[Federal Register Volume 60, Number 2 (Wednesday, January 4, 1995)]
[Proposed Rules]
[Pages 406-410]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-120]



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DEPARTMENT OF THE TREASURY
26 CFR Part 1

[IA-55-94]
RIN 1545-AT13


Accuracy-related Penalty

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document contains proposed regulations which provide 
guidance as to when a taxpayer may rely upon the advice of others as 
evidence of reasonable cause and good faith within the meaning of 
section 6664(c) of the Internal Revenue Code of 1986 for purposes of 
avoiding the accuracy-related penalty of section 6662, and what 
constitutes reasonable cause and good faith within the meaning of 
section 6664(c) as it applies to the substantial understatement penalty 
of section 6662(b)(2) with respect to tax shelter items of a 
corporation. The proposed regulations implement changes to the 
accuracy-related penalty under section 6662 that were made by Title VII 
of the Uruguay Round Agreements Act (the Act) implementing the Uruguay 
Round of the General Agreement on Tariffs and Trade. Finally, this 
document provides notice of a public hearing on the proposed amendments 
to the regulations.

DATES: Written comments must be received by April 7, 1995. The IRS 
intends to hold a public hearing on these proposed regulations on April 
28, 1995, beginning at 10 a.m. Persons wishing to speak at the hearing 
must submit outlines of their comments by April 7, 1995.

ADDRESSES: Send submissions to: Internal Revenue Service, Attn: 
CC:DOM:CORP:T:R (IA-55-94), room 5228, POB 7604, Ben Franklin Station, 
Washington, DC 20044. The public hearing will be held in the IRS 
Auditorium, Internal Revenue Building, 1111 Constitution Avenue, NW, 
Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, David L. 
Meyer, 202-622-6232; concerning submissions, Christina Vasquez, 202-
622-6803. (These are not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

    Section 6662 of the Internal Revenue Code (Code) imposes an 
accuracy-related penalty on certain underpayments of tax. Section 
6664(c) provides that no accuracy-related penalty is imposed with 
respect to any portion of an underpayment if it is shown that there was 
a reasonable cause for such portion and that the taxpayer acted in good 
faith with respect to such portion.
    Under current regulations interpreting sections 6662 and 6664, a 
taxpayer's good faith reliance on the advice (including an opinion) of 
a professional tax advisor may be taken into account for purposes of 
determining whether the taxpayer will be subject to an accuracy-related 
penalty. See, e.g., Secs. 1.6662-4(g)(4)(ii) and 1.6664-4(b).
    Section 6662(b)(2) of the Code imposes a penalty for a substantial 
understatement of income tax. An understatement is substantial if it 
exceeds the greater of 10 percent of the tax required to be shown on 
the taxpayer's return for the taxable year, or $5,000 ($10,000 in the 
case of a corporation other than an S corporation or a personal holding 
company). An understatement is defined as the excess of (1) the amount 
of tax required to be shown on the taxpayer's return, over (2) the 
amount of tax imposed which is shown on the return, reduced by any 
rebate.
    The Code provides that the amount of an understatement is reduced 
to the extent that certain conditions are met. For example, section 
6662(d)(2), prior to amendment by the Act (Pub. L. 103-465), provided 
that an understatement is reduced by the portion of the understatement 
attributable to a tax shelter item of the taxpayer (the section 6662 
tax shelter rule) if: (1) there is substantial authority for the 
taxpayer's treatment of the tax shelter item; and (2) the taxpayer 
reasonably believed (at the time its return was filed) that its 
treatment of such item was more likely than not the proper treatment.
    The substantial understatement penalty was first adopted in section 
323 of the Tax Equity and Fiscal Responsibility Act of 1982, Pub. L. 
97-248. At that time, Congress believed that the new standards would 
``assure that taxpayers who take highly aggressive filing positions are 
penalized while those who endeavor in good faith to self-assess are not 
penalized'' and that, with respect to tax shelters, ``if the principal 
purpose of a transaction is the reduction of tax, it is not 
unreasonable to hold participants to a higher standard than ordinary 
taxpayers.'' H.R. Conf. Rep. No. 97th Cong., 2d Sess. 575-76 (1982), 
1982-2 C.B.650. More recently, Congress has been concerned that the 
substantial understatement penalty has not been effectively deterring 
corporate tax shelter transactions and thus, in Section 744 of the Act, 
eliminated the section 6662 tax shelter rule as it applies to 
corporations. As a result of this change, ``the standards applicable to 
corporate tax shetlers are tightened'' and ``in no instance [will] this 
modification result in a penalty not being imposed where a penalty 
would have been imposed under prior law.'' S. Rep. No. 412, 103d Cong., 
2d Sess. 165 (1994); H.R. Rep. No. 826, 103d Cong., 2d Sess. 198-99 
(1994). The change is effective for transactions occurring after 
December 8, 1994.
    The proposed regulations set forth in this document address issues 
related to the section 6662 tax shelter rule and the reasonable cause 
exception of section 6664. This guidance includes, but is not limited 
to, rules that reflect the amendment of section 6662 by the Act.

