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Tax shelter Temp. Regs.


* The new material advisor rules substantially expand the parties responsible for maintaining investor lists.

* The existing corporate registration regulations will likely be expanded to cover transactions entered into by individuals, partnerships, S corporations and trusts.

* Treasury and IRS are evaluating amendments to Circular 230 for tax shelter opinions.


On Oct. 22, 2002,Treasury released temporary Regulations (32) on tax return disclosure statements and maintenance of investor lists for "reportable transactions." Part I of this two-part article examined the reportable transactions subject to the taxpayer return disclosure and the advisor list-maintenance rules under the modified temporary regulations. Part II, below, discusses key provisions in the temporary regulations that place the list-maintenance obligation on a newly defined category of "material advisors" Under the prior temporary regulations, list maintenance of investors in potentially abusive tax shelters applied only to promoters, organizers and sellers. (33)

Part II also discusses expected changes to the rules (34) on registration of confidential corporate tax shelters. Proposed legislation would require material advisors to register "reportable transactions" (not just confidential corporate tax shelters) with the IRS; Treasury indicated that it will amend the Sec. 6111 regulations when such legislation is enacted. (35) Finally, Part II also addresses expected amendments to the Circular 230 regulations on tax shelter opinions.

Revised Effective Dates

When published in October 2002, the temporary taxpayer disclosure and advisor list-maintenance regulations were to be effective for transactions entered into after Dec. 31,2002. On Jan. 17, 2003, however, the IRS issued a notice (36) amending certain effective dates and stating that it intends to publish revised final regulations in 2003.

Although the October 2002 temporary disclosure regulations under Sec. 6011 will continue to apply to transactions entered into after 2002, the revised final regulations will permit taxpayers who entered into transactions after Dec. 31, 2002, and before the filing date of the revised final regulations, to elect to apply the revised final regulations instead.

The effective date of the October 2002 temporary list-maintenance regulations under Sec. 6112 will be changed to the filing date of the revised final regulations. In general, the temporary list-maintenance requirements will not apply to transactions entered into after 2002 and before the filing date of the revised final regulations. The delayed effective date, however, will not apply to listed transactions and transactions required to be registered under Sec. 6111.

Material Advisor

The definition of a "material advisor" is critical to the application of the list-maintenance regulations. Under Temp. Regs. Sec. 301.6112-1T(c)(2), a "material advisor" is any person who (1) receives (or expects to receive) at least a "minimum fee" in connection with a reportable transaction and (2) makes or provides any statement (oral or written) to any personas to the potential tax consequences of that transaction. A material advisor is required to list each person to whom the material advisor makes or provides a statement (oral or written) as to the potential tax consequences of a transaction that is a potentially abusive tax shelter, if the material advisor knows (or has reason to know) that the person (or any related party) participated in (or will participate in) the transaction (or a substantially similar transaction).

A potentially abusive tax shelter is any transaction subject to registration for purposes of Sec. 6111 and any reportable transaction for purposes of Sec. 6011. The IRS and Treasury are considering whether the minimum-fee requirement (discussed below) should be eliminated as to listed transactions. (37)

Under the new rules, if the minimum-fee threshold is exceeded, a material advisor's obligation to prepare and maintain a list as to a particular reportable transaction should coincide in almost every case with the taxpayer's obligation to disclose it. (38) The one exception would be when the material advisor is required to maintain a list as to a transaction that is not a reportable transaction, but is otherwise required to be registered with the IRS as a Sec. 6111 tax shelter (until the Code and existing registration regulations are amended to conform to the new taxpayer disclosure and advisor list-maintenance regulations).

