[Senate Report 107-189]
[From the U.S. Government Publishing Office]



                                                       Calendar No. 466
107th Congress                                                   Report
                                 SENATE
 2d Session                                                     107-189

======================================================================



 
                      TAX SHELTER TRANSPARENCY ACT

                                _______
                                

                 June 28, 2002.--Ordered to be printed

                                _______
                                

   Mr. Baucus, from the Committee on Finance, submitted the following

                              R E P O R T

                         [To accompany S. 2498]

    The Committee on Finance, to which was referred the bill 
(S. 2498) to amend the Internal Revenue Code of 1986 to require 
adequate disclosure of transactions which have a potential for 
tax avoidance or evasion and for other purposes, having 
considered the same, report favorably thereon with an amendment 
and recommend that the bill as amended do pass.

                                CONTENTS

                                                                   Page
  I. Legislative Background...........................................2
 II. Provisions Relating to the Tax Shelter Transparency Act..........2
        A. Penalty for Failure to Disclose Reportable 
            Transactions (sec. 101 of the bill and new sec. 6707A 
            of the Code).........................................     2
        B. Modifications to the Accuracy-Related Penalties for 
            Listed Transactions and Reportable Transactions 
            Having a Significant Tax Avoidance Purpose (sec. 102 
            of the bill and new sec. 6662A and secs. 6662 and 
            6664 of the Code)....................................     7
        C. Modifications to the Substantial Understatement 
            Penalty (sec. 103 of the bill and sec. 6662 of the 
            Code)................................................    11
        D. Tax Shelter Exception to Confidentiality Privileges 
            Relating to Taxpayer Communications (sec. 104 of the 
            bill and sec. 7525 of the Code)......................    12
        E. Disclosure of Reportable Transactions by Material 
            Advisors (secs. 201 and 202 of the bill and secs. 
            6111 and 6707 of the Code)...........................    13
        F. Investor Lists and Applicable Penalties (secs. 201 and 
            203 of the bill and secs. 6112 and 6708 of the Code).    16
        G. Actions to Enjoin Conduct with Respect to Tax Shelters 
            (sec. 204 of the bill and sec. 7408 of the Code).....    18
        H. Understatement of Taxpayer's Liability by Income Tax 
            Return Preparer (sec. 211 of the bill and sec. 6694 
            of the Code).........................................    18
        I. Penalty on Failure to Report Interests in Foreign 
            Financial Accounts (sec. 212 of the bill and sec. 
            5321 of Title 31, United States Code)................    19
        J. Frivolous Tax Returns and Submissions (sec. 213 of the 
            bill and sec. 6702 of the Code)......................    21
        K. Regulation of Individuals Practicing Before the 
            Department of the Treasury (sec. 214 of the bill and 
            sec. 330 of Title 31, United States Code)............    22
        L. Penalties on Promoters of Tax Shelters (sec. 215 of 
            the bill and sec. 6700 of the Code)..................    23
III. Other Provisions................................................24
        A. Modification With Respect to Rite Aid case............    24
 IV. Budget Effects of the Bill......................................28
        A. Committee Estimates...................................    28
        B. Budget Authority and Tax Expenditures.................    30
        C. Consultation with Congressional Budget Office.........    30
  V. Votes of the Committee..........................................30
 VI. Regulatory Impact and Other Matters.............................30
        A. Regulatory Impact.....................................    30
        B. Unfunded Mandates Statement...........................    31
        C. Tax Complexity Analysis...............................    31
VII. Changes in Existing Law Made by the Bill as Reported............31

                       I. LEGISLATIVE BACKGROUND

    The Senate Committee on Finance began a mark up of an 
original bill, S. 2498 (the ``Tax Shelter Transparency Act'') 
on June 13, 2002. On June 18, 2002, the Senate Committee on 
Finance resumed the mark up and approved the Committee 
amendment by a voice vote on that date.
    The Committee held a hearing on March 21, 2002, regarding 
the proliferation of tax shelters.

      II. PROVISIONS RELATING TO THE TAX SHELTER TRANSPARENCY ACT


       A. Penalty for Failure To Disclose Reportable Transactions


(Sec. 101 of the bill and new sec. 6707A of the Code)

                              PRESENT LAW

    Regulations under section 6011 require a taxpayer to 
disclose with its tax return certain information with respect 
to each ``reportable transaction'' in which the taxpayer 
participates.\1\
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    \1\ Temp. Treas. Reg. sec. 1.6011-4T; Prop. Treas. Reg. sec. 
1.6011-4. Effective June 14, 2002, the regulations were modified to 
require non-corporate taxpayers (i.e., individuals, trusts, 
partnerships, and S corporations) to disclose their participation in 
reportable transactions that have been specified by the Treasury 
Department as ``listed'' transactions. See T.D. 9000, 67 Fed. Reg. 
41,324 (June 18, 2002). Disclosure of other reportable transactions 
under the regulations continues to be limited to corporate taxpayers.
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    There are two categories of reportable transactions. The 
first category includes any transaction that is the same as (or 
substantially similar to) \2\ a transaction that is specified 
by the Treasury Department as a tax avoidance transaction whose 
tax benefits are subject to disallowance under present law 
(referred to as a ``listed transaction''). A taxpayer must 
disclose any listed transaction that is expected to reduce the 
taxpayer's Federal income tax liability by more than $1 million 
in any single taxable year or more than $2 million in any 
combination of years.\3\
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    \2\ The recently-modified regulations clarify that the term 
``substantially similar'' includes any transaction that is expected to 
obtain the same or similar types of tax benefits and that is either 
factually similar or based on the same or similar tax strategy. Also, 
the term must be broadly construed in favor of disclosure. See T.D. 
9000, 67 Fed. Reg. 41,324 (June 18, 2002).
    \3\ Temp. Treas. Reg. sec. 1.6011-4T(b)(2) and (b)(4)(i).
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    The second category of reportable transactions includes 
transactions that are expected to reduce a taxpayer's Federal 
income tax liability by more than $5 million in any single year 
or $10 million in any combination of years and that have at 
least two of the following characteristics: (1) the taxpayer 
has participated in the transaction under conditions of 
confidentiality; (2) the taxpayer has obtained or been provided 
with contractual protection against the possibility that part 
or all of the intended tax benefits from the transaction will 
not be sustained; (3) the promoters of the transaction have 
received or are expected to receive fees or other consideration 
with an aggregate value in excess of $100,000, and such fees 
are contingent on the taxpayer's participation; (4) the 
transaction results in a reported book/tax difference in excess 
of $5 million in any taxable year; or (5) the transaction 
involves a person that the taxpayer knows or has reason to know 
is in a Federal income tax position that differs from that of 
the taxpayer (such as a tax-exempt entity or foreign person), 
and the taxpayer knows or has reason to know that such 
difference has permitted the transaction to be structured to 
provide the taxpayer with a more favorable Federal income tax 
treatment.\4\
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    \4\ Temp. Treas. Reg. sec. 1.6011-4T(b)(3)(i)(A)-(E). In certain 
circumstances, a taxpayer can avoid disclosure with respect to the 
second category of reportable transactions. See Temp. Treas. Reg. sec. 
1.6011-4T(b)(3)(ii)(A)-(E).
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    Under present law, there is no specific penalty for failing 
to disclose a reportable transaction; however, such a failure 
may jeopardize the taxpayer's ability to claim that any income 
tax understatement attributable to such undisclosed transaction 
is due to reasonable cause, and that the taxpayer acted in good 
faith.\5\
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    \5\ Section 6664(c) provides that a taxpayer can avoid the 
imposition of a section 6662 accuracy-related penalty in cases where 
the taxpayer can demonstrate that there was reasonable cause for the 
underpayment and that the taxpayer acted in good faith.
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                           REASONS FOR CHANGE

    The Committee is aware that individuals and corporations 
are increasingly using sophisticated transactions to avoid or 
evade Federal income tax.\6\ Such a phenomenon could pose a 
serious threat to the efficacy of the tax system because of 
both the potential loss of revenue and the potential threat to 
the integrity of the self-assessment system.
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    \6\ In this regard, the Committee has concerns with the outcomes 
and rationales used by courts in some recent decisions involving tax-
motivated transactions. For a more detailed discussion of recent court 
decisions and other developments regarding tax shelters, see Joint 
Committee on Taxation, Background and Present Law Relating to Tax 
Shelters (JCX 19-02), March 19, 2002.
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    The Committee over two years ago began working on 
legislation to address this significant compliance problem. In 
addition, the Treasury Department, using the tools available, 
issued regulations requiring disclosure of certain transactions 
and requiring organizers and promoters of tax-engineered 
transactions to maintain customer lists and make these lists 
available to the IRS. Nevertheless, the Committee believed that 
additional legislation was needed to provide the Treasury 
Department with additional tools to assist its efforts to 
curtail abusive transactions. In that regard, the Committee 
issued for public comment three separate staff discussion 
drafts designed to address the tax shelter problem. The most 
recent draft (released in August 2001) focused on a regime that 
emphasized disclosure of tax shelter transactions.
    On March 21, 2002, the Committee heard testimony from 
Treasury Department and IRS officials that only 272 
transactions by 99 different taxpayers were disclosed under the 
present law for the 2001 tax-filing season. In connection with 
the hearing, the Treasury Department announced a new initiative 
(the ``Treasury shelter initiative'') that is designed to 
provide the Treasury Department and the Internal Revenue 
Service (``IRS'') with the tools necessary torespond to abusive 
tax avoidance transactions.\7\ The Treasury shelter initiative 
emphasizes combating abusive transactions by requiring increased 
disclosure of such transactions by all parties involved. To facilitate 
such disclosure, the Treasury shelter initiative proposes clearer 
definitions to identify transactions that must be disclosed, and 
stiffer penalties for failure to disclose such transactions. The 
Treasury shelter initiative provides for
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    \7\ See generally, ``The Treasury Department's Enforcement 
Proposals for Abusive Tax Avoidance Transactions,'' released on March 
20, 2002, reprinted electronically at 2002 TNT 55-28 (March 21, 2002).

         [A] series of clear, mutually reinforcing rules for 
        disclosure, registration, and list maintenance. These 
        rules will be easier for taxpayers and their advisors 
        to apply, and harder for those who seek to avoid 
        disclosure to manipulate. * * * The Treasury 
        Department's proposals, for example, will broaden and 
        align the rules and regulations for disclosure, 
        registration, and list keeping under Sections 6011, 
        6111, and 6112 of the Code. * * * The Treasury 
        Department's enforcement initiative will create a 
        single, clear definition of a transaction that must be 
        disclosed and registered, and for which lists must be 
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        maintained.