Explanation of Provisions

Reliance on Tax Advisor

    The proposed regulations set forth general rules clarifying when a 
taxpayer may be considered to have reasonably relied in good faith upon 
advice (including an opinion provided by a professional tax advisor). 
These rules apply to all taxpayers and to both tax shelter items and 
non-tax shelter items. In particular, the rules apply in determining 
whether reasonable cause and good faith exist for purposes of section 
6664(c) and also apply in determining whether a taxpayer other than a 
corporation is considered to have reasonably relied in good faith on an 
opinion in order to satisfy the ``reasonable belief'' requirement of 
the section 6662 tax shelter rule.
    In general, the proposed regulations require advice to be based on 
all material facts (including, for example, the taxpayer's purposes for 
entering into a transaction) and to relate applicable law to such facts 
in reaching its conclusion. The advice must not be based upon 
unreasonable factual or legal assumptions (including assumptions as to 
future events), nor [[Page 407]] unreasonably rely on the 
representations, findings or agreements of the taxpayer or any other 
person.

Reasonable Cause for Tax Shelter Items of a Corporation

    The proposed regulations provide additional guidance with respect 
to the application of the reasonable cause exception of section 6664(c) 
to a substantial understatement penalty attributable to a tax shelter 
item of a corporation. These changes apply only to corporations. 
Accordingly, no inference is intended with respect to the application 
of section 6664(c) to a substantial understatement penalty attributable 
to a tax shelter item of a taxpayer other than a corporation. Treasury 
and the IRS invite comments as to the need for clarification of the 
application of this exception to such items.
    The proposed regulations provide that a corporation's legal 
justification may be taken into account, as appropriate, in 
establishing that the corporation acted with reasonable cause and in 
good faith in its treatment of a tax shelter item only if there is 
substantial authority for the treatment of the item and the corporation 
reasonably believes in good faith that such treatment is more likely 
than not the proper treatment. For this purpose, legal justification 
includes any justification relating to the treatment or 
characterization under the Federal tax law of the tax shelter item or 
of the entity, plan or arrangement that gave rise to the item. Thus, a 
taxpayer's belief (whether independently formed or based on the advice 
of others) as to the merits of the taxpayer's underlying position is a 
legal justification. Satisfaction of the substantial authority and 
reasonable belief criteria is an important factor to be considered in 
determining whether the taxpayer acted with reasonable cause and in 
good faith. However, it is not necessarily dispositive. A corporation 
will qualify for the reasonable cause and good faith exception only if, 
under all pertinent facts and circumstances, it acted with reasonable 
cause and in good faith.
    The proposed regulations also provide that facts and circumstances 
other than a corporation's legal justification may be taken into 
account, as appropriate, in determining whether it acted with 
reasonable cause and in good faith, regardless of whether the 
substantial authority and reasonable belief requirements are satisfied.
    The provisions relating to the reasonable cause and good faith 
exception with respect to corporate tax shelters apply only for 
purposes of the substantial understatement penalty. No inference is 
intended with respect to how the reasonable cause exception may apply 
to the negligence penalty of section 6662(b)(1). The proposed 
regulations do not alter the definitions of tax shelter or tax shelter 
items contained in Sec. 1.6662-4(g)(2) and (3).