Conversely, if the minimum-free threshold is not exceeded as to a reportable transaction, the taxpayer discloses the transaction without a corresponding list-maintenance obligation for the advisor. Further, advisors making a statement about tax consequences after a transaction is entered into may become material advisors, thus blurring the line between material advisors and tax preparers. (39)

A material advisor is presently required to maintain lists for 10 years after he or she last made an oral or written statement as to the potential tax consequences of a transaction. Temp. Regs. Sec. 301.6112-1T(f) is unadministerable in firms with several tax practitioners, because keeping track of statements made by all practitioners in such firms is not feasible. A more workable standard would link document retention policy to a certain period (e.g., six years) after the first transaction is entered into by a participant. (40) Advisors should review how their client records are maintained and how clients are billed for services. (41)

The New York State Bar Association (NYSBA) notes that the broad definition of material advisor potentially sweeps into the list-maintenance and penalty regimes businesses whose contacts with a transaction are limited and whose disclosures are likely to be only marginally useful. They suggest, for example, that requiring returns of a Delaware counsel who forms a Delaware limited liability company and opines that it is duly formed and in good standing, or by a brokerage house that executes a trade, imposes a significant burden on persons whose relationship to (and knowledge of) the reportable transaction may be limited. (42)

The NYSBA also suggests that it would be unreasonable to require disclosure from material advisors when the designation of a transaction as reportable depends on facts to which the advisor may not have access, such as the potential amount of any resulting book-tax difference. They note that imposing a "know or have reason to know" standard on businesses performing customary client services with no promotional role in the reportable transaction would create a significant burden on such businesses, yet may not provide useful information. (43) Further, due to the objective nature of the categories defining reportable transactions, promoters can no longer rely on tax adviser opinions to protect them from penalties for failing to maintain a list.

Minimum-Fee Threshold

The minimum fee under Temp. Regs. Sec. 301.6112-1T(c)(3) is:

* $250,000 if all persons who acquire an interest, directly or indirectly, in the transaction are corporations (other than S corporations).

* $50,000 for any noncorporate transaction.

In determining whether the minimum-fee threshold is satisfied, all fees for advice (whether of not tax advice) regarding, or for implementation of, a transaction are considered, including related document work and tax preparation. In addition, each transaction is evaluated separately to determine whether the threshold is satisfied.

The AICPA is also concerned that the definition of "fees" for the minimum-fee threshold is too broad and implies that return preparation fees will be considered part of the fee. (44) Tax preparation fees alone may exceed the fee minimums when performed for large corporations, master limited partnerships and other large passthrough entities. While understanding Treasury's concern as to the potential for misallocation of lees to avoid the fee minimums, such risk could also exist among lees for various transaction types; misallocation issues are more properly dealt with in the audit process. (45)

Like the concerns expressed by commentators on the inclusion of a business that provides customary client services as a "material advisor," commentators have also voiced concerns that the minimum-fee threshold may trigger the list-maintenance obligation for similarly situated businesses. The NYSBA suggests that Treasury consider the burden placed on businesses: (1) not involved in the development or promotion of the reportable transaction; (2) not aware that their services relate to a reportable transaction; of (3) with compensation comparable to standard third-party charges for similar services. (46)

Essentially, Treasury and the IRS have expanded the parties responsible for maintaining lists well beyond that of the earlier promoter or organizer rules; as a result, without the minimum-fee threshold, the parties responsible for maintaining the lists and furnishing them to the IRS could be read to include virtually everyone providing services, because it may be difficult not to refer to the tax aspects of many business transactions that involve tax incentive provisions (such as various credits and exclusions). The material advisor standard that applies to "any person ... who makes any statement ... as to the potential tax consequences" of a transaction should be limited to substantive and meaningful tax advice.

Temp. Regs. Sec. 301.6112-1T(i) has been added to allow advisors to request a ruling as to whether a transaction is subject to the list-maintenance rules and whether he or she is a "material advisor" in the transaction.