    The Committee believes that the course of action outlined 
in the Treasury shelter initiative will bolster ongoing efforts 
to combat abusive tax avoidance transactions, and that 
encouraging greater disclosure of transactions with a potential 
for tax avoidance is beneficial to the tax system. Moreover, 
the Committee believes that a penalty for failing to make the 
required disclosures, when the imposition of such penalty is 
not dependent on the tax treatment of the underlying 
transaction ultimately being sustained, will provide an 
additional incentive for taxpayers to satisfy their reporting 
obligations under the new disclosure provisions.

                        EXPLANATION OF PROVISION

In general

    The provision creates a new penalty for any person who 
fails to include with any return or statement any required 
information with respect to a reportable transaction. The new 
penalty applies without regard to whether the transaction 
ultimately results in an understatement of tax, and applies in 
addition to any accuracy-related penalty that may be imposed.

Transactions to be disclosed

    The provision does not define the terms ``listed 
transaction'' \8\ or ``reportable transaction,'' nor does the 
provision explain the type of information that must be 
disclosed in order to avoid the imposition of a penalty. 
Rather, the provision authorizes the Treasury Department to 
define a ``listed transaction'' and a ``reportable 
transaction'' under section 6011. As part of the Treasury 
shelter initiative, the Committee expects the Treasury 
Department to issue new regulations under section 6011 that 
will provide taxpayers with a set of objective standards to be 
applied in determining whether a taxpayer must disclose 
information regarding a particular transaction. The Committee 
anticipates that the new regulations will define a reportable 
transaction to include (but not be limited to) transactions 
with any of the following characteristics: (1) a significant 
loss, (2) a brief holding period, (3) a transaction that is 
marketed under conditions of confidentiality, (4) a transaction 
that is subject to indemnification agreements, or (5) a certain 
amount of book-tax difference.\9\
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    \8\ The provision states that, except as provided in regulations, a 
listed transaction means a reportable transaction, which is the same 
as, or similar to, a transaction specifically identified by the 
Secretary as a tax avoidance transaction for purposes of section 6011. 
The Committee anticipates that regulations under section 6011 will 
provide that a transaction is similar to a listed transaction if such 
transaction is expected to obtain the same or similar types of tax 
benefits and that is either factually similar or based on the same or 
similar tax strategy. The Secretary will have discretion to modify this 
definition as appropriate (as well as the definitions of reportable and 
listed transactions).
    \9\ The Treasury shelter initiative stated that a reportable 
transaction would be defined as any transaction with any of the 
following characteristics: (1) any transaction specifically identified 
by the IRS in published guidance as a tax avoidance transaction without 
regard to the size of the tax savings (i.e., a ``listed transaction''), 
(2) certain loss transactions under section 165 in excess of $10 
million for corporations, partnerships, and S corporations ($2 million 
for trusts and individuals), (3) any transaction resulting in a tax 
credit in excess of $250,000 if the taxpayer held the underlying asset 
for less than 45 days, (4) any book-tax difference of at least $10 
million, subject to certain exceptions, and (5) any transaction 
marketed under conditions of confidentiality, if the transaction is 
expected to result in a reduction in taxable income of at least 
$250,000 ($500,000 in the case of a corporation).
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Disclosure requirements

    The Committee further expects that the new regulations will 
specify the manner in which a taxpayer must disclose reportable 
transactions. The Committee anticipates that the information 
required to be disclosed with respect to reportable 
transactions will be sufficiently detailed so as to provide the 
Treasury Department and IRS the ability to analyze all aspects 
of the transaction and determine an appropriate course of 
action (if any). To accomplish this objective, a taxpayer may 
be required to disclose the following information with respect 
to a reportable transaction: (1) a detailed description of all 
facts relevant to the expected tax treatment of the reportable 
transaction (such as the structure of the transaction and the 
principal elements of the transaction), (2) a description and 
schedule of the expected tax benefits for all tax years 
resulting from the reportable transaction (including any 
anticipated transactions as part of the overall strategy), (3) 
if applicable, the names and addresses of any party who 
promoted, solicited, or recommended the taxpayer's 
participation in the transaction and who had a financial 
interest (including the receipt of fees) in the taxpayer's 
decision to participate, and (4) other information that the 
Secretary may prescribe (e.g., the involvement of any 
accommodation party or any tax-indifferent party, the receipt 
of a tax opinion with respect to the transaction, the amount of 
any fees paid to any promoter or advisor in connection with the 
transaction, any anticipated subsequent transactions or exit 
strategies).
    The Committee intends that, in accordance with section 6065 
(relating to verification of returns), the form the Secretary 
prescribes for taxpayer disclosure of reportable transactions 
will include a written declaration that the information is 
being provided under penalties of perjury. Moreover, the 
Committee intends that the verification under penalties of 
perjury also will apply to any large entity that discloses that 
it did not enter into any reportable transactions during the 
tax year covered by such declaration.

Penalty rate

    The penalty for failing to disclose a reportable 
transaction is $50,000. The amount is increased to $100,000 if 
the failure is with respect to a listed transaction. For large 
entities and high net worth individuals, the penalty amount is 
doubled (i.e., $100,000 for a reportable transaction and 
$200,000 for a listed transaction). The penalty cannot be 
waived with respect to a listed transaction. As to reportable 
transactions, the penalty can be rescinded or abated only in 
exceptional circumstances.\10\ All or part of the penalty may 
be rescinded only if: (1) the taxpayer on whom the penalty is 
imposed has a history of complying with the Federal tax laws, 
(2) it is shown that the violation is due to an unintentional 
mistake of fact, (3) imposing the penalty would be against 
equity and good conscience, and (4) rescinding the penalty 
would promote compliance with the tax laws and effective tax 
administration. The authority to rescind the penalty can only 
be exercised by the Commissioner personally or the head of the 
Office of Tax Shelter Analysis; this authority to rescind 
cannot otherwise be delegated by the Commissioner. Thus, the 
penalty cannot be rescinded by a revenue agent, an appeals 
officer, or other IRS personnel. The decision to rescind a 
penalty must be accompanied by a record describing the facts 
and reasons for the action and the amount rescinded. There will 
be no taxpayer right to appeal a refusal to rescind a penalty.
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    \10\ The Committee recognizes that the Secretary's present-law 
authority to postpone certain tax-related deadlines because of 
Presidentially-declared disasters (sec. 7508A) will also encompass the 
authority to postpone the reporting deadlines established by the 
provision.
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    The IRS also is required to submit an annual report to 
Congress summarizing the application of the disclosure 
penalties and providing a description of each penalty rescinded 
under this provision and the reasons for the rescission.
    A ``large entity'' is defined as any entity with gross 
receipts in excess of $10 million in the year of the 
transaction or in the preceding year. A ``high net worth 
individual'' is defined as any individual whose net worth 
exceeds $2 million, based on the fair market value of the 
individual's assets and liabilities immediately before entering 
into the transaction.
    A public entity that is required to pay a penalty for 
failing to disclose a listed transaction (or is subject to an 
accuracy-related penalty for a nondisclosed listed transaction 
or a nondisclosed reportable transaction with a significant tax 
avoidance purpose \11\) must disclose the imposition of the 
penalty in reports to the Securities and Exchange Commission 
(``SEC'') for such period as the Secretary shall specify. The 
provision applies without regard to whether the taxpayer 
determines the amount of the penalty to be material to the 
reports in which the penalty must appear, and treats any 
failure to disclose a transaction in such reports as a failure 
to disclose a listed transaction. A taxpayer must disclose a 
penalty in reports to the SEC once the taxpayer has exhausted 
its administrative and judicial remedies with respect to the 
penalty (or if earlier, when paid).
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    \11\ This category of transactions is described in greater detail 
below in connection with the provision modifying the accuracy-related 
penalty to tax shelters.
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    As described above in connection with present law, current 
regulations under section 6011 require the disclosure of 
certain reportable transactions. Until such regulations are 
modified to reflect the new categories of reportable 
transactions, the penalty will apply to taxpayers who fail to 
timely disclose any reportable transaction under the 
definitions contained in the current regulations.

                             EFFECTIVE DATE

    The provision is effective for returns and statements the 
due date for which is after the date of enactment.

     B. Modifications to the Accuracy-Related Penalties for Listed 
   Transactions and Reportable Transactions Having a Significant Tax 
                           Avoidance Purpose


(Sec. 102 of the bill and new sec. 6662A and secs. 6662 and 6664 of the 
        Code)

                              PRESENT LAW

    The accuracy-related penalty applies to the portion of any 
underpayment that is attributable to (1) negligence, (2) any 
substantial understatement of income tax, (3) any substantial 
valuation misstatement, (4) any substantial overstatement of 
pension liabilities, or (5) any substantial estate or gift tax 
valuation understatement. If the correct income tax liability 
exceeds that reported by the taxpayer by the greater of 10 
percent of the correct tax or $5,000 ($10,000 in the case of 
corporations), then a substantial understatement exists and a 
penalty may be imposed equal to 20 percent of the underpayment 
of tax attributable to the understatement.\12\ The amount of 
any understatement generally is reduced by any portion 
attributable to an item if (1) the treatment of the item is 
supported by substantial authority, or (2) facts relevant to 
the tax treatment of the item were adequately disclosed and 
there was a reasonable basis for its tax treatment.\13\
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    \12\ Sec. 6662.
    \13\ Sec. 6662(d)(2)(B).
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    Special rules apply with respect to tax shelters.\14\ For 
understatements by non-corporate taxpayers attributable to tax 
shelters, the penalty may be avoided only if the taxpayer 
establishes that, in addition to having substantial authority 
for the position, the taxpayer reasonably believed that the 
treatment claimed was more likely than not the proper treatment 
of the item. This reduction in the penalty is unavailable to 
corporate tax shelters.
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    \14\ Sec. 6662(d)(2)(C).
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    The understatement penalty generally is abated (even with 
respect to tax shelters) in cases in which the taxpayer can 
demonstrate that there was ``reasonable cause'' for the 
underpayment and that the taxpayer acted in good faith.\15\ The 
relevant regulations provide that reasonable cause exists where 
the taxpayer ``reasonably relies in good faith on an opinion 
based on a professional tax advisor's analysis of the pertinent 
facts and authorities [that] * * * unambiguously concludes that 
there is a greater than 50-percent likelihood that the tax 
treatment of the item will be upheld if challenged'' by the 
IRS.\16\
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    \15\ Sec. 6664(c).
    \16\ Treas. Reg. sec. 1.6662-4(g)(4)(i)(B); Treas. Reg. sec. 
1.6664-4(c).
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                           REASONS FOR CHANGE

