[Federal Register Volume 63, Number 231 (Wednesday, December 2, 1998)]
[Rules and Regulations]
[Pages 66433-66435]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-31985]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 8790]
RIN 1545-AU38


Definition of Reasonable Basis

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations relating to the 
accuracy-related penalty. These amendments are necessary to define 
reasonable basis and to make conforming changes to existing 
regulations. These regulations affect any taxpayer that files a tax 
return.

DATES: Effective date. These regulations are effective December 2, 
1998.
    Applicability date. For dates of applicability, see Secs. 1.6662-
2(d) and 1.6664-1(b)(2).

FOR FURTHER INFORMATION CONTACT: Beverly A. Baughman, 202-622-4940 (not 
a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    On September 1, 1995, the IRS issued final regulations [TD 8617 (60 
FR 45661)], relating to the accuracy-related penalty under chapter 1 of 
the Internal Revenue Code. Those regulations provided guidance 
concerning the reasonable basis standard for purposes of (1) the 
negligence penalty under section 6662(b)(1), and (2) the disclosure 
exception to the penalties for disregarding rules or regulations under 
section 6662(b)(1) and the substantial understatement of income tax 
under section 6662(b)(2). In the preamble to the final regulations, the 
IRS and Treasury Department requested comments and suggestions on 
providing further guidance on the reasonable basis standard. On 
November 12, 1996, proposed regulations [IA-42-95 (1996-49 I.R.B. 21) 
(see Sec. 601.601(d)(2)(ii)(b) of this chapter)] defining reasonable 
basis and making conforming changes to the final regulations relating 
to the accuracy-related penalty were published in the Federal Register 
(61 FR 58020).
    Written comments responding to the notice of proposed rulemaking 
were received. A public hearing was held on February 25, 1997. After 
consideration of all the comments, the proposed regulations under 
section 6662 relating to the definition of reasonable basis for 
purposes of the accuracy-related penalty are adopted as revised by this 
Treasury decision.
    In addition, on August 5, 1997, the Taxpayer Relief Act (TRA) of 
1997, Pub. L. 105-34 (111 Stat. 788), was enacted. The Act added a 
restriction regarding whether or not a corporation has a reasonable 
basis for its tax treatment of an item for purposes of reducing the 
amount of the substantial understatement penalty. This restriction has 
been incorporated into the final regulations.