Treasury and the IRS have become increasingly skeptical of claims of privilege on reportable transactions. Generally, the names of participants in reportable transactions are neither protected by the attorney-client privilege nor the tax practitioner privilege under Sec. 7525, and unreasonable claims of privilege may be subject to penalties under Sec. 6708. (47) IRS Chief Counsel Williams espoused his views on the limited viability of the identity privilege in his July 2002 "Alamo Speech." (48)

Confidentiality privileges may still be viable defenses against disclosure of certain tax advice communications between a practitioner and a taxpayer. The Sec. 7525(b) tax shelter exception to the tax practitioner privilege should only apply if the practitioner promoted the tax shelter. Nevertheless, many practitioner opinions are intended to be disclosed to the IRS in defense of the taxpayer's position. Chief Counsel Williams pointed out that generic or marketing-type opinions (used for more than one transaction) may lack any confidential information.

In a recent district court case, (49) KPMG LLP was ordered to submit to a U.S. magistrate judge a copy of its entire privilege log and copies of each document referred to in the log. Based on the court's findings, it would be difficult to demonstrate that opinions on tax consequences of transactions are prepared other than in conjunction with the preparation of a tax return, in which case privilege protection will not be afforded. The court's decision confirms that privilege protections afforded to tax practitioners are very limited and bolsters the IRS position in its enforcement actions. However, the IRS itself could become more vulnerable to taxpayer requests for information if the protections of privilege are sufficiently weakened. (50)

Expected Changes to the Registration Rules

The existing temporary regulations on registration cannot be modified until legislation is enacted to facilitate conformity with the list-maintenance and disclosure temporary regulations. Accordingly, the existing registration rules continue to apply.

Any new registration rules under Sec. 6111 will likely be expanded to cover transactions entered into by individuals, partnerships, S corporations and trusts. Based on the March 2002 Treasury Proposals, (51) the intent is to broaden the list of persons responsible for registering transactions. (52) In addition, based on Treasury's comments that taxpayers and promoters are reading the exceptions liberally, the existing exceptions may also be dropped from any proposed registration rules; they will conform in all significant respects to the October 2002 temporary regulations for reportable transactions.

Two key questions need to be considered in any proposed registration rule:

* Who will be responsible for registration?

* What is the timing of registration?


IRS and Treasury intend to amend the Sec. 6111 regulations to clarify that all parties materially involved in a reportable transaction must register a transaction. Under the March 2002 Treasury Proposals, material participation would be measured by the fees received (or expected to be received) as a result of the transaction or a series of related transactions. (53) The definition of "material advisor" for registration purposes should also be conformed to that for list-maintenance purposes, so that a practitioner engaged to prepare a taxpayer's return would not be regarded as being a material advisor to a transaction if he or she identifies a potentially abusive transaction.


Presently, a registration must be filed by the day on which a transaction is first offered to a participant. However, the taxpayer's return due date for the year the transaction is consummated is a more practical time to file the registration, because book-tax differences will only be known when the financial statements and the return have been completed.

In addition, requiring registration of consummated transactions would be preferable, as appears to be the case for list-maintenance purposes (except for potential participants who acquire an interest to transfer it to others). However, given the IRS and Treasury objective of receiving warnings of perceived tax shelters at the earliest opportunity, they may require the filing of a registration by a material advisor when the transaction is first entered into by a potential participant.

Circular 230

Treasury and the IRS are evaluating amendments to Circular 230 (54) for tax shelter opinions. Opinion due diligence requirements under Circular 230 should only apply to opinions on transactions described in the objective categories of reportable transactions under the disclosure and list-maintenance rules, so that practitioners can clearly identify which opinions are subject to Circular 230 and to promote consistency with the tax shelter reporting regulations. (55)

Based on the Jan. 12, 2001 proposed amendments to Circular 230 Sections 10.33 and 10.35, Treasury and the IRS intend to require enhanced due-diligence standards for tax shelter opinions to address business purpose, applicable court doctrines and anti-abuse rules, assumptions and representations and each material tax issue. (56) Written tax shelter opinions will be required to be complete and comprehensive, but what about informal opinions or scaled-down advice? Will Circular 230 permit advisors to opt out of the complete and comprehensive opinion? (57)


Although many practitioners may view the harmonization of the disclosure and list-maintenance rules as a step in the right direction, many risks continue to exist. At present, the registration rules do not conform to the new reportable transaction regime. Accordingly, different standards still apply in determining whether a transaction requires registration, and who is responsible for registration.