    The Committee understands that taxpayers are being advised 
not to disclose tax avoidance transactions on the grounds that 
any accuracy-related penalty that could result from 
anunderpayment of tax on such a transaction can be avoided.\17\ Because 
the Treasury shelter initiative emphasizes combating abusive tax 
avoidance transactions by requiring increased disclosure of such 
transactions by all parties involved, the Committee believes that 
taxpayers should be subject to a strict liability penalty on an 
understatement of tax that is attributable to non-disclosed listed 
transactions or non-disclosed reportable transactions that have a 
significant purpose of tax avoidance. Furthermore, in order to deter 
taxpayers from entering into tax avoidance transactions, the Committee 
believes that a more meaningful (but less stringent) accuracy-related 
penalty should apply to such transactions even when disclosed.
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    \17\ See ``The Treasury Department's Enforcement Proposals for 
Abusive Tax Avoidance Transactions,'' at 12 (released on March 20, 
2002), reprinted electronically at 2002 TNT 55-28 (March 21, 2002).
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                        EXPLANATION OF PROVISION

In general

    The provision modifies the present-law accuracy related 
penalty by replacing the rules applicable to tax shelters with 
a new accuracy-related penalty that applies to listed 
transactions and reportable transactions with a significant tax 
avoidance purpose (hereinafter referred to as a ``reportable 
avoidance transaction'').\18\ The penalty rate and the taxpayer 
defenses available to avoid the penalty vary depending on the 
category of the transaction (i.e., listed or reportable 
avoidance transaction) and whether the transaction was 
adequately disclosed.
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    \18\ The terms ``reportable transaction'' and ``listed 
transaction'' have the same meanings as previously described in 
connection with the penalty for failing to disclose a reportable 
transaction.
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    In general, a 20-percent accuracy-related penalty is 
imposed on any understatement attributable to a listed 
transaction or a reportable avoidance transaction. The only 
exception to the penalty is if the taxpayer satisfies a more 
stringent reasonable cause and good faith exception 
(hereinafter referred to as the ``strengthened reasonable cause 
exception''), which is described below. The strengthened 
reasonable cause exception is available only if the relevant 
facts affecting the tax treatment are adequately disclosed, 
there is or was substantial authority for the claimed tax 
treatment, and the taxpayer reasonably believed that the 
claimed tax treatment was more likely than not the proper 
treatment.
    If the taxpayer does not adequately disclose the 
transaction, the strengthened reasonable cause exception is not 
available (i.e., a no-fault penalty applies), and the taxpayer 
is subject to an increased penalty rate. If the understatement 
is attributable to an undisclosed listed transaction, the 
penalty rate is increased to 30 percent of the understatement. 
For understatements attributable to an undisclosed reportable 
avoidance transaction, the penalty rate is 25 percent of the 
understatement.

Determination of the understatement amount

    The penalty is applied to the amount of any understatement 
attributable to the listed or reportable avoidance transaction 
without regard to other items on the tax return. For purposes 
of this provision, the amount of the understatement is 
determined as the sum of (1) the product of the highest 
corporate or individual tax rate (as appropriate) and the 
increase in taxable income resulting from the difference 
between the taxpayer's treatment of the item and the proper 
treatment of the item (without regard to other items on the tax 
return),\19\ and (2) the amount of any decrease in the 
aggregate amount of credits which results from a difference 
between the taxpayer's treatment of an item and the proper tax 
treatment of such item.
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    \19\ For this purpose, any reduction in the excess of deductions 
allowed for the taxable year over gross income for such year, and any 
reduction in the amount of capital losses which would (without regard 
to section 1211) be allowed for such year, shall be treated as an 
increase in taxable income.
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    Except as provided in regulations, the taxpayer's treatment 
of an item shall not take into account any amendment or 
supplement to a return if the amendment or supplement is filed 
after the earlier of when the taxpayer is first contacted 
regarding an examination of the return or such other date as 
specified by the Secretary.

Strengthened reasonable cause exception

    A penalty is not imposed under the provision with respect 
to any portion of an understatement if it is shown that there 
was reasonable cause for such portion and the taxpayer acted in 
good faith. Such a showing requires (1) adequate disclosure of 
the facts affecting the transaction in accordance with the 
regulations under section 6011,\20\ (2) there is or was 
substantial authority for such treatment, and (3) the taxpayer 
reasonably believed that such treatment was more likely than 
not the proper treatment. For this purpose, a taxpayer will be 
treated as having a reasonable belief with respect to the tax 
treatment of an item only if such belief (1) is based on the 
facts and law that exist at the time the tax return (that 
includes the item) is filed, and (2) relates solely to the 
taxpayer's chances of success on the merits and does not take 
into account the possibility that (a) a return will not be 
audited, (b) the treatment will not be raised on audit, or (c) 
the treatment will be resolved through settlement if raised.
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    \20\ See the previous discussion regarding the penalty for failing 
to disclose a reportable transaction.
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    A taxpayer may (but is not required to) rely on an opinion 
of a tax advisor in establishing its reasonable belief with 
respect to the tax treatment of the item. However, a taxpayer 
may not rely on an opinion of a tax advisor for this purpose if 
the opinion (1) is provided by a ``disqualified tax advisor,'' 
or (2) is a ``disqualified opinion.''
            Disqualified tax advisor
    A disqualified tax advisor is any material advisor \21\ who 
(1) participates in the organization, management, promotion or 
sale of the transaction or is related (within the meaning of 
section 267 or 707) to any person who so participates, (2) is 
compensated by another material advisor with respect to the 
transaction, (3) has a fee arrangement with respect to the 
transaction that is contingent on all or part of the intended 
tax benefits from the transaction being sustained, or (4) as 
determined under regulations prescribed by the Secretary, has a 
continuing financial interest with respect to the 
transaction.\22\
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    \21\ The term ``material advisor'' (defined below in connection 
with the new information filing requirements for material advisors) 
means any person who provides any material aid, assistance, or advice 
with respect to organizing, promoting, selling, implementing, or 
carrying out any reportable transaction, and who derives gross income 
in excess of $50,000 in the case of a reportable transaction 
substantially all of the tax benefits from which are provided to 
natural persons ($250,000 in any other case).
    \22\ This situation could arise, for example, when an advisor has 
an arrangement or understanding (oral or written) with an organizer, 
manager, or promoter of a reportable transaction that such party will 
recommend or refer potential participants to the advisor for an opinion 
regarding the tax treatment of the transaction.
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            Organization, management, promotion or sale of a 
                    transaction
    The Committee intends that a material advisor be considered 
as participating in the ``organization'' of a transaction if 
the advisor performs acts relating to the development of the 
transaction. This may include, for example, preparing documents 
(1) establishing a structure used in connection with the 
transaction (such as a partnership agreement), (2) describing 
the transaction (such as an offering memorandum or other 
statement describing the transaction), or (3) relating to the 
registration of the transaction with any federal, state or 
local government body.\23\ Participation in the ``management'' 
of a transaction means involvement in the decision-making 
process regarding any business activity with respect to the 
transaction. Participation in the ``promotion or sale'' of a 
transaction means involvement in the marketing or solicitation 
of the transaction to others. Thus, an advisor who provides 
information about the transaction to a potential participant is 
involved in the promotion or sale of a transaction, as is any 
advisor who recommends the transaction to a potential 
participant.
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    \23\ An advisor should not be treated as participating in the 
organization of a transaction if the advisor's only involvement with 
respect to the organization of the transaction is the rendering of an 
opinion regarding the tax consequences of such transaction. However, 
such an advisor may be a ``disqualified tax advisor'' with respect to 
the transaction if the advisor participates in the management, 
promotion or sale of the transaction (or if the material advisor is 
compensated by another material advisor, has a fee arrangement that is 
contingent on the tax benefits of the transaction, or as determined by 
the Secretary, has a continuing financial interest with respect to the 
transaction).
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            Disqualified opinion
    An opinion may not be relied upon if the opinion (1) is 
based on unreasonable factual or legal assumptions (including 
assumptions as to future events), (2) unreasonably relies upon 
representations, statements, finding or agreements of the 
taxpayer or any other person, (3) does not identify and 
consider all relevant facts, or (4) fails to meet any other 
requirement prescribed by the Secretary.

Coordination with other penalties

    Any understatement to which a penalty is imposed under this 
provision is not subject to the accuracy-related penalty under 
section 6662. However, such understatement is included for 
purposes of determining whether any understatement (as defined 
in sec. 6662(d)(2)) is a substantial understatement as defined 
under section 6662(d)(1).
    The penalty imposed under this provision shall not apply to 
any portion of an understatement to which a fraud penalty is 
applied under section 6663.

                             EFFECTIVE DATE

    The provision is effective for taxable years ending after 
the date of enactment.

       C. Modifications to the Substantial Understatement Penalty


(Sec. 103 of the bill and sec. 6662 of the Code)

                              PRESENT LAW

Definition of substantial understatement

    An accuracy-related penalty equal to 20 percent applies to 
any substantial understatement of tax. A ``substantial 
understatement'' exists if the correct income tax liability for 
a taxable year exceeds that reported by the taxpayer by the 
greater of 10 percent of the correct tax or $5,000 ($10,000 in 
the case of most corporations).\24\
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    \24\ Sec. 6662(a) and (d)(1)(A).
---------------------------------------------------------------------------

Reduction of understatement for certain positions

    For purposes of determining whether a substantial 
understatement penalty applies, the amount of any 
understatement generally is reduced by any portion attributable 
to an item if (1) the treatment of the item is supported by 
substantial authority, or (2) facts relevant to the tax 
treatment of the item were adequately disclosed and there was a 
reasonable basis for its tax treatment.\25\
---------------------------------------------------------------------------
    \25\ Sec. 6662(d)(2)(B).
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    The Secretary is required to publish annually in the 
Federal Register a list of positions for which the Secretary 
believes there is not substantial authority and which affect a 
significant number of taxpayers.\26\
---------------------------------------------------------------------------
    \26\ Sec. 6662(d)(2)(D).
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                           REASONS FOR CHANGE

    The Committee believes that the present-law definition of 
substantial understatement allows large corporate taxpayers to 
avoid the accuracy-related penalty on questionable transactions 
of a significant size. The Committee believes that an 
understatement of more than $10 million is substantial in and 
of itself, regardless of the proportion it represents of the 
taxpayer's total tax liability.
    The Committee believes that a higher compliance standard 
should be imposed on any taxpayer in order to reduce the amount 
of an understatement resulting from a transaction that the 
taxpayer did not adequately disclose. The Committee further 
believes that a taxpayer should not take a position on a tax 
return that could give rise to a substantial understatement 
penalty that the taxpayer does not believe is more likely than 
not the correct tax treatment unless this information is 
disclosed to the IRS.

                        EXPLANATION OF PROVISION

Definition of substantial understatement

    The provision modifies the definition of ``substantial'' 
for corporate taxpayers. Under the provision, a corporate 
taxpayer has a substantial understatement if the amount of the 
understatement for the taxable year exceeds the lesser of (1) 
10 percent of the tax required to be shown on the return for 
the taxable year (or, if greater, $10,000), or (2) $10 million.