Conforming Changes

    The proposed regulations would amend the existing regulations under 
section 6662 to reflect the changes made by the Act and to clarify the 
definition of reasonable belief under the section 6662 tax shelter 
rule.
    In addition, the proposed regulations clarify that the 
determination of whether a corporate or non-corporate taxpayer acted 
with reasonable cause and in good faith with respect to an underpayment 
that is related to an item reflected on the return of a pass-through 
entity is made on the basis of all pertinent facts and circumstances, 
including the taxpayer's own actions, as well as the actions of the 
pass-through entity.

Proposed Effective Date

    The amendments contained in this notice are proposed to be 
effective for returns the due date of which (determined without regard 
to extensions) is after the date on which final regulations are 
published in the Federal Register.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in EO 12866. Therefore, 
a regulatory assessment is not required. It has also been determined 
that section 553(b) of the Administrative Procedure Act (5 U.S.C. 
chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do 
not apply to these regulations, and therefore, a Regulatory Flexibility 
Analysis is not required. Pursuant to section 7805(f) of the Internal 
Revenue Code, this notice of proposed rulemaking will be submitted to 
the Chief Counsel for Advocacy of the Small Business Administration for 
comment on its impact on small business.

Comments and Public Hearing

    Before the adoption of these proposed regulations, consideration 
will be given to any written comments that are submitted timely (a 
signed original and eight (8) copies) to the IRS. All comments will be 
available for public inspection and copying in their entirety.
    A public hearing will be held on April 28, 1995, in the IRS 
Auditorium, Internal Revenue Building, 1111 Constitution Avenue, NW, 
Washington, DC. Because of access restrictions, visitors will not be 
admitted beyond the building lobby more than 15 minutes before the 
hearing starts.
    The rules of 26 CFR 601.601(a)(3) apply to the hearing.
    Persons who wish to present oral comments at the hearing must 
submit written comments, an outline of the topics to be discussed, and 
the time to be devoted to each topic by April 7, 1995.
    A period of 10 minutes will be allotted to each person for making 
comments.
    An agenda showing the scheduling of the speakers will be prepared 
after the deadline for receiving outlines has passed. Copies of the 
agenda will be available free of charge at the hearing.

Drafting Information

    The principal author of these proposed regulations is David L. 
Meyer, Office of Assistant Chief Counsel, Income Tax and Accounting, 
IRS. However, other personnel from the IRS and Treasury Department 
participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *

    Par. 2. Section 1.6662-0 is amended by revising the entries for 
Secs. 1.6662-2(d) and 1.6662-4(g) to read as follows:


Sec. 1.6662-0  Table of contents.

* * * * *

Sec. 1.6662-2  Accuracy related penalty.

* * * * *
(d) Effective date.
    (1) In general.
    (2) Special rules for tax shelter items.
* * * * *

Sec. 1.6662-4  Substantial understatement of income tax.

* * * * *
(g) Items relating to tax shelters.
    (1) In general.
    (i) Non-corporate taxpayers.
    (ii) Corporate taxpayers.
    (A) In general.
    (B) Special rule for transactions occurring prior to December 9, 
1994.
    (iii) Disclosure irrelevant.
    (iv) Cross-reference. [[Page 408]] 
    (2) Tax shelter.
    (i) In general.
    (ii) Principal purpose.
    (3) Tax shelter item.
    (4) Reasonable belief.
    (i) In general.
    (ii) Facts and circumstances; reliance on tax advisor.
* * * * *
    Par. 3. Section 1.6662-2 is amended by:
    1. Redesignating the text of paragraph (d) following the heading as 
paragraph (d)(1), adding a new heading for newly designated paragraph 
(d)(1), and revising the second sentence of newly redesignated 
paragraph (d)(1).
    2. Adding a new paragraph (d)(2).
    The additions and revisions read as follows:


Sec. 1.6662-2  Accuracy-related penalty.