Explanation of Provisions and Summary of Comments

    These final regulations provide that a return position will have a 
reasonable basis for purposes of the accuracy-related penalties if it 
is reasonably based on one or more certain authorities. Also, if the 
return position does not satisfy the reasonable basis standard, a 
reasonable cause and good faith exception may still apply.
    One commentator suggested that the substantial authority standard 
in Sec. 1.6662-4(d)(3)(ii) of existing regulations and the reasonable 
basis standard in Sec. 1.6662-3(b)(3) of the proposed regulations be 
expanded to include as authority a well-reasoned construction of the 
applicable regulatory provisions in addition to the statutory 
provisions. The substantial authority standard in Sec. 1.6662-
4(d)(3)(ii) has not been expanded to reflect this comment. However, the 
definition of reasonable basis in Sec. 1.6662-3(b)(3) has been 
clarified to include an explicit cross-reference to the nature of the 
analysis discussion in Sec. 1.6662-4(d)(3)(ii) of the substantial 
authority regulations.
    Several commentators suggested that the final regulations explain 
where the reasonable basis standard ranks in the hierarchy of return 
position standards. This suggestion was not adopted. The final 
regulations do not rank the standards formally because such a 
comparison would change the focus of the reasonable basis regulations 
from the taxpayer's obligation to determine his or her tax liability in 
accordance with the internal revenue laws to the probability of the 
return position prevailing in litigation.
    Several commentators supported the exclusion of a numerical 
qualification of the reasonable basis standard in the proposed 
regulations because they believed that such a qualification would 
encourage arbitrary and mechanical application of the standards and 
create bad precedent outside the scope of the reasonable basis 
standard. The final regulations do not include a numerical 
qualification.
    One commentator requested that the final regulations refer 
specifically to Rev. Rul. 59-60 (1959-1 C.B. 237) (see 
Sec. 601.601(d)(2)(ii)(b) of this chapter), which provides guidance 
regarding the valuation of stock of closely held corporations for 
estate and gift tax purposes. The final regulations do not adopt this 
suggestion. It is not necessary to include a reference to a specific 
revenue ruling because Sec. 1.6662-4(d)(3)(iii) of the existing 
regulations already lists revenue rulings as an acceptable type of 
authority.
    One commentator requested that the final regulations clarify the 
effect of the Omnibus Budget Reconciliation Act of 1993, Pub. L. 103-66 
(107 Stat. 312), and the reasonable cause and good faith exception 
under section 6664 on a taxpayer's access to prepayment litigation in 
Tax Court. The final regulations do not adopt this suggestion. It is 
not necessary to clarify that a taxpayer has access to prepayment 
litigation in Tax Court because under section 6665 the Tax Court has 
jurisdiction to redetermine additions to tax in the same manner as the 
underlying tax.
    Pursuant to the Taxpayer Relief Act of 1997, Pub. L. 105-34 (111 
Stat. 788), Sec. 1.6662-4(e)(3) has been added to the final 
regulations. That section provides that for purposes of reducing the 
amount of the substantial understatement penalty by making an adequate 
disclosure, a corporation will not be treated as having a reasonable 
basis for its tax treatment of an item attributable to a multi-party 
financing transaction entered into after August 5, 1997, if the 
treatment does not clearly reflect the income of the corporation.
    The Chief Counsel for Advocacy of the Small Business Administration 
requested that the preamble to the regulations explain why the IRS has 
concluded that this regulation is not subject to the Regulatory 
Flexibility Act (5 U.S.C. chapter 6). The Chief Counsel for Advocacy 
submits that the regulations tighten the definition of reasonable basis 
and, thus, impose a de facto recordkeeping requirement because they may 
require small businesses to keep and maintain records (such as the 
documents referred to in Sec. 1.6662-4(d)(3)(iii)) to support tax 
reporting decisions.
    After carefully considering these comments, the IRS and Treasury 
have

[[Page 66434]]

concluded that this regulation is not subject to the Regulatory 
Flexibility Act, 5 U.S.C. Sec. 603 (1994). That section requires a 
regulatory flexibility analysis for an interpretative rule involving 
the internal revenue laws only to the extent the interpretative rule 
imposes a collection of information requirement on small entities. A 
collection of information requirement is defined in 5 U.S.C. 
Sec. 601(7) (1994) to mean the obtaining, causing to be obtained, 
soliciting, or requiring the disclosure to third parties or the public, 
of facts or opinions by or for an agency, regardless of form or format, 
calling for either (i) answers to identical questions posed to, or 
identical reporting or recordkeeping requirements imposed on, ten or 
more persons, other than agencies, instrumentalities, or employees of 
the United States, or (ii) answers to questions posed to agencies, 
instrumentalities, or employees of the United States that are to be 
used for general statistical purposes.
    Furthermore, the phrase, recordkeeping requirement, is defined in 5 
U.S.C. 601(8) (1994) as a requirement imposed by an agency on persons 
to maintain specified records. Ever since this term was first used in 
the Paperwork Reduction Act of 1980 (44 U.S.C. chapter 35), the IRS and 
Treasury have consistently interpreted the phrase as applying only when 
Treasury regulations directly require persons to maintain specified 
records. We believe this interpretation is consistent with the explicit 
statutory language as well as Congressional intent to apply the law 
only to situations in which government agencies require persons to 
maintain particular records.
    Thus, we believe the final regulations do not impose a 
recordkeeping requirement or other collection of information 
requirement, as defined in 5 U.S.C. 601(7), (8) (1994). The regulations 
do not impose on taxpayers additional requirements to either report 
information to the IRS or to keep specified records. Because the 
regulations do not contain a reporting requirement or other collection 
of information requirement, the provisions of the Regulatory 
Flexibility Act do not apply.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in EO 12866. Therefore, a 
regulatory assessment is not required. It also has been determined that 
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) 
does not apply to these regulations. Pursuant to section 7805(f) of the 
Internal Revenue Code, the notice of proposed rulemaking preceding 
these regulations was submitted to the Chief Counsel for Advocacy of 
the Small Business Administration for comment on the impact of the 
proposed regulations on small business. The Chief Counsel for Advocacy 
submitted comments on these regulations, which are discussed above.
    Drafting Information: The principal author of these regulations is 
Beverly A. Baughman, Office of the Assistant Chief Counsel (Income Tax 
& Accounting). 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.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 1 is 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:
    1. Adding the entry for Sec. 1.6662-2(d)(4).
    2. Removing the entries for Sec. 1.6662-3(b)(3)(i) and (ii).
    3. Adding the entry for Sec. 1.6662-4(e)(3).
    4. Revising the entry for Sec. 1.6662-7(d).
    5. Removing the entries for Sec. 1.6662-7(d)(1) and (2).
    The revision and additions read as follows:


Sec. 1.6662-0  Table of contents.

* * * * *
    Sec. 1.6662-2  Accuracy-related penalty.
* * * * *
    (d) * * *
    (4) Special rule for reasonable basis.
* * * * *
    Sec. 1.6662-4  Substantial understatement of income tax.
* * * * *
    (e) * * *
    (3) Restriction for corporations.
* * * * *
    Sec. 1.6662-7  Omnibus Budget Reconciliation Act of 1993 changes 
to the accuracy-related penalty.
* * * * *
    (d) Reasonable basis.

    Par 3. Section 1.6662-2 is amended by:
    1. Revising the second sentence in paragraph (d)(1).
    2. Revising the first sentence in paragraph (d)(2).
    3. Adding paragraph (d)(4).
    The addition and revisions read as follows:


Sec. 1.6662-2  Accuracy-related penalty.

* * * * *
    (d) * * * (1) * * * Except as provided in the preceding sentence 
and in paragraphs (d)(2), (3), and (4) 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, but before January 1, 1994. * * *
    (2) Returns due after December 31, 1993. Except as provided in 
paragraphs (d)(3) and (4) of this section and the last sentence of this 
paragraph (d)(2), the provisions of Secs. 1.6662-1 through 1.6662-4 and 
Sec. 1.6662-7 (as revised to reflect the changes made to the accuracy-
related penalty by the Omnibus Budget Reconciliation Act of 1993) and 
of Sec. 1.6662-5 apply to returns the due date of which (determined 
without regard to extensions of time for filing) is after December 31, 
1993. * * *
* * * * *
    (4) Special rules for reasonable basis. Section 1.6662-3(b)(3) 
applies to returns filed on or after December 2, 1998.
    Par. 4. Section Sec. 1.6662-3 is amended by:
    1. Revising the third sentence in paragraph (b)(1) introductory 
text.
    2. Revising paragraph (b)(3).
    The revisions read as follows:


Sec. 1.6662-3  Negligence or disregard of rules or regulations.

* * * * *
    (b)* * * (1) * * * A return position that has a reasonable basis as 
defined in paragraph (b)(3) of this section is not attributable to 
negligence. * * *
* * * * *
    (3) Reasonable basis. Reasonable basis is a relatively high 
standard of tax reporting, that is, significantly higher than not 
frivolous or not patently improper. The reasonable basis standard is 
not satisfied by a return position that is merely arguable or that is 
merely a colorable claim. If a return position is reasonably based on 
one or more of the authorities set forth in Sec. 1.6662-4(d)(3)(iii) 
(taking into account the relevance and persuasiveness of the 
authorities, and subsequent developments), the return position will 
generally satisfy the reasonable basis standard even though it may not 
satisfy the substantial authority standard as defined in Sec. 1.6662-
4(d)(2). (See Sec. 1.6662-4(d)(3)(ii) for rules with

[[Page 66435]]

respect to relevance, persuasiveness, subsequent developments, and use 
of a well-reasoned construction of an applicable statutory provision 
for purposes of the substantial understatement penalty.) In addition, 
the reasonable cause and good faith exception in Sec. 1.6664-4 may 
provide relief from the penalty for negligence or disregard of rules or 
regulations, even if a return position does not satisfy the reasonable 
basis standard.
* * * * *
    Par. 5. Section 1.6662-4 is amended by:
    1. Revising the second sentence in paragraph (d)(2).
    2. Adding paragraph (e)(3).
    The addition and revision reads as follows:


Sec. 1.6662-4  Substantial understatement of income tax.