Reduction of understatement for certain positions

    The provision elevates the standard that a taxpayer must 
satisfy in order to reduce the amount of an understatement for 
undisclosed items. With respect to the treatment of an item 
whose facts are not adequately disclosed, a resulting 
understatement is reduced only if the taxpayer had a reasonable 
belief that the tax treatment was more likely than not the 
proper treatment. The provision also authorizes (but does not 
require) the Secretary to publish a list of positions for which 
it believes there is not substantial authority or there is no 
reasonable belief that the tax treatment is more likely than 
not the proper treatment (without regard to whether such 
positions affect a significant number of taxpayers). The list 
shall be published in the Federal Register or the Internal 
Revenue Bulletin.

                             EFFECTIVE DATE

    The provision is effective for taxable years beginning 
after date of enactment.

  D. Tax Shelter Exception to Confidentiality Privileges Relating to 
                        Taxpayer Communications


(Sec. 104 of the bill and sec. 7525 of the Code)

                              PRESENT LAW

    In general, a common law privilege of confidentiality 
exists for communications between an attorney and client with 
respect to the legal advice the attorney gives the client. The 
Code provides that, with respect to tax advice, the same common 
law protections of confidentiality that apply to a 
communication between a taxpayer and an attorney also apply to 
a communication between a taxpayer and a federally authorized 
tax practitioner to the extent the communication would be 
considered a privileged communication if it were between a 
taxpayer and an attorney. This rule is inapplicable to 
communications regarding corporate tax shelters.

                           REASONS FOR CHANGE

    The Committee believes that the rule currently applicable 
to corporate tax shelters should be applied to all tax 
shelters, regardless of whether or not the participant is a 
corporation.

                        EXPLANATION OF PROVISION

    The bill modifies the rule relating to corporate tax 
shelters by making it applicable to all tax shelters, whether 
entered into by corporations, individuals, partnerships, tax-
exempt entities, or any other entity. Accordingly, 
communications with respect to tax shelters are not subject to 
the confidentiality provision of the Code that otherwise 
applies to a communication between a taxpayer and a federally 
authorized tax practitioner.

                             EFFECTIVE DATE

    The provision is effective with respect to communications 
made on or after the date of enactment.

     E. Disclosure of Reportable Transactions by Material Advisors


(Secs. 201 and 202 of the bill and secs. 6111 and 6707 of the Code)

                              PRESENT LAW

Registration of tax shelter arrangements

    An organizer of a tax shelter is required to register the 
shelter with the Secretary not later than the day on which the 
shelter is first offered for sale.\27\ A ``tax shelter'' means 
any investment with respect to which the tax shelter ratio \28\ 
for any investor as of the close of any of the first five years 
ending after the investment is offered for sale may be greater 
than two to one and which is: (1) required to be registered 
under Federal or State securities laws, (2) sold pursuant to an 
exemption from registration requiring the filing of a notice 
with a Federal or State securities agency, or (3) a substantial 
investment (greater than $250,000 and at least five 
investors).\29\
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    \27\ Sec. 6111(a).
    \28\ The tax shelter ratio is, with respect to any year, the ratio 
that the aggregate amount of the deductions and 350 percent of the 
credits, which are represented to be potentially allowable to any 
investor, bears to the investment base (money plus basis of assets 
contributed) as of the close of the tax year.
    \29\ Sec. 6111(c).
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    Other promoted arrangements are treated as tax shelters for 
purposes of the registration requirement if: (1) a significant 
purpose of the arrangement is the avoidance or evasion of 
Federal income tax by a corporate participant; (2) the 
arrangement is offered under conditions of confidentiality; and 
(3) the promoter may receive fees in excess of $100,000 in the 
aggregate.\30\
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    \30\ Sec. 6111(d).
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    A transaction has a ``significant purpose of avoiding or 
evading Federal income tax'' if the transaction: (1) is the 
same as or substantially similar to a ``listed transaction,'' 
\31\ or (2) is structured to produce tax benefits that 
constitute an important part of the intended results of the 
arrangement and the promoter reasonably expects to present the 
arrangement to more than one taxpayer.\32\ Certain exceptions 
are provided with respect to the second category of 
transactions.\33\
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    \31\ Temp. Treas. Reg. sec. 301.6111-2T(b)(2).
    \32\ Temp. Treas. Reg. sec. 301.6111-2T(b)(3).
    \33\ Temp. Treas. Reg. sec. 301.6111-2T(b)(4).
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    An arrangement is offered under conditions of 
confidentiality if: (1) an offeree has an understanding or 
agreement to limit the disclosure of the transaction or any 
significant tax features of the transaction; or (2) the 
promoter claims, knows, or has reason to know that a partyother 
than the potential participant claims that the transaction (or any 
aspect of it) is proprietary to the promoter or any party other than 
the offeree, or is otherwise protected from disclosure or 
use.34
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    \34\ The regulations provide that the determination of whether an 
arrangement is offered under conditions of confidentiality is based on 
all the facts and circumstances surrounding the offer. If an offeree's 
disclosure of the structure or tax aspects of the transaction are 
limited in any way by an express or implied understanding or agreement 
with or for the benefit of a tax shelter promoter, an offer is 
considered made under conditions of confidentiality, whether or not 
such understanding or agreement is legally binding. Treas. Reg. sec. 
301.6111-2T(c)(1).
---------------------------------------------------------------------------

Failure to register tax shelter

    The penalty for failing to timely register a tax shelter 
(or for filing false or incomplete information with respect to 
the tax shelter registration) generally is the greater of one 
percent of the aggregate amount invested in the shelter or 
$500.35 However, if the tax shelter involves an 
arrangement offered to a corporation under conditions of 
confidentiality, the penalty is the greater of $10,000 or 50 
percent of the fees payable to any promoter with respect to 
offerings prior to the date of late registration. Intentional 
disregard of the requirement to register increases the penalty 
to 75 percent of the applicable fees.
---------------------------------------------------------------------------
    \35\ Sec. 6707.
---------------------------------------------------------------------------
    Section 6707 also imposes (1) a $100 penalty on the 
promoter for each failure to furnish the investor with the 
required tax shelter identification number, and (2) a $250 
penalty on the investor for each failure to include the tax 
shelter identification number on a return.

                           REASONS FOR CHANGE

    The Committee has been advised that the current promoter 
registration rules have not proven particularly helpful, 
because the rules are not appropriate for the kinds of abusive 
transactions now prevalent, and because the limitations 
regarding confidential corporate arrangements have proven easy 
to circumvent.
    The Committee believes that providing a single, clear 
definition regarding the types of transactions that must be 
disclosed by taxpayers and material advisors (as outlined in 
the Treasury shelter initiative), coupled with more meaningful 
penalties for failing to disclose such transactions, are 
necessary tools if the effort to curb the use of abusive tax 
avoidance transactions is to be effective.36
---------------------------------------------------------------------------
    \36\ The Treasury Department's enforcement proposals for abusive 
tax avoidance transactions are described in greater detail above in 
connection with the penalty for failing to disclose reportable 
transactions (new sec. 6707A).
---------------------------------------------------------------------------

                        EXPLANATION OF PROVISION

Disclosure of reportable transactions by material advisors

    The provision repeals the present law rules with respect to 
registration of tax shelters. Instead, the provision requires 
each material advisor with respect to any reportable 
transaction 37 to timely file an information return 
with the Secretary (in such form and manner as the Secretary 
may prescribe). The return must be filed on such date as 
specified by the Secretary.
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    \37\ The terms ``reportable transaction'' and ``listed 
transaction'' have the same meaning as previously described in 
connection with the taxpayer-related provisions.
---------------------------------------------------------------------------
    The information return will include (1) information 
identifying and describing the transaction, (2) information 
describing any potential tax benefits expected to result from 
the transaction, and (3) such other information as the 
Secretary may prescribe. It is expected that the Secretary may 
seek from the material advisor the same type of information 
that the Secretary may request from a taxpayer in connection 
with a reportable transaction.38
---------------------------------------------------------------------------
    \38\ See the previous discussion regarding the disclosure 
requirements under new section 6707A.
---------------------------------------------------------------------------
    A ``material advisor'' means any person (1) who provides 
material aid, assistance, or advice with respect to organizing, 
promoting, selling, implementing, or carrying out any 
reportable transaction, and (2) who directly or indirectly 
derives gross income in excess of $250,000 ($50,000 in the case 
of a reportable transaction substantially all of the tax 
benefits from which are provided to natural persons) for such 
advice or assistance.
    The Secretary may prescribe regulations which provide (1) 
that only one material advisor has to file an information 
return in cases in which two or more material advisors would 
otherwise be required to file information returns with respect 
to a particular reportable transaction, (2) exemptions from the 
requirements of this section, and (3) other rules as may be 
necessary or appropriate to carry out the purposes of this 
section.

Penalty for failing to furnish information regarding reportable 
        transactions

    The provision repeals the present law penalty for failure 
to register tax shelters. Instead, the provision imposes a 
penalty on any material advisor who fails to file an 
information return with respect to any reportable transaction, 
or who files a false or incomplete information return with the 
Secretary with respect to a reportable 
transaction.39 The amount of the penalty is $50,000. 
If the penalty is with respect to a listed transaction, the 
amount of the penalty is increased to the greater of (1) 
$200,000, or (2) 50 percent of the gross income of such person 
with respect to aid, assistance, or advice which is provided 
with respect to the reportable transaction before the date the 
information return that includes the transaction is filed. 
Intentional disregard by a material advisor of the requirement 
to disclose a reportable transaction increases the penalty to 
75 percent of such gross income.
---------------------------------------------------------------------------
    \39\ The terms ``reportable transaction'' and ``listed 
transaction'' have the same meaning as previously described in 
connection with the taxpayer-related provisions.
---------------------------------------------------------------------------
    The penalty cannot be waived with respect to a listed 
transaction. As to reportable transactions, the penalty can be 
rescinded or abated only in exceptional 
circumstances.40 All or part of the penalty may be 
rescinded only if: (1) the material advisor on whom the penalty 
is imposed has a history of complying with the Federal tax 
laws, (2) it is shown that the violation is due to an 
unintentional mistake of fact, (3) imposing the penalty would 
be against equity and good conscience, and (4) rescinding the 
penalty would promote compliance with the tax laws and 
effective tax administration. The authority to rescind the 
penalty can only be exercised by the Commissioner personally or 
the head of the Office of Tax Shelter Analysis; this authority 
to rescind cannot otherwise be delegated by the Commissioner. 
Thus, the penalty cannot be rescinded by a revenue agent, an 
appeals officer, or other IRS personnel. The decision to 
rescind a penalty must be accompanied by a record describing 
the facts and reasons for the action and the amount rescinded. 
There will be no right to appeal a refusal to rescind a 
penalty. The IRS also is required to submit an annual report to 
Congress summarizing the application of the disclosure 
penalties and providing a description of each penalty rescinded 
under this provision and the reasons for the rescission.
---------------------------------------------------------------------------
    \40\ The Committee recognizes that the Secretary's present-law 
authority to postpone certain tax-related deadlines because of 
Presidentially-declared disasters (sec. 7508A) will also encompass the 
authority to postpone the reporting deadlines established by the 
provision.
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                             EFFECTIVE DATE

    The provision requiring disclosure of reportable 
transactions by material advisors applies to transactions with 
respect to which material aid, assistance or advice is provided 
after the date of enactment.
    The provision imposing a penalty for failing to disclose 
reportable transactions applies to returns the due date for 
which is after the date of enactment.