* * * * *
    (d) Effective date--(1) In general. * * * Except as provided in the 
preceding sentence and in paragraph (d)(2) of this section, 
Secs. 1.6662-1 through 1.6662-5 apply to returns the due date of which 
(determined without regard to extensions of time for filing) is after 
December 31, 1989. * * *
    (2) Special rules for tax shelter items. Sections 1.6662-4(g)(1) 
and 1.6662-4(g)(4) apply to returns the due date of which (determined 
without regard to extensions of time for filing) is after the date on 
which final regulations are published in the Federal Register. Sections 
1.6662-4(g)(1) and (4) (as contained in 26 CFR Part 1 revised April 1, 
1994) apply to returns the due date of which (determined without regard 
to extensions of time for filing) is on or before the date on which 
final regulations are published in the Federal Register and after 
December 31, 1989, subject to changes resulting from Section 744 of 
Title VII of the Uruguay Round Agreements Act, Pub. L. 103-465 (108 
Stat, 4809).
    Par. 4. Section 1.6662-4 is amended by revising paragraphs (g)(1), 
(g)(4), and (g)(5) to read as follows:


Sec. 1.6662-4  Substantial understatement of income tax.

* * * * *
    (g) Items relating to tax shelters--(1) In general--(i) Non-
corporate taxpayers. Tax shelter items (as defined in paragraph (g)(3) 
of this section) of a taxpayer other than a corporation are treated for 
purposes of this section as if such items were shown properly on the 
return for a taxable year in computing the amount of tax shown on the 
return, and thus the tax attributable to such items is not included in 
the understatement for the year, if--
    (A) There is substantial authority (as provided in paragraph (d) of 
this section) for the tax treatment of that item; and
    (B) The taxpayer reasonably believed at the time the return was 
filed that the tax treatment of that item was more likely than not the 
proper treatment.
    (ii) Corporate taxpayers--(A) In general. Except as provided in 
paragraph (g)(1)(ii)(B) of this section, all tax shelter items (as 
defined in paragraph (g)(3) of this section) of a corporation are taken 
into account in computing the amount of any understatement.
    (B) Special rule for transactions occurring prior to December 9, 
1994. The tax shelter items of a corporation arising in connection with 
transactions occurring prior to December 9, 1994 are treated for 
purposes of this section as if such items were shown properly on the 
return if the requirements of paragraph (g)(1)(i) are satisfied with 
respect to such items.
    (iii) Disclosure irrelevant. Disclosure made with respect to a tax 
shelter item of either a corporate or non-corporate taxpayer does not 
affect the amount of an understatement.
    (iv) Cross-reference. See Sec. 1.6664-4(e) for certain rules 
regarding the availability of the reasonable cause and good faith 
exception to the substantial understatement penalty with respect to tax 
shelter items of corporations.
* * * * *
    (4) Reasonable belief--(i) In general. For purposes of section 
6662(d) and paragraph (g)(1)(i)(B) of this section (pertaining to tax 
shelter items of non-corporate taxpayers), a taxpayer is considered 
reasonably to believe that the tax treatment of an item is more likely 
than not the proper tax treatment if (without taking into account the 
possibility that a return will not be audited, that an issue will not 
be raised on audit, or that an issue will be settled)--
    (A) The taxpayer analyzes the pertinent facts and authorities in 
the manner described in paragraph (d)(3)(ii) of this section, and in 
reliance upon that analysis, reasonably concludes in good faith that 
there is a greater than 50-percent likelihood that the tax treatment of 
the item will be upheld if challenged by the Internal Revenue Service; 
or
    (B) The taxpayer reasonably relies in good faith on the opinion of 
a professional tax advisor, if the opinion is based on the tax 
advisor's analysis of the pertinent facts and authorities in the manner 
described in paragraph (d)(3)(ii) of this section and unambiguously 
states that the tax advisor concludes that there is a greater than 50-
percent likelihood that the tax treatment of the item will be upheld if 
challenged by the Internal Revenue Service.
    (ii) Facts and circumstances; reliance on professional tax advisor. 
All facts and circumstances must be taken into account in determining 
whether a taxpayer satisfies the requirements of paragraph (g)(4)(i) of 
this section. However, in no event will a taxpayer be considered to 
have reasonably relied in good faith on the opinion of a professional 
tax advisor for purposes of paragraph (g)(4)(i)(B) of this section 
unless the requirements of Sec. 1.6664-4(c)(1) are met. The fact that 
the requirements of Sec. 1.6664-4(c)(1) are satisfied will not 
necessarily establish that the taxpayer reasonably relied on the 
opinion in good faith. For example, reliance may not be reasonable or 
in good faith if the taxpayer knew, or should have known, that the 
advisor lacked knowledge in the relevant aspects of Federal tax law.
    (5) Pass-through entities. In the case of tax shelter items 
attributable to a pass-through entity, the actions described in 
paragraphs (g)(4)(i)(A) and (B) of this section, if taken by the 
entity, are deemed to have been taken by the taxpayer and are 
considered in determining whether the taxpayer reasonably believed that 
the tax treatment of an item was more likely than not the proper tax 
treatment.
    Par. 5. Section 1.6664-0 is amended by revising the entries for 
Secs. 1.6664-1(b) and 1.6664-4 to read as follows:


Sec. 1.6664-0  Table of contents.

* * * * *

Sec. 1.6664-1  Accuracy-related and fraud penalties; definitions 
and special rules.

* * * * *
(b) Effective date.
    (1) In general.
    (2) Reasonable cause and good faith exception to section 6662 
penalties.
* * * * *

Sec. 1.6664-4  Reasonable cause and good faith exception to section 
6662 penalties.

(a) In general.
(b) Facts and circumstances taken into account.
    (1) In general.
    (2) Examples.
(c) Reliance on opinion or advice.
    (1) Fact and circumstances; minimum requirements.
    (i) All facts and circumstances considered.
    (ii) No unreasonable assumptions.
    (iii) Law is related to actual facts.
    (2) Definitions.
    (i) Advice. [[Page 409]] 
    (ii) Material.
(d) Pass-through items.
(e) Special rules for substantial understatement penalty 
attributable to tax shelter items of corporations.
    (1) In general; facts and circumstances.
    (2) Reasonable cause based on legal justification.
    (i) Minimum requirements.
    (A) Authority requirement.
    (B) Belief requirement.
    (ii) Legal justification defined.
    (3) Minimum requirements not dispositive.
    (4) Other factors.
(f) Transactions between persons described in section 482 and net 
section 482 transfer price adjustments. [Reserved]
(g) Valuation misstatements of charitable deduction property.
    (1) In general.
    (2) Definitions.
    (i) Charitable deduction property.
    (ii) Qualified appraisal.
    (iii) Qualified appraiser.
* * * * *
    Par. 6. Section 1.6664-1 is amended by:
    1. Redesignating the text of paragraph (b) following the heading as 
paragraph (b)(1), adding a heading for newly designated paragraph 
(b)(1), and revising the text of newly designated paragraph (b)(1).
    2. Adding paragraph (b)(2).
    The additions and revisions read as follows:


Sec. 1.6664-1  Accuracy-related and fraud penalties; definitions and 
special rules.

