[Federal Register Volume 67, Number 251 (Tuesday, December 31, 2002)]
[Proposed Rules]
[Pages 79894-79897]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-32927]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-126016-01]
RIN 1545-AY97


Establishing Defenses to the Imposition of the Accuracy-Related 
Penalty

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed regulations that limit the 
defenses available to the imposition of the accuracy-related penalty 
when

[[Page 79895]]

taxpayers fail to disclose reportable transactions or fail to disclose 
that they have taken a position on a return based upon a regulation 
being invalid. By limiting a taxpayer's ability to use an opinion or 
advice from a tax professional as a basis for a defense, the proposed 
regulations are intended to promote the disclosure of reportable 
transactions and positions by taxpayers that conflict with regulations 
issued by the Secretary. The proposed regulations also clarify the 
existing regulations with respect to the facts and circumstances that 
the IRS will consider in determining whether a taxpayer acted with 
reasonable cause and in good faith in relying on an opinion or advice.

DATES: Written or electronically generated comments and requests for a 
public hearing must be received by March 31, 2003.

ADDRESSES: Send submissions to CC: IT&A:RU (REG-126016-01), room 5226, 
Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, 
DC 20044. Submissions may be hand delivered Monday through Friday 
between the hours of 8 a.m. and 4 p.m. to: CC: IT&A:RU (REG-126016-01), 
Courier's Desk, Internal Revenue Building, 1111 Constitution Avenue, 
NW., Washington, DC. Alternatively, taxpayers may submit comments 
electronically directly to the IRS Internet site at: http://www.irs.gov/regs.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Jamie G. Bernstein or Heather L. Dostaler at (202)622-4940; concerning 
submissions of comments and requests for a public hearing, Ms. LaNita 
Van Dyke of the Regulations Unit at (202)622-7180 (not toll-free 
numbers).

SUPPLEMENTARY INFORMATION:

Background

    This document contains proposed regulations amending the 
regulations promulgated pursuant to sections 6662 and 6664, relating to 
the accuracy-related penalty. Section 6662 provides for the imposition 
of an accuracy-related penalty for underpayments of tax, including 
underpayments due to negligence or disregard of rules or regulations 
and understatements that are substantial within the meaning of the 
statute. Taxpayers, however, can avoid the accuracy-related penalty if 
they can establish, among other things, that there was reasonable cause 
for the underpayment and that they acted in good faith within the 
meaning of section 6664(c).
    Temporary regulations issued under section 6011 require taxpayers 
to disclose reportable transactions on their returns within the meaning 
of those temporary regulations. Treas. Reg. Sec.  1.6011-4T. Reportable 
transactions may be abusive tax avoidance transactions. The early 
identification of potentially abusive tax avoidance transactions is a 
high priority for the IRS and Treasury. On October 22, 2002, the IRS 
and Treasury published proposed and temporary regulations that 
significantly revise the definition of certain types of reportable 
transactions. See Tax Shelter Disclosure Statements, (67 FR 64799 and 
67 FR 64840 (October 22, 2002)) (to be codified in 26 CFR parts 1, 20, 
25, 31, 53, 54, 56, and 301). The proposed amendments to the disclosure 
rules under section 6011 generally will apply to transactions entered 
into on or after January 1, 2003.
    The IRS and Treasury believe that taxpayers have improperly relied 
on opinions or advice issued by tax advisors to establish reasonable 
cause and good faith as a basis for avoiding the accuracy-related 
penalty, even when the opinion or advice relates to a reportable 
transaction that the taxpayer should have, but did not, disclose 
pursuant to Sec.  1.6011-4T. The IRS and Treasury also believe that 
taxpayers have improperly relied upon opinions or advice that a 
regulation is invalid without disclosing on their returns their 
position that the regulation is invalid.
    Accordingly, the IRS and Treasury have concluded that the 
regulations under sections 6662 and 6664 should be amended and 
clarified so that (1) a taxpayer who takes a position that a regulation 
is invalid cannot rely on an opinion or advice to satisfy the 
reasonable cause and good faith exception under section 6664(c) with 
respect to any underpayment attributable to such position if the 
position was not disclosed on a return; and (2) a taxpayer who engages 
in a reportable transaction cannot rely on an opinion or advice to 
satisfy the reasonable cause and good faith exception under section 
6664(c) with respect to any underpayment attributable to the 
transaction if the transaction was not disclosed pursuant to the 
regulations promulgated under section 6011. Further, a taxpayer who 
engages in a reportable transaction cannot rely on the realistic 
possibility standard under section 6662 to avoid the accuracy-related 
penalty for negligence or disregard of rules or regulations if the 
position regarding the reportable transaction is contrary to a revenue 
ruling or notice.

