[Federal Register Volume 68, Number 249 (Tuesday, December 30, 2003)]
[Rules and Regulations]
[Pages 75126-75128]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-31899]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9109]
RIN 1545-AY97


Establishing Defenses to the Imposition of the Accuracy-Related 
Penalty

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations that affect the 
defenses available to the imposition of the accuracy-related penalty 
when taxpayers fail to disclose reportable transactions or fail to 
disclose that they have taken a return position based on the conclusion 
that a regulation is invalid. The final regulations are intended to 
promote disclosure of reportable transactions and positions based on 
the conclusion that a regulation is invalid by narrowing a taxpayer's 
ability to establish good faith and reasonable cause as a defense. The 
final regulations also clarify the existing regulations with respect to 
the facts and circumstances to be considered in determining whether a 
taxpayer acted with reasonable cause and in good faith.

DATES: Effective Date: These regulations are effective December 30, 
2003.
    Applicability Dates: These regulations apply to returns filed after 
December 31, 2002, with respect to transactions entered into on or 
after January 1, 2003.

FOR FURTHER INFORMATION CONTACT: Jamie G. Bernstein at (202) 622-4940 
(not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    This document contains amendments to 26 CFR part 1. On December 31, 
2002, the IRS and the Treasury Department published in the Federal 
Register (67 FR 79894) proposed amendments to the regulations (REG-
126016-01) under sections 6662 and 6664 of the Internal Revenue Code 
(Code). No public hearing was requested or held. Written and electronic 
comments responding to the notice of proposed rulemaking were received. 
After consideration of all the comments, the proposed regulations under 
section 6662 and 6664 are adopted as amended by this Treasury decision. 
The revisions are discussed below.

Explanation of Revisions and Summary of Comments

    These final regulations generally adopt the provisions of the 
proposed regulations. The changes to the proposed regulations reflected 
in these final regulations, as well as comments received, are discussed 
below.

1. Applicability of Disclosure Regulations Under Section 6011 and 
Effective Date

    These final regulations were 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 temporary regulations 
relating to disclosure, promulgated under section 6011 and applicable 
for transactions entered into on or after January 1, 2003 (the 
Temporary Disclosure Regulations). The Temporary Disclosure Regulations 
were published in the Federal Register on October 22, 2002. See 67 FR 
64799 and 67 FR 64840 (October 22, 2002). Final regulations under 
section 6011 were published on March 4, 2003, and apply to transactions 
entered into on or after February 28, 2003. See 68 FR 10161, 10163 
(March 4, 2003) (the Final Disclosure Regulations). The Final 
Disclosure Regulations define reportable transactions more narrowly 
than the Temporary Disclosure Regulations. For transactions entered 
into on or after January 1, 2003, and before February 28, 2003, the 
taxpayer may apply the Final Disclosure Regulations instead of the 
Temporary Disclosure Regulations. Revisions throughout these final 
regulations refer to the definition of reportable transaction in Sec.  
1.6011-4(b) or 1.6011-4T(b), as applicable, to accommodate situations 
in which the Temporary Disclosure Regulations apply to a transaction.
    One commentator suggested that the final regulations under sections 
6662 and 6664 apply to transactions entered into on or after February 
28, 2003, because that date is the effective date for the Final 
Disclosure Regulations. See 68 FR 10161, 10163 (March 4, 2003). The 
final regulations do not adopt this recommendation. The proposed 
regulations under sections 6662 and 6664 provided adequate notice that 
failure to comply with the Temporary or Final Disclosure Regulations 
could limit the penalty defenses available under sections 6662 and 
6664.