* * * * *
    (b) Effective date--(1) In general. Sections 1.6664-1 through 
1.6664-3 apply to returns the due date of which (determined without 
regard to extensions of time for filing) is after December 31, 1989.
    (2) Reasonable cause and good faith exception to section 6662 
penalties. Section 1.6664-4 applies to returns the due date of which 
(determined without regard to extensions of time for filing) is after 
the date on which the final regulations are published in the Federal 
Register. Section 1.6664-4 (as contained in 26 CFR Part 1 revised April 
1, 1994) applies to returns the due date of which (determined without 
regard to extensions of time for filing) is on or before the date on 
which the final regulations are published in the Federal Register and 
after December 31, 1989, subject to changes resulting from Section 744 
of Title VII of the Uruguay Round Agreements Act, Pub. L. 103-465 (108 
Stat. 4809).
    Par. 7. Section 1.6664-4 is amended by:
    1. Revising the last sentence of paragraph (a).
    2. Revising paragraph (b)(1).
    3. Revising the introductory language of paragraph (b)(2) and 
Example 1.
    4. Redesignating paragraphs (c), (d) and (e) as paragraphs (d), (f) 
and (g), respectively.
    5. Revising newly designated paragraph (d).
    6. Adding new paragraphs (c) and (e).
    The revisions and additions read as follows:


Sec. 1.6664-4  Reasonable cause and good faith exception to section 
6662 penalties.

    (a) * * * Rules for determining whether the reasonable cause and 
good faith exception applies are set forth in paragraphs (b) through 
(g) of this section.
    (b) Facts and circumstances taken into account--(1) In general. The 
determination of whether a taxpayer acted with reasonable cause and in 
good faith is made on a case-by-case basis, taking into account all 
pertinent facts and circumstances. (See paragraph (e) of this section 
for certain rules relating to a substantial understatement penalty 
attributable to tax shelter items of corporations.) Generally, the most 
important factor is the extent of the taxpayer's effort to assess the 
taxpayer's proper tax liability. Circumstances that may indicate 
reasonable cause and good faith include an honest misunderstanding of 
fact or law that is reasonable in light of all of the facts and 
circumstances, including the experience, knowledge and education of the 
taxpayer. An isolated computational or transcriptional error generally 
is not inconsistent with reasonable cause and good faith. Reliance on 
an information return or on the advice of a professional tax advisor or 
an appraiser does not necessarily demonstrate reasonable cause and good 
faith. Similarly, reasonable cause and good faith is not necessarily 
indicated by reliance on facts that, unknown to the taxpayer, are 
incorrect. Reliance on an information return, professional advice or 
other facts, however, constitutes reasonable cause and good faith if, 
under all the circumstances, such reliance was reasonable and the 
taxpayer acted in good faith. (See paragraph (c) of this section for 
certain rules relating to reliance on the advice of others.) For 
example, reliance on erroneous information (such as an error relating 
to the cost or adjusted basis of property, the date property was placed 
in service, or the amount of opening or closing inventory) 
inadvertently included in data compiled by the various divisions of a 
multidivisional corporation or in financial books and records prepared 
by those divisions generally indicates reasonable cause and good faith, 
provided the corporation employed internal controls and procedures, 
reasonable under the circumstances, that were designed to identify such 
factual errors. Reasonable cause and good faith ordinarily is not 
indicated by the mere fact that there is an appraisal of the value of 
property. Other factors to consider include the methodology and 
assumptions underlying the appraisal, the appraised value, the 
relationship between appraised value and purchase price, the 
circumstances under which the appraisal was obtained, and the 
appraiser's relationship to the taxpayer or to the activity in which 
the property is used. (See paragraph (g) of this section for certain 
rules relating to appraisals for charitable deduction property.) A 
taxpayer's reliance on erroneous information reported on a Form W-2, 
Form 1099 or other information return indicates reasonable cause and 
good faith, provided the taxpayer did not know or have reason to know 
that the information was incorrect. Generally, a taxpayer knows or has 
reason to know that the information on an information return is 
incorrect if such information is inconsistent with other information 
reported or otherwise furnished to the taxpayer, or with the taxpayer's 
knowledge of the transaction. This knowledge includes, for example, the 
taxpayer's knowledge of the terms of his employment relationship or of 
the rate of return on a payor's obligation.
    (2) Examples. The following examples illustrate this paragraph (b). 
They do not involve tax shelter items. (See paragraph (e) of this 
section for certain rules relating to the substantial understatement 
penalty in connection with the tax shelter items of corporations.)