Treasury has recognized that the revised disclosure and list-maintenance regulations will cover many transactions that may not be abusive tax-avoidance transactions. (58) However, an alternative view suggests that the risks of enhanced disclosure (e.g., the IRS becomes inundated with disclosures of transactions and taxpayers incur a costly compliance burden) is outweighed by the potential improvements to the quality of the audit process and encouragement of taxpayers to exercise greater care prior to participating in potential tax avoidance transactions. (59) The challenge is to design a disclosure and listing regime that strikes a balance between objective standards and over-inclusiveness.

No doubt, taxpayers may not want their names to be included on lists maintained by their advisors, nor their transactions to be registered by their advisors, but these concerns should subside if they too are routinely disclosing transactions in their returns. Additionally, failure to comply with the new regulations may carry significant risks, such as a proposed six-year statute of limitations, significant future penalties, proposed SEC disclosure, tax shelter information document requests and tax-accrual, workpaper disclosure. The new list-maintenance regulations strongly suggest that the names of participants in potential tax shelter transactions are not protected by the attorney-client privilege or the Sec. 7525 practitioner privilege, and that improper assertions of privilege may lead to advisor penalties. (60) In addition, advisors may be subject to Circular 230 sanctions.

Taxpayers and their advisors need to revisit their record-retention policies to address the possibility that a list and related documents may need to be retained for many years. Ordinary transactions that are not abusive tax shelters may nevertheless be reportable and mandate compliance with the new record-retention requirements.

Sooner or later, Congress will enact significant new and enhanced penalties on advisors for failure to comply with the regulations and on taxpayers for failure to disclose reportable transactions in their returns. The IRS's ability to waive penalties may be severely limited by tax shelter legislation. Further, reporting penalties will likely apply regardless of whether taxpayers prevail on the merits of the transactions. (61) Consequently, taxpayers and their advisors must be able to timely and accurately identify reportable transactions.

Editor's note: Mr. Mendelson chairs the AICPA Tax Division's Tax Practice Responsibilities Committee.

(32) TD 9017 and 9018 (both dated 10/22/02).

(33) TD 8875 and REG-103736-00 (both dated 2/28/00).

(34) TD 8876 and REG-110311-98 (both dated 2/28/00).

(35) See the preamble to TD 9017, note 32 supra.

(36) Notice 2003-11, IRB 2003-6.

(37) See the preamble to TD 9018, note 32 supra.

(38) During December 2002, the IKS released on its website ( an advance proof copy of Form 8886, "Reportable Transaction Disclosure Statement." Taxpayer information required on the form includes the name, address and taxpayer identification number (TIN). Required information as to the reportable transaction includes: transaction name and registration number (if any); transaction type; identification of a substantially similar listed transaction (if any); number of transactions; name and TIN of any investment conduits; affirmation of certain increases in asset basis (if any); name, contact information and fees paid to promoters and tax advisers as to the transaction; principal facts surrounding the transaction; expected tax results; and estimated tax benefits.

(39) Post-transaction advice may trigger the listing requirement, because the temporary regulations require a material advisor to list a person if he orshe knows (or has reason to know) that the person or any related party participated in or will participate in a reportable transaction. If "material advisor" includes persons making a statement about the transaction after it has been consummated, who be able to render an opinion (for penalty relief purposes) to the taxpayer, as contemplated in the proposed tax shelter legislation?

(40) In contrast to the controversial document retention requirements for material advisors, Temp. Regs. Sec. 1.6011-4T(g) requires taxpayers to retain a copy of all material documents and records for a reportable transaction until the expiration of the statute of limitations for the final tax year in which disclosure of the transaction was required. Such documents include those material to understanding the facts of the transaction, the expected tax treatment of the transaction or the taxpayer's decision to participate in the transaction. This document retention rule is also difficult to comply with and perhaps impossible for newly designated listed transactions that can retroactively relate to transactions entered into after Feb. 27, 2000.