Explanation of Provisions

    These proposed regulations amend 26 CFR part 1 relating to the 
defenses available to the imposition of the accuracy-related penalty 
under section 6662(b)(1) (underpayments of tax attributable to 
negligence or disregard of rules or regulations) and the general 
exception to the accuracy-related penalty under section 6664(c).
    Under these proposed regulations, the adequate disclosure exception 
to the accuracy-related penalty for underpayments of tax attributable 
to negligence or disregard of rules or regulations (see Sec.  1.6662-
3(a)) will not apply to underpayments relating to a reportable 
transaction unless the reportable transaction also is disclosed under 
Sec.  1.6011-4T. In addition, if a position relates to a reportable 
transaction and is contrary to a revenue ruling or notice (other than a 
notice of proposed rulemaking), a taxpayer may not rely upon the fact 
that the position has a realistic possibility of being sustained on the 
merits as a defense to the penalty imposed under section 6662(b)(1). 
The taxpayer instead would be required to satisfy the adequate 
disclosure exception under Sec.  1.6662-3(c)(1), including the 
disclosure of the reportable transaction under Sec.  1.6011-4T.
    The proposed regulations also clarify and modify the standards for, 
and limits on, the use of opinions and advice to satisfy the reasonable 
cause and good faith exception under section 6664(c) as a defense to 
the imposition of the accuracy-related penalty under section 6662. The 
proposed regulations, for instance, clarify that a taxpayer's 
education, sophistication and business experience will be relevant in 
determining whether the taxpayer's reliance on the opinion or advice 
was reasonable and made in good faith. The IRS currently takes these 
facts and circumstances into account in determining whether a taxpayer 
has satisfied the reasonable cause and good faith exception under 
section 6664(c).
    These proposed regulations amend Sec.  1.6664-4(c) to specify when 
a taxpayer cannot rely upon an opinion or advice to satisfy the 
reasonable cause and good faith exception. Taxpayers who do not 
disclose positions based upon a regulation being invalid (see Sec.  
1.6662-3(c)(2)) cannot use an opinion or advice concerning the 
invalidity of the regulation as a basis for satisfying the reasonable 
cause and good faith exception under section 6664(c). Similarly, the 
proposed regulations prohibit taxpayers from using an opinion or advice 
as a basis for satisfying the reasonable cause and good faith exception 
under section 6664(c) with respect to a reportable transaction

[[Page 79896]]

that the taxpayer did not disclose in accordance with Sec.  1.6011-4T.
    Under these proposed regulations, a taxpayer, in order to properly 
disclose a transaction, may be required to file with the taxpayer's 
return more than one disclosure form for the same transaction in order 
to satisfy the requirements in the regulations under sections 6662 and 
6664 (as modified by these proposed regulations), and section 6011. The 
IRS and Treasury may consider permitting taxpayers to use a single 
disclosure document to satisfy those regulations, provided that all 
required information is provided by the taxpayer and provided that the 
taxpayer files a copy of the document with the Office of Tax Shelter 
Analysis as required under Sec.  1.6011-4T (or as may be otherwise 
provided in any successor regulations).

Proposed Effective Date

    These regulations are proposed to apply to returns filed after 
December 30, 2002, with respect to transactions entered into on or 
after January 1, 2003, to coincide with the temporary regulations 
relating to disclosure, promulgated under section 6011 and applicable 
for transactions entered into on or after January 1, 2003. The IRS, 
however, cautions taxpayers and tax practitioners that it will 
rigorously apply the existing facts and circumstances standard under 
Sec.  1.6664-4(c) regarding a taxpayer's reasonable reliance in good 
faith on advice from a tax professional, as well as the other 
provisions of the regulations under sections 6662 and 6664, including 
Sec.  1.6664-4(c) relating to special rules for the substantial 
understatement penalty attributable to tax shelter items of a 
corporation. In addition to the modifications contained in these 
proposed regulations, and regardless of when a transaction was entered 
into, the IRS, in appropriate circumstances, may consider a taxpayer's 
failure to disclose a reportable transaction or failure to disclose a 
position that a regulation is invalid as a factor in determining 
whether the taxpayer has satisfied the reasonable cause and good faith 
exception under section 6664(c) to the accuracy-related penalty.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
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) does not apply to these regulations, and because 
the regulation does not impose a collection of information on small 
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply. 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 their 
impact on small businesses.

Comments and Requests for a Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written (a signed original and eight 
copies) or electronic comments that are submitted timely to the IRS. 
The IRS and Treasury Department request comments on the clarity of the 
proposed regulations and how they can be made easier to understand. All 
comments will be available for public inspection and copying. A public 
hearing may be scheduled if requested in writing by any person that 
timely submits written comments. If a public hearing is scheduled, 
notice of the date, time, and place for the public hearing will be 
published in the Federal Register.

Drafting Information

    The principal authors of these regulations are Jamie G. Bernstein 
and Heather L. Dostaler of the Office of Associate of Chief Counsel 
(Procedure and Administration), Administrative Provisions and Judicial 
Practice Division.

