RRA changes

According to the temporary regulations, the effective dates of the RRA changes are as follows.

* Substantial understatement of income tax:

1. The new reasonable basis disclosure standard, and

2. the new definition of the reasonable basis standard apply to returns due (determined without regard to extensions) after Dec. 31, 1993.

* Negligence or disregard of rules or regulations:

1. The new reasonable basis disclosure standard, and

2. the new difinition of the reasonable basis standard apply to returns due (determined without regard to extensions) after Dec. 31, 1993, and filed after Mar. 14, 1994 (including qualified amended returns).

With respect to the new definition of reasonable basis, it would seem that, as a practical matter, taxpayers may continue to rely on the existing definition of reasonable basis (i.e., arguable but fairly unlikely to prevail in court) until a different definition is provided in the final regulations.
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Author:Kedda, Lisa B.
Publication:The Tax Adviser
Date:Jun 1, 1994
Words:718
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