2. Applicability of the Reasonable Cause and Good Faith Defense

    The proposed regulations prohibited reliance on tax advice to 
establish a reasonable cause and good faith defense

[[Page 75127]]

to the accuracy-related penalties if a taxpayer failed to disclose a 
reportable transaction pursuant to the Final or Temporary Disclosure 
Regulations, as applicable. Three commentators suggested that it is 
inappropriate to preclude a taxpayer from relying on the advice of a 
tax advisor in circumstances in which the taxpayer does not lack good 
faith in failing to disclose a reportable transaction. The Treasury 
Department and the IRS believe that good faith requires taxpayers to be 
forthcoming and that taxpayers should construe the Final and Temporary 
Disclosure Regulations broadly in favor of disclosure. Nonetheless, 
there may be circumstances in which a taxpayer does not lack good faith 
in failing to disclose a reportable transaction. Accordingly, the final 
regulations revise the proposed regulations to provide that a 
taxpayer's failure to disclose a reportable transaction is a strong 
indication that the taxpayer failed to act in good faith, which would 
bar relief under section 6664(c).
    These final regulations also adopt the requirement in the proposed 
regulations that 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 in good faith unless the taxpayer adequately 
disclosed its position that the regulation is invalid. One commentator 
suggested that this provision is inappropriate because it would be 
difficult for a taxpayer to discern whether its position is contrary to 
a regulation without consulting with a tax advisor. This suggestion was 
rejected because the requirement of revised Sec.  1.6664-4(c)(2)(iii) 
does not apply to situations in which a taxpayer has taken a position 
that is merely contrary to a regulation, but instead applies to 
situations in which a taxpayer has taken a return position based on 
advice or an opinion that a regulation is invalid.

3. Definition of Advice

    One commentator suggested that the proposed regulations more 
clearly define what constitutes professional advice or opinion. Section 
1.6664-4(c)(2) defines the term advice. Neither the proposed nor the 
final regulations change the definition of the term advice.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 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, and because 
these regulations do 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 Code, the proposed 
regulations preceding these regulations were submitted to the Chief 
Counsel for Advocacy of the Small Business Administration for comment 
on its impact on small business.

Drafting Information

    The principal author of these regulations is Jamie Bernstein, 
Office of the Associate 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.

Adoption of Amendments to the Regulations

0
Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
1. The authority citation for part 1 continues to read, in part, as 
follows:

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


0
2. Section 1.6662-0 is amended by adding an entry for Sec.  1.6662-
2(d)(5) to read as follows:

Sec.  1.6662-0 Table of contents.
* * * * *

Sec.  1.6662-2 Accuracy-related penalty.
* * * * *
    (d) * * *
    (5) Returns filed after December 31, 2002.

* * * * *

0
3. Section 1.6662-2 is amended by:
0
1. Revising the first sentence of paragraph (d)(2).
0
2. Adding new paragraph (d)(5).
    The revision and addition read as follows:


Sec.  1.6662-2  Accuracy-related penalty.

* * * * *
    (d) * * * (1) * * *
    (2) * * * Except as provided in paragraphs (d)(3), (4) and (5) of 
this section and the last sentence of this paragraph (d)(2), the 
provisions of Sec. Sec.  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. * * *
* * * * *
    (5) For returns filed after December 31, 2002. Sections 1.6662-
3(a), 1.6662-3(b)(2) and 1.6662-3(c)(1) (relating to adequate 
disclosure) apply to returns filed after December 31, 2002, with 
respect to transactions entered into on or after January 1, 2003. 
Except as provided in paragraph (d)(1) of this section, Sec. Sec.  
1.6662-3(a), 1.6662-3(b)(2) and 1.6662-3(c)(1) (as contained in 26 CFR 
part 1 revised April 1, 2003) apply to returns filed with respect to 
transactions entered into prior to January 1, 2003.