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 1.6662-3 is amended by:
    1. Revising paragraph (a).
    2. Revising the last sentence of paragraph (b)(2)
    3. Revising the first sentence of paragraph (c)(1).
    The revisions read as follows:


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

    (a) In general. If any portion of an underpayment, as defined in 
section 6664(a) and Sec.  1.6664-2, of any income tax imposed under 
subtitle A of the Internal Revenue Code that is required to be shown on 
a return is attributable to negligence or disregard of rules or 
regulations, there is added to the tax an amount equal to 20 percent of 
such portion. The penalty for disregarding rules or regulations does 
not apply, however, if the requirements of paragraph (c)(1) of this 
section are satisfied and the position in question is adequately 
disclosed as provided in paragraph (c)(2) of this section (and, if the 
position relates to a reportable transaction as defined in Sec.  
1.6011-4T(b), the transaction is disclosed in accordance with Sec.  
1.6011-4T), or to the extent that the reasonable cause and good faith 
exception to this penalty set forth in Sec.  1.6664-4 applies. In 
addition, if a position with respect to an item (other than with 
respect to a reportable transaction, as defined in Sec.  1.6011-4T(b)) 
is contrary to a revenue ruling or notice (other than a notice of 
proposed rulemaking) issued by the Internal Revenue Service and 
published in the Internal Revenue Bulletin (see Sec.  601.601(d)(2) of 
this chapter), this penalty does not apply if the position has a 
realistic possibility of being sustained on its merits. See Sec.  
1.6694-2(b) of the income tax return preparer penalty regulations for a 
description of the realistic possibility standard.
    (b)
* * * * *
    (2) * * * Nevertheless, a taxpayer who takes a position (other than 
with respect to a reportable transaction, as defined in Sec.  1.6011-
4T(b)) contrary to a revenue ruling or a notice has not disregarded the 
ruling or notice if the contrary position has a realistic possibility 
of being sustained on its merits.
* * * * *
    (c) * * * (1) * * * No penalty under section 6662(b)(1) may be 
imposed on any portion of an underpayment that is attributable to a 
position contrary to a rule or regulation if the position is disclosed 
in accordance with the rules of paragraph (c)(2) of this section (and, 
if the position relates to a reportable transaction as defined in Sec.  
1.6011-4T(b), the transaction is disclosed in accordance with Sec.  
1.6011-4T) and, in case of a position contrary to a regulation, the 
position represents a good faith challenge to the validity of the 
regulation.

    Par. 3. Section 1.6664-0 is amended by:
    1. Adding an entry for Sec.  1.6664-4(c)(1)(iii).

[[Page 79897]]

    2. Redesignating the entries for Sec.  1.6664-4(c)(2) and (c)(3) as 
Sec.  1.6664-4(c)(3) and (c)(4), respectively.
    3. Adding a new entry for Sec.  1.6664-4(c)(2).
    The additions read as follows:


Sec.  1.6664-0  Table of contents.

* * * * *


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

* * * * *
    (c) * * *
    (1) * * *
    (iii) Reliance on the invalidity of a regulation.
    (2) Opinions or advice relating to reportable transactions.

* * * * *

    Par. 4. Section 1.6664-4 is amended by:
    1. Revising paragraph (c)(1) introductory text.
    2. Revising the last sentence of paragraph (c)(1)(i).
    3. Adding paragraph (c)(1)(iii).
    4. Redesignating paragraphs (c)(2) and (c)(3) as paragraphs (c)(3) 
and (c)(4), respectively.
    5. Adding a new paragraph (c)(2).
    The revision and additions read as follows:


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

    (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. For example, the taxpayer's 
education, sophistication and business experience will be relevant in 
determining whether the taxpayer's reliance on the advice was 
reasonable and made in good faith. In no event will a taxpayer be 
considered to have reasonably relied in good faith on advice (including 
an opinion) unless the requirements of this paragraph (c)(1) are 
satisfied and the advice is not disqualified under paragraph (c)(2) of 
this section. The fact that these requirements are satisfied, however, 
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 reasonably should have known, that the 
advisor lacked knowledge in the relevant aspects of Federal tax law.
    (i) * * * In addition, the requirements of this paragraph (c)(1) 
are not satisfied if the taxpayer fails to disclose a fact that it 
knows, or reasonably should know, to be relevant to the proper tax 
treatment of an item.
* * * * *
    (iii) Reliance on the invalidity of a regulation. A taxpayer may 
not rely on an opinion or advice that a regulation is invalid to 
establish that the taxpayer acted with reasonable cause and good faith 
unless the taxpayer adequately disclosed, in accordance with Sec.  
1.6662-3(c)(2), including the disclosure of the position that the 
regulation in question is invalid, and, if the position relates to a 
reportable transaction as defined in Sec.  1.6011-4T(b), the 
transaction is disclosed in accordance with Sec.  1.6011-4T.
    (2) Opinions or advice relating to reportable transactions. 
Taxpayers may not reasonably rely on an opinion or advice of a tax 
advisor if the opinion or advice is disqualified under this paragraph. 
An opinion or advice is disqualified if it relates to the appropriate 
tax treatment of a reportable transaction, as defined in Sec.  1.6011-
4T(b), and the taxpayer does not disclose the transaction in accordance 
with Sec.  1.6011-4T.
* * * * *

David A. Mader,
Assistant Deputy Commissioner of Internal Revenue.
[FR Doc. 02-32927 Filed 12-30-02; 8:45 am]
BILLING CODE 4830-01-P