(41) See Lipton, "New Tax Shelter Disclosure And Listing Regulations Promise Headaches For Everyone," 98J. of Tax'n 5 (January 2003).

(42) See Comments submitted May 22, 2002, by the NYSBA to Pamela F. Olson and Charles O. Rossotti (hereinafter, "NYSBA Comments") on the March 2002 Treasury Proposals, note 51 infra (available at

(43) Id.

(44) See AICPA Comments on Temporary and Proposed Regulations, Sections 1.6011-4T, 301.6111-2T, 301.6112-1T (12/26/02).

(45) The temporary rules can be read to mean that only tax preparation fees related to the transaction need be taken into account for purposes of determining the minimum fee, unless the IRS discovers a misallocation of fees for transaction advice to tax preparation. It is even less clear whether accounting services, fees from subcontractors and expenses are taken into account.

(46) See NYSBA Comments, note 42 supra.

(47) See the preamble to TD 9018, note 32 supra.

(48) See "IRS Battles Promoter Privilege Claims," Tax Notes Today (6/07/02).

(49) See KPMG LLP, DC DC, 12/20/02.

(50) See Smith, "After The Alamo: Taxpayer Claims Of Privilege And The IRS War On Tax Shelters," 98 Tax Notes 233 (01/13/03).

(51) See the "The Treasury Department's Enforcement Proposals for Abusive Tax Avoidance Transactions" (3/20/02) (available at po2018.htm)(herein, "March 2002 Treasury Proposals").

(52) See HR 5095, American Competitiveness and Corporate Accountability Act of 2002; StaffoftheJoint Committee on Taxation's Description of the Small Business and Farm Economic Recovery Act (JCX-88-02, 9/17/02); see also S. 9, Pension Protection and Expansion Act of 2003 (1/7/03).

(53) See March 2002 Treasury Proposals, note 51 supra.

(54) Treasury Circular 230, Regulations Governing the Practice of Attorneys, Certified Public Accountants, Enrolled Agents and Appraisers Before the Internal Revenue Service.

(55) AICPA comments on proposed regulations to amend Circular 230 (REG-111835- 99, 6/17/02), stated it has "significant concerns that dissimilar standards would add unnecessary complexities into this area and undercut practitioner's efforts to comply with the new rules."

(56) REG-111835-99 (1/12/01). Treasury plans to repropose tax shelter opinion standards per its business plan in late 2003.

(57) See Schler, "Ten More Truths About Tax Shelters: The Problem, Possible Solutions and a Reply to Professor Weisbach," 55 Tax L. Rev. 325 (Spring 2002), which states, "In general, an opinion would be required to be based on the real rather than hypothetical facts, to discuss all material issues including judicial doctrines, and to unambiguously state its conclusions. This approach to the tax shelter problem is useful. If nothing else, it provides a certain amount of consumer protection to users of tax shelter opinions. It does this by requiring that such opinions on their rice be complete and comprehensive. This often has not been the case."

(58) See note 51, supra.

(59) See Pearlman, "Demystifying Disclosure: First Steps," 55 Tax L. Rev. 289 (Spring 2002).

(60) See the preamble to TD 9018, note 32 supra.

(61) Proposed Sec. 6662 regulations (REG-126016-01, 12/30/02) may even subject taxpayers to accuracy-related penalties for failure to disclose reportable transactions without regard to the merits and without statutory revisions to Sec. 6662.

Dan L. Mendelson Partner Pricewaterhouse Coopers LLP Washington, DC

Nayan Bhikha Senior Manager Pricewaterhouse Coopers LLP Washington, DC

Jim Emilian Manager Pricewaterhouse Coopers LLP Washington, DC
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Title Annotation:part 2
Author:Emilian, Jim
Publication:The Tax Adviser
Date:Mar 1, 2003
Previous Article:Web-based tax resources.
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