               F. Investor Lists and Applicable Penalties


(Secs. 201 and 203 of the bill and secs. 6112 and 6708 of the Code)

                              PRESENT LAW

Investor lists

    A promoter must maintain (for a period of seven years) a 
list identifying each person who was sold an interest in any 
tax shelter with respect to which registration was required 
under section 6111 (even though the particular party may not 
have been subject to confidentiality restrictions).\41\ 
Regulations under section 6112 provide that, in addition to the 
name, tax shelter identification number and other identifying 
information the promoter must include detailed information 
about the tax shelter (including details of the shelter and the 
expected tax benefits, as well as copies of any additional 
written material given to any participant or advisor).\42\ A 
limited exception is provided for certain shelters if the total 
fees are less than $25,000 or if the expected reduction in tax 
liabilities for any single year is less than $1 million for 
corporations or $250,000 for non-corporate taxpayers.\43\ The 
Secretary is required to prescribe regulations which provide 
that, in cases in which 2 or more persons are required to 
maintain the same list, only one person would be required to 
maintain the list.\44\
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    \41\ Sec. 6112.
    \42\ See Temp. Treas. Reg. sec. 301.6112-1T Q&A 17.
    \43\ See Temp. Treas. Reg. sec. 301-6112-1T Q&A 8.
    \44\ Sec. 6112(c)(2).
---------------------------------------------------------------------------

Penalties for failing to maintain investor lists

    Under section 6708, the penalty for failing to maintain the 
list required under section 6112 is $50 for each name omitted 
from the list (with a maximum penalty of $100,000 per year).

                           REASONS FOR CHANGE

    The Committee has been advised that the present-law 
penalties for failure to maintain customer lists are not 
meaningful and that promoters often have refused to provide 
requested information to the IRS. The Committee believes that 
requiring material advisors to maintain a list of advisees with 
respect to each reportable transaction, coupled with more 
meaningful penalties for failing to maintain an investor list, 
are important tools in the ongoing efforts to curb the use of 
abusive tax avoidance transactions. Furthermore, these 
provisions are consistent with the course of action outlined in 
the Treasury shelter initiative.\45\
---------------------------------------------------------------------------
    \45\ The Treasury Department's enforcement proposals for abusive 
tax avoidance transactions are described in greater detail above in 
connection with the penalty for failing to disclose reportable 
transactions (new sec. 6707A).
---------------------------------------------------------------------------

                        EXPLANATION OF PROVISION

Investor lists

    Each material advisor \46\ that is required to file an 
information return with respect to a reportable transaction 
\47\ is required to maintain a list that (1) identifies each 
person with respect to whom the advisor acted as a material 
advisor with respect to the reportable transaction, and (2) 
contains other information as may be required by the Secretary. 
In addition, the provision authorizes (but does not require) 
the Secretary to prescribe regulations which provide that, in 
cases in which 2 or more persons are required to maintain the 
same list, only one person would be required to maintain the 
list.
---------------------------------------------------------------------------
    \46\ The term ``material advisor'' has the same meaning as when 
used in connection with the requirement to file an information return 
under section 6111.
    \47\ The term ``reportable transaction'' has the same meaning as 
previously described in connection with the taxpayer-related 
provisions.
---------------------------------------------------------------------------

Penalty for failing to maintain investor lists

    The provision modifies the penalty for failing to maintain 
the required list by making it a time-sensitive penalty. Thus, 
a material advisor who is required to maintain an investor list 
and who fails to make the list available upon request by the 
Secretary within 20 business days after the request will be 
subject to a $10,000 per day penalty. The penalty applies to a 
person who fails to maintain a list, maintains an incomplete 
list, or has in fact maintained a list but does not make the 
list available to the Secretary. The penalty can be waived if 
the failure to make the list available is due to reasonable 
cause.\48\
---------------------------------------------------------------------------
    \48\ In no event will failure to maintain a list be considered 
reasonable cause for failing to make a list available to the Secretary.
---------------------------------------------------------------------------

                             EFFECTIVE DATE

    The provision requiring a material advisor to maintain an 
investor list applies to transactions with respect to which 
material aid, assistance or advice is provided after the date 
of enactment.
    The provision imposing a penalty for failing to maintain 
investor lists applies to requests made after the date of 
enactment.

       G. Actions To Enjoin Conduct With Respect to Tax Shelters


(Sec. 204 of the bill and sec. 7408 of the Code)

                              PRESENT LAW

    The Code authorizes civil action to enjoin any person from 
promoting abusive tax shelters or aiding or abetting the 
understatement of tax liability.\49\
---------------------------------------------------------------------------
    \49\ Sec. 7408.
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee understands that some promoters are blatantly 
ignoring the rules regarding registration and list maintenance 
regardless of the penalties. An injunction would place these 
promoters in a public proceeding under court order. Thus, the 
Committee believes that the types of tax shelter activities 
with respect to which an injunction may be sought should be 
expanded.

                        EXPLANATION OF PROVISION

    The bill expands this rule so that injunctions may also be 
sought with respect to the requirements relating to the 
reporting of tax shelters \50\ and the keeping of lists of 
investors by material advisors.\51\ Thus, under the provision, 
an injunction may be sought against a material advisor to 
enjoin the advisor from (1) failing to file an information 
return with respect to a reportable transaction, or (2) failing 
to maintain, or to timely furnish upon written request by the 
Secretary, a list of investors with respect to each reportable 
transaction.
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    \50\ Sec. 6707, as amended by other provisions of this bill.
    \51\ Sec. 6708, as amended by other provisions of this bill.
---------------------------------------------------------------------------

                             EFFECTIVE EATE

    The provision is effective on the day after the date of 
enactment.

H. Understatement of Taxpayer's Liability by Income Tax Return Preparer


(Sec. 211 of the bill and sec. 6694 of the Code)

                              PRESENT LAW

    An income tax return preparer who prepares a return with 
respect to which there is an understatement of tax that is due 
to a position for which there was not a realistic possibility 
of being sustained on its merits and the position was not 
disclosed (or was frivolous) is liable for a penalty of $250, 
provided that the preparer knew or reasonably should have known 
of the position. An income tax return preparer who prepares a 
return and engages in specified willful or reckless conduct 
with respect to preparing such a return is liable for a penalty 
of $1,000.

                           REASONS FOR CHANGE

    The Committee believes that the standards of conduct 
applicable to income tax return preparers should be the same as 
the standards applicable to taxpayers. Accordingly, the minimum 
standard for each undisclosed position on a tax return would be 
that the preparer must reasonably believe that the tax 
treatment is more likely than not the proper tax treatment. The 
Committee believes that this standard is appropriate because 
the tax return is signed under penalties of perjury, which 
implies a high standard of diligence in determining the facts 
and substantial accuracy in determining and applying the rules 
that govern those facts. The Committee believes that it is both 
appropriate and vital to the tax system that both taxpayers and 
their return preparers file tax returns that they reasonably 
believe are more likely than not correct. In addition, 
conforming the standards of conduct applicable to income tax 
return preparers to the standards applicable to taxpayers will 
simplify the law by reducing confusion inherent in different 
standards applying to the same behavior.

                        EXPLANATION OF PROVISION

    The bill alters the standards of conduct that must be met 
to avoid imposition of the first penalty. The bill replaces the 
realistic possibility standard with a requirement that there be 
a reasonable belief that the tax treatment of the position was 
more likely than not the proper treatment. The bill also 
replaces the not frivolous standard with the requirement that 
there be a reasonable basis for the tax treatment of the 
position.
    In addition, the bill increases the amount of these 
penalties. The penalty relating to not having a reasonable 
belief that the tax treatment was more likely than not the 
proper tax treatment is increased from $250 to $1,000. The 
penalty relating to willful or reckless conduct is increased 
from $1,000 to $5,000.

                             EFFECTIVE DATE

    The provision is effective for documents prepared after the 
date of enactment.

I. Penalty on Failure To Report Interests in Foreign Financial Accounts


(Sec. 212 of the bill and sec. 5321 of Title 31, United States Code)

                              PRESENT LAW

    The Secretary of the Treasury must require citizens, 
residents, or persons doing business in the United States to 
keep records and file reports when that person makes a 
transaction or maintains an account with a foreign financial 
entity.\52\ In general, individuals must fulfill this 
requirement by answering questions regarding foreign accounts 
or foreign trusts that are contained in Part III of Schedule B 
of the IRS Form 1040. Taxpayers who answer ``yes'' in response 
to the question regarding foreign accounts must then file 
Treasury Department Form TD F 90-22.1. This form must be filed 
with the Department of the Treasury, and not as part of the tax 
return that is filed with the IRS.
---------------------------------------------------------------------------
    \52\ 31 U.S.C. 5314.
---------------------------------------------------------------------------
    The Secretary of the Treasury may impose a civil penalty on 
any person who willfully violates this reporting requirement. 
The civil penalty is the amount of the transaction or the value 
of the account, up to a maximum of $100,000; the minimum amount 
of the penalty is $25,000.\53\ In addition, any person who 
willfully violates this reporting requirement is subject to a 
criminal penalty. The criminal penalty is a fine of not more 
than $250,000 or imprisonment for not more than five years (or 
both); if the violation is part of a pattern of illegal 
activity, the maximum amount of the fine is increased to 
$500,000 and the maximum length of imprisonment is increased to 
10 years.\54\
---------------------------------------------------------------------------
    \53\ 31 U.S.C. 5321(a)(5).
    \54\ 31 U.S.C. 5322.
---------------------------------------------------------------------------
    On April 26, 2002, the Secretary of the Treasury submitted 
to the Congress a report on these reporting requirements.\55\ 
This report, which was statutorily required,\56\ studies 
methods for improving compliance with these reporting 
requirements. It makes several administrative recommendations, 
but no legislative recommendations. A further report is 
required to be submitted by the Secretary of the Treasury to 
the Congress by October 26, 2002.
---------------------------------------------------------------------------
    \55\ A Report to Congress in Accordance with Sec. 361(b) of the 
Uniting and Strengthening America by Providing Appropriate Tools 
Required to Intercept and Obstruct Terrorism Act of 2001, April 
26,2002.
    \56\ Sec. 361(b) of the USA PATRIOT Act of 2001 (Pub. L. 107-56).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee understands that the number of individuals 
involved in using offshore bank accounts to engage in abusive 
tax scams has grown significantly in recent years. For one 
scheme alone, the IRS estimates that there may be one to two 
million taxpayers with offshore bank accounts attempting to 
conceal income from the IRS. The Committee is concerned about 
this activity and believes that improving compliance with this 
reporting requirement is vitally important to sound tax 
administration, to combating terrorism, and to preventing the 
use of abusive tax schemes and scams. Adding a new civil 
penalty that applies without regard to willfulness will improve 
compliance with this reporting requirement.