    Example 1. A, an individual calendar year taxpayer, engages B, a 
professional tax advisor, to give A advice concerning the 
deductibility of certain state and local taxes. A provides B with 
full details concerning the taxes at issue. B advises A that the 
taxes are fully deductible. A, in preparing his own tax return, 
claims a deduction for the taxes. Absent other facts, and assuming 
the facts and circumstances surrounding B's advice and A's reliance 
on such advice satisfy the requirements of paragraph (c) of this 
section, A is considered to have demonstrated good faith by seeking 
the advice of a professional tax advisor, and to have shown 
reasonable cause for any underpayment attributable to the deduction 
claimed for the taxes. However, if A had sought advice from someone 
that A knew, or should have known, lacked knowledge in the relevant 
aspects of Federal tax law, or if other facts demonstrate that A 
failed to act reasonably or in good faith, A would not be considered 
to have shown reasonable cause or to have acted in good faith.
* * * * * [[Page 410]] 
    (c) Reliance on opinion or advice--(1) Facts and circumstances; 
minimum requirements. All facts and circumstances must be taken into 
account in determining whether a taxpayer has reasonably relied in good 
faith on advice (including the opinion of a professional tax advisor) 
as to the treatment of the taxpayer (or any entity, plan or 
arrangement) under Federal tax law. However, in no event will a 
taxpayer be considered to have reasonably relied in good faith on 
advice unless the requirements of this paragraph (c)(1) are satisfied. 
The fact that these requirements are satisfied will not necessarily 
establish that the taxpayer reasonably relied on the advice (including 
the opinion of a professional tax advisor) in good faith. For example, 
reliance may not be reasonable or in good faith if the taxpayer knew, 
or should have known, that the advisor lacked knowledge in the relevant 
aspects of Federal tax law.
    (i) All facts and circumstances considered. The advice must be 
based upon all material facts and circumstances, including, for 
example, the taxpayer's purposes (and the relative weight of such 
purposes) for entering into a transaction and for structuring a 
transaction in a particular manner.
    (ii) No unreasonable assumptions. The advice must not be based on 
unreasonable factual or legal assumptions (including assumptions as to 
future events) and must not unreasonably rely on the representations, 
statements, findings or agreements of the taxpayer or any other person. 
For example, the advice must not be based upon a representation or 
assumption which the taxpayer knows or has reason to know is unlikely 
to be true, such as an inaccurate representation or assumption as to 
the taxpayer's purposes for entering into a transaction or for 
structuring a transaction in a particular manner.
    (iii) Law is related to actual facts. The advice must be based on 
the law as it relates to the actual facts.
    (2) Definitions--(i) Advice. Advice is any communication, including 
the opinion of a professional tax advisor, setting forth the analysis 
or conclusion of a person, other than the taxpayer, provided to (or for 
the benefit of) the taxpayer and on which the taxpayer relies, directly 
or indirectly, with respect to the imposition of the section 6662 
accuracy-related penalty. Advice does not have to be in any particular 
form.
    (ii) Material. A fact is material if it reasonably could be 
expected, based upon information available at the time the advice is 
given, to be relevant to the proper tax treatment of the item or the 
taxpayer's exposure to the accuracy-related penalty under section 6662.
    (d) Pass-through items. The determination of whether a taxpayer 
acted with reasonable cause and in good faith with respect to an 
underpayment that is related to an item reflected on the return of a 
pass-through entity shall be made on the basis of all pertinent facts 
and circumstances, including the taxpayer's own actions, as well as the 
actions of the pass-through entity.
    (e) Special rules for substantial understatement penalty 
attributable to tax shelter items of corporations--(1) In general; 