* * * * *
    (d) * * *
    (2) * * * The substantial authority standard is less stringent than 
the more likely than not standard (the standard that is met when there 
is a greater than 50-percent likelihood of the position being upheld), 
but more stringent than the reasonable basis standard as defined in 
Sec. 1.6662-3(b)(3). * * * 
* * * * *
    (e) * * *
    (3) Restriction for corporations. For purposes of paragraph 
(e)(2)(i) of this section, a corporation will not be treated as having 
a reasonable basis for its tax treatment of an item attributable to a 
multi-party financing transaction entered into after August 5, 1997, if 
the treatment does not clearly reflect the income of the corporation.
* * * * *
    Par. 6. In Sec. 1.6662-7, paragraph (d) is revised to read as 
follows:


Sec. 1.6662-7  Omnibus Budget Reconciliation Act of 1993 changes to the 
accuracy-related penalty.

* * * * *
    (d) Reasonable basis. For purposes of Secs. 1.6662-3(c) and 1.6662-
4(e) and (f) (relating to methods of making adequate disclosure), the 
provisions of Sec. 1.6662-3(b)(3) apply in determining whether a return 
position has a reasonable basis.
    Par. 7. Section 1.6664-0 is amended by:
    1. Revising the entry for Sec. 1.6664-4(c)(2).
    2. Removing the entries for Secs. 1.6664-4(c)(1)(iii), (c)(2)(i), 
and (c)(2)(ii).
    3. Adding the entry for Sec. 1.6664-4(g)(3).
    The revision and addition reads as follows:


Sec. 1.6664-0  Table of contents.

* * * * *
    Sec. 1.6664-4 Reasonable cause and good faith exception to 
section 6662 penalties.
* * * * *
    (c) * * *
    (2) Advice defined.
* * * * *
    (g) * * *
    (3) Special rules.
* * * * *
    Par. 8. In Sec. 1.6664-4, paragraph (g) is revised to read as 
follows:


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

* * * * *
    (g) Valuation misstatements of charitable deduction property--(1) 
In general. There may be reasonable cause and good faith with respect 
to a portion of an underpayment that is attributable to a substantial 
(or gross) valuation misstatement of charitable deduction property (as 
defined in paragraph (g)(2) of this section) only if--
    (i) The claimed value of the property was based on a qualified 
appraisal (as defined in paragraph (g)(2) of this section) by a 
qualified appraiser (as defined in paragraph (g)(2) of this section); 
and
    (ii) In addition to obtaining a qualified appraisal, the taxpayer 
made a good faith investigation of the value of the contributed 
property.
    (2) Definitions. For purposes of this paragraph (g):
    Charitable deduction property means any property (other than money 
or publicly traded securities, as defined in Sec. 1.170A-13(c)(7)(xi)) 
contributed by the taxpayer in a contribution for which a deduction was 
claimed under section 170.
    Qualified appraisal means a qualified appraisal as defined in 
Sec. 1.170A-13(c)(3).
    Qualified appraiser means a qualified appraiser as defined in 
Sec. 1.170A-13(c)(5).
    (3) Special rules. The rules of this paragraph (g) apply regardless 
of whether Sec. 1.170A-13 permits a taxpayer to claim a charitable 
contribution deduction for the property without obtaining a qualified 
appraisal. The rules of this paragraph (g) apply in addition to the 
generally applicable rules concerning reasonable cause and good faith.
Michael P. Dolan,
Deputy Commissioner of Internal Revenue.
    Approved: November 17, 1998.
Donald C. Lubick,
Acting Assistant Secretary of the Treasury.
[FR Doc. 98-31985 Filed 12-1-98; 8:45 am]
BILLING CODE 4830-01-u