                        EXPLANATION OF PROVISION

    The bill adds an additional civil penalty that may be 
imposed on any person who violates this reporting requirement 
(without regard to willfulness). This new civil penalty is up 
to $5,000. The penalty may be waived if any income from the 
account was properly reported on the income tax return and 
there was reasonable cause for the failure to report.

                             EFFECTIVE DATE

    The provision is effective with respect to failures to 
report occurring on or after the date of enactment.

                J. Frivolous Tax Returns and Submissions


(Sec. 213 of the bill and sec. 6702 of the Code)

                              PRESENT LAW

    The Code provides that an individual who files a frivolous 
income tax return is subject to a penalty of $500 imposed by 
the IRS (sec. 6702). The Code also permits the Tax Court \57\ 
to impose a penalty of up to $25,000 if a taxpayer has 
instituted or maintained proceedings primarily for delay or if 
the taxpayer's position in the proceeding is frivolous or 
groundless (sec. 6673(a)).
---------------------------------------------------------------------------
    \57\ Because in general the Tax Court is the only pre-payment forum 
available to taxpayers, it deals with most of the frivolous, 
groundless, or dilatory arguments raised in tax cases.
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The IRS has been faced with a significant number of tax 
filers who are filing returns based on frivolous arguments or 
who are seeking to hinder tax administration by filing returns 
that are patently incorrect. In addition, taxpayers are using 
existing procedures for collection due process hearings, 
offers-in-compromise, installment agreements, and taxpayer 
assistance orders to impede or delay tax administration by 
raising frivolous arguments. These procedures were intended to 
provide assistance to taxpayers genuinely seeking to resolve 
legitimate disputes with the IRS, and the use of these 
procedures for impeding or delaying tax administration diverts 
scarce IRS resources away from resolving genuine disputes. 
Allowing the IRS to assert more substantial penalties for 
frivolous submissions and to dismiss frivolous requests without 
the need to follow otherwise mandated procedures will deter 
frivolous taxpayer behavior and enable the IRS to use its 
resources to better assist taxpayers in resolving genuine 
disputes.

                        EXPLANATION OF PROVISION

    The bill modifies the IRS-imposed penalty by increasing the 
amount of the penalty to up to $5,000 and by applying it to all 
taxpayers and to all types of Federal taxes.
    The provision also modifies present law with respect to 
certain submissions that raise frivolous arguments or that are 
intended to delay or impede tax administration. The submissions 
to which this provision applies are requests for a collection 
due process hearing, installment agreements, offers-in-
compromise, and taxpayer assistance orders. First, the 
provision permits the IRS to dismiss such requests. Second, the 
provision permits the IRS to impose a penalty of up to $5,000 
for such requests, unless the taxpayer withdraws the request 
after being given an opportunity to do so.
    The provision requires the IRS to publish a list of 
positions, arguments, requests, and proposals determined to be 
frivolous for purposes of these provisions.

                             EFFECTIVE DATE

    The provision is effective for submissions made and issues 
raised after the date on which the Secretary first prescribes 
the required list.

 K. Regulation of Individuals Practicing Before the Department of the 
                                Treasury


(Sec. 214 of the bill and sec. 330 of Title 31, United States Code)

                              PRESENT LAW

    The Secretary of the Treasury is authorized to regulate the 
practice of representatives of persons before the Department of 
the Treasury.\58\ The Secretary is also authorized to suspend 
or disbar from practice before the Department a representative 
who is incompetent, who is disreputable, who violates the rules 
regulating practice before the Department, or who (with intent 
to defraud) willfully and knowingly misleads or threatens the 
person being represented (or a person who may be represented). 
The rules promulgated by the Secretary pursuant to this 
provision are contained in Circular 230.
---------------------------------------------------------------------------
    \58\ 31 U.S.C. 330.
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes that it is critical that the 
Secretary have the authority to censure tax advisors as well as 
to impose monetary sanctions against tax advisors because of 
the important role of tax advisors in our tax system. Use of 
these sanctions is expected to curb the participation of tax 
advisors in both tax shelter activity and any other activity 
that is contrary to Circular 230 standards.

                        EXPLANATION OF PROVISION

    The bill makes two modifications to expand the sanctions 
that the Secretary may impose pursuant to these statutory 
provisions. First, the bill expressly permits censure as a 
sanction. Second, the bill permits the imposition of a monetary 
penalty as a sanction. If the representative is acting on 
behalf of an employer or other entity, the Secretary may impose 
a monetary penalty on the employer or other entity if it knew, 
or reasonably should have known, of the conduct. This monetary 
penalty on the employer or other entity may be imposed in 
addition to any monetary penalty imposed directly on the 
representative. These monetary penalties are not to exceed the 
gross income derived (or to be derived) from the conduct giving 
rise to the penalty. These monetary penalties may be in 
addition to, or in lieu of, any suspension, disbarment, or 
censure.
    The bill also confirms the present-law authority of the 
Secretary to impose standards applicable to written advice with 
respect to an entity, plan, or arrangement that is of a type 
that the Secretary determines as having a potential for tax 
avoidance or evasion.

                             EFFECTIVE DATE

    The modifications to expand the sanctions that the 
Secretary may impose are effective for actions taken after the 
date of enactment.

               L. Penalties on Promoters of Tax Shelters


(Sec. 215 of the bill and sec. 6700 of the Code)

                              PRESENT LAW

    A penalty is imposed on any person who organizes, assists 
in the organization of, or participates in the sale of any 
interest in, a partnership or other entity, any investment plan 
or arrangement, or any other plan or arrangement, if in 
connection with such activity the person makes or furnishes a 
qualifying false or fraudulent statement or a gross valuation 
overstatement.\59\ A qualified false or fraudulent statement is 
any statement with respect to the allowability of any deduction 
or credit, the excludability of any income, or the securing of 
any other tax benefit by reason of holding an interest in the 
entity or participating in the plan or arrangement which the 
person knows or has reason to know is false or fraudulent as to 
any material matter. A ``gross valuation overstatement'' means 
any statement as to the value of any property or services if 
the stated value exceeds 200 percent of the correct valuation, 
and the value is directly related to the amount of any 
allowable income tax deduction or credit.
---------------------------------------------------------------------------
    \59\ Sec. 6700.
---------------------------------------------------------------------------
    The amount of the penalty is $1,000 (or, if the person 
establishes that it is less, 100 percent of the gross income 
derived or to be derived by the person from such activity). A 
penalty attributable to a gross valuation misstatement can be 
waived on a showing that there was a reasonable basis for the 
valuation and it was made in good faith.

                           REASONS FOR CHANGE

    The Committee believes that the present-law penalty rate is 
insufficient to deter the type of conduct that gives rise to 
the penalty.

                        EXPLANATION OF PROVISION

    The provision modifies the penalty amount to equal 50 
percent of the gross income derived by the person from the 
activity for which the penalty is imposed. The new penalty rate 
applies to any activity that involves a statement regarding the 
tax benefits of participating in a plan or arrangement if the 
person knows or has reason to know that such statement is false 
or fraudulent as to any material matter. The enhanced penalty 
does not apply to a gross valuation overstatement.

                             EFFECTIVE DATE

    The provision is effective for activities after the date of 
enactment.

                         III. OTHER PROVISIONS


       A. Affirmation of Consolidated Return Regulation Authority


(Sec. 301 of the bill and sec. 1502 of the Code)

                              PRESENT LAW

    An affiliated group of corporations may elect to file a 
consolidated return in lieu of separate returns. A condition of 
electing to file a consolidated return is that all corporations 
that are members of the consolidated group must consent to all 
the consolidated return regulations prescribed under section 
1502 prior to the last day prescribed by law for filing such 
return.\60\
---------------------------------------------------------------------------
    \60\ Sec. 1501.
---------------------------------------------------------------------------
    Section 1502 states:

          The Secretary shall prescribe such regulations as he 
        may deem necessary in order that the tax liability of 
        any affiliated group of corporations making a 
        consolidated return and of each corporation in the 
        group, both during and after the period of affiliation, 
        may be returned, determined, computed, assessed, 
        collected, and adjusted, in such manner as clearly to 
        reflect the income-tax liability and the various 
        factors necessary for the determination of such 
        liability, and in order to prevent the avoidance of 
        such tax liability.\61\
---------------------------------------------------------------------------
    \61\ Sec. 1502.