facts and circumstances. The determination of whether a corporation 
acted with reasonable cause and in good faith in its treatment of a tax 
shelter item (as defined in Sec. 1.6662-4(g)(3)) is based on all 
pertinent facts and circumstances. Paragraphs (e)(2), (3) and (4) of 
this section set forth rules which apply, in the case of a penalty 
attributable to a substantial understatement of income tax (within the 
meaning of section 6662(d)), in determining whether a corporation acted 
with reasonable cause and in good faith with respect to a tax shelter 
item.
    (2) Reasonable cause based on legal justification--(i) Minimum 
requirements. A corporation's legal justification (as described in 
paragraph (e)(2)(ii) of this section) may be taken into account, as 
appropriate, in establishing that the corporation acted with reasonable 
cause and in good faith in its treatment of a tax shelter item only if 
the authority requirement of paragraph (e)(2)(i)(A) of this section and 
the belief requirement of paragraph (e)(2)(i)(B) of this section are 
satisfied (the minimum requirements). Thus, a failure to satisfy the 
minimum requirements will preclude a finding of reasonable cause and 
good faith based (in whole or in part) on the corporation's legal 
justification.
    (A) Authority requirement. The authority requirement is satisfied 
only if there is substantial authority (within the meaning of 
Sec. 1.6662-4(d)) for the tax treatment of the item.
    (B) Belief requirement. The belief requirement is satisfied only 
if, based on all facts and circumstances, the corporation reasonably 
believed, at the time the return was filed, that the tax treatment of 
the item was more likely than not the proper treatment. For purposes of 
the preceding sentence, a corporation is considered reasonably to 
believe that the tax treatment of an item is more likely than not the 
proper tax treatment if (without taking into account the possibility 
that a return will not be audited, that an issue will not be raised on 
audit, or that an issue will be settled)--
    (1) The corporation analyzes the pertinent facts and authorities in 
the manner described in Sec. 1.6662-4(d)(3)(ii), and in reliance upon 
that analysis, reasonably concludes in good faith that there is a 
greater than 50-percent likelihood that the tax treatment of the item 
will be upheld if challenged by the Internal Revenue Service; or
    (2) The corporation reasonably relies in good faith on the opinion 
of a professional tax advisor, if the opinion is based on the tax 
advisor's analysis of the pertinent facts and authorities in the manner 
described in Sec. 1.6662-4(d)(3)(ii) and unambiguously states that the 
tax advisor concludes that there is a greater than 50-percent 
likelihood that the tax treatment of the item will be upheld if 
challenged by the Internal Revenue Service. (See paragraph (c) of this 
section for certain rules governing reliance upon the opinion of a 
professional tax advisor.)
    (ii) Legal justification defined. For purposes of this paragraph 
(e), legal justification includes any justification relating to the 
treatment or characterization under the Federal tax law of the tax 
shelter item or of the entity, plan or arrangement that gave rise to 
the item. Thus, a taxpayer's belief (whether independently formed or 
based on the advice of others) as to the merits of the taxpayer's 
underlying position is a legal justification.
    (3) Minimum requirements not dispositive. Satisfaction of the 
minimum requirements of paragraph (e)(2) of this section is an 
important factor to be considered in determining whether a corporation 
acted with reasonable cause and in good faith, but is not necessarily 
dispositive.
    (4) Other factors. Facts and circumstances other than a 
corporation's legal justification may be taken into account, as 
appropriate, in determining whether the corporation acted with 
reasonable cause and in good faith with respect to a tax shelter item 
regardless of whether the minimum requirements of paragraph (e)(2) of 
this section are satisfied.
* * * * *
Margaret Milner Richardson,
Commissioner of Internal Revenue.
[FR Doc. 95-120 Filed 1-3-95; 8:45 am]
BILLING CODE 4830-01-U