    Under this authority, the Treasury Department has issued 
extensive consolidated return regulations.\62\
---------------------------------------------------------------------------
    \62\ Regulations issued under the authority of section 1502 are 
considered to be ``legislative'' regulations rather than 
``interpretative'' regulations, and as such are usually given greater 
deference by courts in case of a taxpayer challenge to such a 
regulation. See, S. Rep. No. 960, 70th Cong., 1st Sess. at 15, 
describing the consolidated return regulations as ``legislative in 
character''. The Supreme Court has stated that ``* * * legislative 
regulations are given controlling weight unless they are arbitrary, 
capricious, or manifestly contrary to the statute.'' Chevron, U.S.A., 
Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837, 844 
(1984) (involving an environmental protection regulation). For examples 
involving consolidated return regulations, see, e.g., Wolter 
Construction Company v. Commissioner, 634 F.2d 1029 (6th Cir. 1980); 
Garvey, Inc. v. United States, 1 Ct. Cl. 108 (1983), aff'd 726 F.2d 
1569 (Fed. Cir. 1984), cert. denied 469 U.S. 823 (1984). Compare, e.g., 
Audrey J. Walton v. Commissioner, 115 T.C. 589 (2000), describing 
different standards of review. The case did not involve a consolidated 
return regulation.
---------------------------------------------------------------------------
    In the recent case of Rite Aid Corp. v. United States, \63\ 
the Federal Circuit Court of Appeals addressed the application 
of a particular provision of certain consolidated return loss 
disallowance regulations, and concluded that the provision was 
invalid.\64\ The particular provision, known as the 
``duplicated loss'' provision,\65\ would have denied a loss on 
the sale of stock of a subsidiary by a parent corporation that 
had filed a consolidated return with the subsidiary, to the 
extent the subsidiary corporation had assets that had a built-
in loss, or had a net operating loss, that could be recognized 
or used later.\66\
---------------------------------------------------------------------------
    \63\ 255 F.3d 1357 (Fed. Cir. 2001), reh'g denied, 2001 U.S. App. 
LEXIS 23207 (Fed. Cir. Oct. 3, 2001).
    \64\ Prior to this decision, there had been a few instances 
involving prior laws in which certain consolidated return regulations 
were held to be invalid. See, e.g., American Standard, Inc. v. United 
States, 602 F.2d 256 (Ct. Cl. 1979), discussed in the text infra. see 
also Union Carbide Corp. v. United States, 612 F.2d 558 (Ct. Cl. 1979), 
and Allied Corporation v. United States, 685 F.2d 396 (Ct. Cl. 1982), 
all three cases involving the allocation of income and loss within a 
consolidated group for purposes of computation of a deduction allowed 
under prior law by the Code for Western Hemisphere Trading 
Corporations. See also Joseph Weidenhoff v. Commissioner, 32 T.C. 1222, 
1242-1244 (1959), involving the application of certain regulations to 
the excess profits tax credit allowed under prior law, and concluding 
that the Commissioner had applied a particular regulation in an 
arbitrary manner inconsistent with the wording of the regulation and 
inconsistent with even a consolidated group computation. Cf. Kanawha 
Gas & Utilities Co. v. Commissioner, 214 F.2d 685 (1954), concluding 
that the substance of a transaction was an acquisition of assets rather 
than stock. Thus, a regulation governing basis of the assets of 
consolidated subsidiaries did not apply to the case. See also General 
Machinery Corporation v. Commissioner, 33 B.T.A. 1215 (1936); Lefcourt 
Realty Corporation, 31 B.T.A. 978 (1935); Helvering v. Morgans, Inc., 
293 U.S. 121 (1934), interpreting the term ``taxable year.''
    \65\ Treas. Reg. Sec. 1.1502-20(c)(1)(iii).
    \66\ Treasury Regulation section 1.1502-20, generally imposing 
certain ``loss disallowance'' rules on the disposition of subsidiary 
stock, contained other limitations besides the ``duplicated loss'' rule 
that could limit the loss available to the group on a disposition of a 
subsidiary's stock. Treasury Regulation section 1.1502-20 as a whole 
was promulgated in connection with regulations issued under section 
337(d), principally in connection with the so-called General Utilities 
repeal of 1986 (referring to the case of General Utilities & Operating 
Company v. Helvering, 296 U.S. 200 (1935)). Such repeal generally 
required a liquidating corporation, or a corporation acquired in a 
stock acquisition treated as a sale of assets, to pay corporate level 
tax on the excess of the value of its assets over the basis. Treasury 
regulation section 1.1502-20 principally reflected an attempt to 
prevent corporations filing consolidated returns from offsetting income 
with a loss on the sale of subsidiary stock. Such a loss could result 
from the unique upward adjustment of a subsidiary's stock basis 
required under the consolidated return regulations for subsidiary 
income earned in consolidation, an adjustment intended to prevent 
taxation of both the subsidiary and the parent on the same income or 
gain. As one example, absent a denial of certain losses on a sale of 
subsidiary stock, a consolidated group could obtain a loss deduction 
with respect to subsidiary stock, the basis of which originally 
reflected the subsidiary's value at the time of the purchase of the 
stock, and that had then been adjusted upward on recognition of any 
built-in income or gain of the subsidiary reflected in that value. The 
regulations also contained the duplicated loss factor addressed by the 
court in Rite Aid. The preamble to the regulations stated: ``it is not 
administratively feasible to differentiate between loss attributable to 
built-in gain and duplicated loss.'' T.D. 8364, 1991-2 C.B. 43, 46 
(Sept. 13, 1991). The government also argued in the Rite Aid case that 
duplicated loss was a separate concern of the regulations. 255 F.3d at 
1360.
---------------------------------------------------------------------------
    The Federal Circuit Court opinion contained language 
discussing the fact that the regulation produced a result 
different than the result that would have obtained if the 
corporations had filed separate returns rather than 
consolidated returns.\67\
---------------------------------------------------------------------------
    \67\ For example, the court stated: ``The duplicated loss factor * 
* * addresses a situation that arises from the sale of stock regardless 
of whether corporations file separate or consolidated returns. With 
I.R.C. secs. 382 and 383, Congress has addressed this situation by 
limiting the subsidiary's potential future deduction, not the parent's 
loss on the sale of stock under I.R.C. sec. 165.'' 255 F.3d 1357, 1360 
(Fed. Cir. 2001).
---------------------------------------------------------------------------
    The Federal Circuit Court opinion cited a 1928 Senate 
Finance Committee Report to legislation that authorized 
consolidated return regulations, which stated that ``many 
difficult and complicated problems, * * * have arisen in the 
administration of the provisions permitting the filing of 
consolidated returns'' and that the committee ``found it 
necessary to delegate power to the commissioner to prescribe 
regulations legislative in character covering them.'' \68\ The 
Court's opinion also cited a previous decision of the Court of 
Claims for the proposition, interpreting this legislative 
history, that section 1502 grants the Secretary ``the power to 
conform the applicable income tax law of the Code to the 
special, myriad problems resulting from the filing of 
consolidated income tax returns;'' but that section 1502 ``does 
not authorize the Secretary to choose a method that imposes a 
tax on income that would not otherwise be taxed.'' \69\
---------------------------------------------------------------------------
    \68\ S. Rep. No. 960, 70th Cong., 1st Sess. 15 (1928). Though not 
quoted by the court in Rite Aid, the same Senate report also indicated 
that one purpose of the consolidated return authority was to permit 
treatment of the separate corporations as if they were a single unit, 
stating ``The mere fact that by legal fiction several corporations 
owned by the same shareholders are separate entities should not obscure 
the fact that they are in reality one and the same business owned by 
the same individuals and operated as a unit.'' S. Rep. No. 960, 70th 
Cong., 1st Sess. 29 (1928).
    \69\ American Standard, Inc. v. United States, 602 F.2d 256, 261 
(Ct. Cl. 1979). That case did not involve the question of separate 
returns as compared to a single return approach. It involved the 
computation of a Western Hemisphere Trade Corporation (``WHTC'') 
deduction under prior law (which deduction would have been computed as 
a percentage of each WHTC's taxable income if the corporations had 
filed separate returns), in a case where a consolidated group included 
several WHTCs as well as other corporations. The question was how to 
apportion income and losses of the admittedly consolidated WHTCs and 
how to combine that computation with the rest of the group's 
consolidated income or losses. The court noted that the new, changed 
regulations approach varied from the approach taken to a similar 
problem involving public utilities within a group and previously 
allowed for WHTCs. The court objected that the allocation method 
adopted by the regulation allowed non-WHTC losses to reduce WHTC 
income. However, the court did not disallow a method that would net 
WHTC income of one WHTC with losses of another WHTC, a result that 
would not have occurred under separate returns. Nor did the court 
expressly disallow a different fractional method that would net both 
income and losses of the WHTCs with those of other corporations in the 
consolidated group. The court also found that the regulation had been 
adopted without proper notice.
---------------------------------------------------------------------------
    The Federal Circuit Court construed these authorities and 
applied them to invalidate Treas. Reg. Sec. 1.1502-
20(c)(1)(iii), stating that:

          The loss realized on the sale of a former 
        subsidiary's assets after the consolidated group sells 
        the subsidiary's stock is not a problem resulting from 
        the filing of consolidated income tax returns. The 
        scenario also arises where a corporate shareholder 
        sells the stock of a non-consolidated subsidiary. The 
        corporate shareholder could realize a loss under I.R.C. 
        sec. 1001, and deduct the loss under I.R.C. sec. 165. 
        The subsidiary could then deduct any losses from a 
        later sale of assets. The duplicated loss factor, 
        therefore, addresses a situation that arises from the 
        sale of stock regardless of whether corporations file 
        separate or consolidated returns. With I.R.C. secs. 382 
        and 383, Congress has addressed this situation by 
        limiting the subsidiary's potential future deduction, 
        not the parent's loss on the sale of stock under I.R.C. 
        sec. 165.\70\
---------------------------------------------------------------------------
    \70\ Rite Aid, 255 F.3d at 1360.

    The Treasury Department has announced that it will not 
continue to litigate the validity of the duplicated loss 
provision of the regulations, and has issued interim 
regulations that permit taxpayers for all years to elect a 
different treatment, though they may apply the provision for 
the past if they wish.\71\
---------------------------------------------------------------------------
    \71\ See Temp. Reg. 1.1502-20T(i)(2). The Treasury Department has 
also indicated its intention to continue to study all the issues that 
the original loss disallowance regulations addressed (including issues 
of furthering single entity principles) and possibly issue different 
regulations (not including the particular approach of Treas. Reg. Sec. 
1.1502-20(c)(1)(iii)) on the issues in the future. See Notice 2002-11, 
2002-7 I.R.B. 526 (Feb. 19, 2002); T.D. 8984, 67 F.R. 11034 (March 12, 
2002); REG-102740-02, 67 F.R. 11070 (March 12, 2002); see also Notice 
2002-18, 2002-12 I.R.B. 644 (March 25, 2002).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee is concerned that the language and analysis 
in the Rite Aid decision might lead taxpayers to attempt to 
challenge other Treasury consolidated return regulations that 
prescribe a tax result different from the result that would 
occur if separate returns were filed.
    The Committee is concerned that any such challenges may 
lead to protracted litigation and commitment of Internal 
Revenue Service resources to defending the consolidated return 
provisions.
    The Committee wishes to clarify that the fact that a result 
under the consolidated return regulations differs from the 
result under separate returns does not provide a basis to 
challenge a Treasury consolidated return regulation.
    The Committee believes that the result of the case with 
respect to the type of factual situation in Rite Aid, involving 
the ``duplicated loss factor'' portion of Treasury Regulation 
section 1.1502-20, which Treasury has announced that taxpayers 
need not follow, should not be overturned. Therefore, the 
committee legislatively allows the specific result of the case 
to stand for the taxpayer in Rite Aid or any similarly situated 
taxpayers.
    Apart from that specific result, the Committee disagrees 
with the reasoning of the case and believes it should not be 
applied to support any challenge to other consolidated return 
regulations. The Committee also wishes to reaffirm the broad 
authority of the Treasury Department to issue consolidated 
return regulations.

                        EXPLANATION OF PROVISION

    The provision confirms that, in exercising its authority 
under section 1502 to issue consolidated return regulations, 
the Treasury Department may provide rules treating corporations 
filing consolidated returns differently from corporations 
filing separate returns.
    Thus, under the statutory authority of section 1502, the 
Treasury Department is authorized to issue consolidated return 
regulations utilizing either a single taxpayer or separate 
taxpayer approach or a combination of the two approaches, as 
Treasury deems necessary in order that the tax liability of any 
affiliated group of corporations making a consolidated return, 
and of each corporation in the group, both during and after the 
period of affiliation, may be determined and adjusted in such 
manner as clearly to reflect the income-tax liability and the 
various factors necessary for the determination of such 
liability, and in order to prevent avoidance of such liability.
    Rite Aid is thus overruled to the extent it suggests that 
there is not a problem that can be addressed in consolidated 
return regulations if application of a particular Code 
provision on a separate taxpayer basis would produce a result 
different from single taxpayer principles that may be used for 
consolidation.
    The provision nevertheless allows the result of the Rite 
Aid case to stand with respect to the type of factual situation 
presented in the case. That is, the legislation provides for 
the override of the regulatory provision that took the approach 
of denying a loss on a deconsolidating disposition of stock of 
a consolidated subsidiary \72\ to the extent the subsidiary had 
net operating losses or built in losses that could be used 
later outside the group.\73\
---------------------------------------------------------------------------
    \72\ Treas. Reg. Sec. 1.1502-20(c)(1)(iii).
    \73\ The Committee does not intend to overrule the current Treasury 
Department regulations, which allow taxpayers for the past to follow 
Treasury Regulations Section 1.1502-20(c)(1)(iii), if they choose to do 
so. Temp. Reg. Sec. 1.1502-20T(i)(2).
---------------------------------------------------------------------------
    Retaining the result in the Rite Aid case with respect to 
the particular regulation section 1.1502-20(c)(1)(iii) as 
applied to the factual situation of the case does not in any 
way prevent or invalidate the various approaches Treasury has 
announced it will apply or that it intends to consider in lieu 
of the approach of that regulation, including, for example, the 
denial of a loss on a stock sale if inside losses of a 
subsidiary may also be used by the consolidated group, and the 
possible requirement that inside attributes be adjusted when a 
subsidiary leaves a group.\74\
---------------------------------------------------------------------------
    \74\ See, e.g., Notice 2002-11, 2002-7 I.R.B. 526 (Feb. 19, 2002); 
T.D. 8984, 67 F.R. 11034 (Mar. 12, 2002); REG-102740-02, 67 F.R. 11070 
(Mar. 12, 2002); see also Notice 2002-18, 2002-12 I.R.B. 644 (Mar. 25, 
2002). In exercising its authority under section 1502, the Secretary is 
also authorized to prescribe rules that protect the purpose of General 
Utilities repeal using presumptions and other simplifying conventions.
---------------------------------------------------------------------------

                             EFFECTIVE DATE

    The provision is effective for all years, whether beginning 
before, on, or after the date of enactment of the provision.
    No inference is intended that the results following from 
this provision are not the same as the results under present 
law.

                     IV. BUDGET EFFECTS OF THE BILL


                         A. Committee Estimates

    In compliance with paragraph 11(a) of rule XXVI of the 
Standing Rules of the Senate, the following statement is made 
concerning the estimated budget effects of the committee 
amendment to the bill as reported.

                   ESTIMATED REVENUE EFFECTS OF S. 2498, THE ``TAX SHELTER TRANSPARENCY ACT,'' AS REPORTED BY THE COMMITTEE ON FINANCE
                                                    [Fiscal years 2002-2012, in millions of dollars]
--------------------------------------------------------------------------------------------------------------------------------------------------------
             Provision                    Effective       2002   2003   2004   2005   2006   2007   2008   2009   2010   2011   2012   2002-07   2002-12
--------------------------------------------------------------------------------------------------------------------------------------------------------
1. Provisions relating to            various dates.....     16     55     98    121    124    124    127    132    139    148    160       540     1,247
 reportable transactions and tax     after DOE \2\.....
 shelters (sections 101, 102, 104,
 201 through 203, and 215) \1\.
2. Modification to the substantial   tyba DOE..........  .....  .....  .....      8     11     19     23     26     30     34     38        38       188
 understatement penalty (section
 103) \1\.
3. Actions to enjoin conduct with    DOE...............                                         Negligible Revenue Effect
 respect to tax shelters (section
 204).
4. Understatement of taxpayer's      dpa DOE...........                                         Negligible Revenue Effect
 liability by income tax return
 preparer (section 211).
5. Impose a civil penalty (of up to  DOE...............  (\3\)  (\3\)  (\3\)  (\3\)  (\3\)  (\3\)  (\3\)  (\3\)  (\3\)  (\3\)  (\3\)         1         3
 $5,000) on failure to report
 interest in foreign financial
 accounts (section 212).
6. Frivolous tax submissions         DOE (\4\).........  .....      3      3      3      3      3      3      3      3      3      3        15        30
 (section 213).
7. Regulation of individuals         ata DOE...........                                             No Revenue Effect
 practicing before the Department
 of Treasury (section 214).
8. Affirmation of consolidated       (\5\).............                                         Negligible Revenue Effect
 return regulation authority
 (section 301).
      Net Total....................  ..................     16     58    101    132    138    146    153    161    172    185    201       594     1,468
--------------------------------------------------------------------------------------------------------------------------------------------------------
Legend for ``Effective'' column: ata=actions taken after; DOE=date of enactment; dpa=documents prepared after; tyba=taxable years beginning after.

\1\ Failure or substantial delay of forthcoming regulations for section 6011 of the Internal Revenue Code and other administrative actions to be taken
  by the Treasury Department or the Internal Revenue Service would reduce the estimated revenue effects of these provisions.
\2\ Effective dates for provisions relating to reportable transactions and tax shelters: section 101 is effective for returns and statements the due
  date of which is after the date of enactment; section 102 is effective for taxable years ending after the date of enactment; section 104 is effective
  for communications made on or after the date of enactment; section 201 is effective for transactions with respect to which material aid, assistance or
  advice is provided after the date of enactment; section 202 is effective for returns the due date for which is after the date of enactment; section
  203 is effective for requests made after the date of enactment; and section 215 is effective for activities after the date of enactment.
\3\ Gain of less than $1 million.
\4\ Effective for submissions made and issues raised after the first list is prescribed under section 6702(c).
\5\ Effective for all taxable years, whether beginning before, with, or after the date of enactment.

Note.--Details may not add to totals due to rounding.
Source: Joint Committee on Taxation.

                B. Budget Authority and Tax Expenditures


Budget authority

    In compliance with section 308(a)(1) of the Budget Act, the 
Committee states that the revenue provisions of the committee 
amendment to the bill as reported involve no new or increased 
budget authority.

Tax expenditures

    In compliance with section 308(a)(2) of the Budget Act, the 
Committee states that there are no revenue-reducing provisions 
in the committee amendment to the bill, and the revenue-
increasing provisions of the committee amendment to the bill 
involve reduced expenditures (see revenue table in Part IV.A., 
above).

            C. Consultation With Congressional Budget Office

    In accordance with section 403 of the Budget Act, the 
Committee advises that the Congressional Budget Office 
(``CBO'') has not submitted a statement on the bill. The letter 
from CBO was not received in a timely manner, and therefore 
will be provided separately.

                       V. VOTES OF THE COMMITTEE

    In compliance with paragraph 7(b) of rule XXVI of the 
Standing Rules of the Senate, the following statements are made 
concerning the votes taken on the Committee's consideration of 
the amendment to the bill.

Motion to report the committee amendment

    The amendment to the bill was ordered favorably reported by 
a voice vote, a quorum being present, on June 18, 2002.

Votes on other amendments

    An amendment by Senator Baucus in a Chairman's modification 
to the bill adding the provision regarding the affirmation of 
the consolidated return regulation authority was agreed to by 
voice vote.

                VI. REGULATORY IMPACT AND OTHER MATTERS


                          A. Regulatory Impact

    Pursuant to paragraph 11(b) of rule XXVI of the Standing 
Rules of the Senate, the Committee makes the following 
statement concerning the regulatory impact that might be 
incurred in carrying out the provisions of the bill as amended.

Impact on individuals and businesses

    With respect to individuals and businesses, the bill 
modifies the rules relating to (1) the disclosure of reportable 
transactions and tax shelters; (2) the substantial 
understatement penalty; (3) actions to enjoin conduct with 
respect to tax shelters; (4) an understatement of a taxpayer's 
liability by an income tax return preparer; (5) the imposition 
of a civil penalty (of up to $5,000) on a failure to report 
interest in foreign financial accounts; and (6) frivolous tax 
submissions. The provisions relate to taxpayers that engage in 
certain tax avoidance transactions. The provisions do not 
impose increased regulatory burdens on individuals or 
businesses.

Impact on personal privacy and paperwork

    The provisions of the bill do not impact personal privacy. 
The provisions relate to taxpayers that engage in certain tax 
avoidance transactions. The bill does not impose increased 
paperwork burdens on individuals. Individuals who elect to 
engage in these types of transactions, and certain advisors 
that provide material aid, assistance or advice with respect to 
these transactions, may in some cases need to file certain 
disclosure statements with the IRS.

                     B. Unfunded Mandates Statement

    The information is provided in accordance with section 423 
of the Unfunded Mandates Reform Act of 1995 (P.L. 104-4).
    The Committee has determined that the following provisions 
of the bill contain Federal mandates on the private sector: (1) 
provisions relating to reportable transactions and tax 
shelters; (2) modifications to the substantial understatement 
penalty; (3) actions to enjoin conduct with respect to tax 
shelters; (4) understatement of taxpayer's liability by an 
income tax return preparer; (5) the imposition of a civil 
penalty (of up to $5,000) on a failure to report interest in 
foreign financial accounts; and (6) frivolous tax submissions.
    The costs required to comply with each Federal private 
sector mandate generally are no greater than the estimated 
budget effect of the provision. Benefits from the provisions 
include improved administration of the Federal income tax laws 
and a more accurate measurement of income for Federal income 
tax purposes.

                       C. Tax Complexity Analysis

    Section 4022(b) of the Internal Revenue Service Reform and 
Restructuring Act of 1998 (the ``IRS Reform Act'') requires the 
Joint Committee on Taxation (in consultation with the Internal 
Revenue Service and the Department of the Treasury) to provide 
a tax complexity analysis. The complexity analysis is required 
for all legislation reported by the Senate Committee on 
Finance, the House Committee on Ways and Means, or any 
committee on conference if the legislation includes a provision 
that directly or indirectly amends the Code and has widespread 
applicability to individuals or small businesses.
    The staff of the Joint Committee on Taxation has determined 
that a complexity analysis is not required under section 
4022(b) of the IRS Reform Act because the bill contains no 
provisions that amend the Code and that have ``widespread 
applicability'' to individuals or small businesses.

       VII. CHANGES IN EXISTING LAW MADE BY THE BILL AS REPORTED

    In the opinion of the Committee, it is necessary in order 
to expedite the business of the Senate, to dispense with the 
requirements of paragraph 12 of rule XXVI of the Standing Rules 
of the Senate (relating to the showing of changes in existing 
law made by the bill as reported by the Committee).

                                  
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