0
4. Section 1.6662-3 is amended by revising paragraph (a), the last 
sentence of paragraph (b)(2), and the first sentence of paragraph 
(c)(1) to 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.  
1.6011-4(b) (or Sec.  1.6011-4T(b), as applicable), the transaction is 
disclosed in accordance with Sec.  1.6011-4 (or Sec.  1.6011-4T, as 
applicable)), 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.  1.6011-4(b) or 
Sec.  1.6011-4T(b), as applicable) 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

[[Page 75128]]

defined in Sec.  1.6011-4(b) or Sec.  1.6011-4T(b), as applicable) 
contrary to a revenue ruling or 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.  
1.6011-4(b) (or Sec.  1.6011-4T(b), as applicable), the transaction is 
disclosed in accordance with Sec.  1.6011-4 (or Sec.  1.6011-4T, as 
applicable)) and, in case of a position contrary to a regulation, the 
position represents a good faith challenge to the validity of the 
regulation. * * *
* * * * *


Sec.  1.6662-4  [Amended]

0
5. Section 1.6662-4(g)(1)(iv) is amended by removing the reference to 
``Sec.  1.6664-4(e)'' and adding the reference ``Sec.  1.6664-4(f)'' in 
its place.

0
6. Section 1.6664-0 is amended by:
0
1. Adding entries for Sec.  1.6664-1 (b)(2)(i), (b)(2)(ii) and 1.6664-
4(c)(1)(iii).
0
2. Redesignating the entries for Sec.  1.6664-4(d), (e), (f), and (g), 
as Sec.  1.6664-4(e), (f), (g), and (h), respectively.
0
3. Adding a new entry for Sec.  1.6664-4(d).
    The additions read as follows:

Sec.  1.6664-0 Table of contents.
* * * * *

Sec.  1.6664-1 Accuracy-related and fraud penalties, definitions and 
special rules.
* * * * *
    (b) * * *
    (2) * * *
    (i) For returns due after September 1, 1995.
    (ii) For returns filed after December 31, 2002.
* * * * *.
Sec.  1.6664-4 Reasonable cause and good faith exception to section 
6662 penalties.
* * * * *
    (c) * * *
    (1) * * *
    (iii) Reliance on the invalidity of a regulation.
    (d) Underpayments attributable to reportable transactions.

* * * * *

0
7. Section 1.6664-1 is amended by:
0
1. Redesignating the text of paragraph (b)(2) as (b)(2)(i).
0
2. Adding a new paragraph heading for newly designated paragraph 
(b)(2)(i).
0
3. Adding paragraph (b)(2)(ii).
    The revisions and additions are as follows:


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

* * * * *
    (b) * * * (1) * * *
    (2) * * * (i) For returns due after September 1, 1995. * * *
    (ii) For returns filed after December 31, 2002. Sections 1.6664-
4(c) (relating to relying on opinion or advice) and (d) (relating to 
underpayments attributable to reportable transactions) apply to returns 
filed after December 31, 2002, with respect to transactions entered 
into on or after January 1, 2003. Except as provided in paragraph 
(b)(2)(i) of this section, Sec.  1.6664-4 (as contained in 26 CFR part 
1 revised April 1, 2003) applies to returns filed with respect to 
transactions entered into before January 1, 2003.

0
8. Section 1.6664-4 is amended by:
0
1. Removing the language ``(g) of this section'' from the last sentence 
of paragraph (a) and adding the language ``(h) of this section'' in its 
place.
0
2. Revising paragraph (c)(1) introductory text and the last sentence of 
paragraph (c)(1)(i).
0
3. Adding paragraph (c)(1)(iii).
0
4. Redesignating paragraphs (d), (e), (f) and (g) as paragraphs (e), 
(f), (g) and (h), respectively.
0
5. Adding a new paragraph (d).
0
6. Removing the language ``(e)'' wherever it appears in newly 
designated paragraphs (f)(1), (f)(2)(i), (f)(2)(ii), (f)(3), and (f)(4) 
and adding the language ``(f)'' in its place.
0
7. Removing the language ``(g)'' wherever it appears in newly 
designated paragraphs (h)(1), (h)(1)(i), (h)(2), and (h)(3) and adding 
the language ``(h)'' in its place.
    The revisions 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 tax 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. 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 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), the position that the regulation in question is 
invalid.
    (d) Underpayments attributable to reportable transactions. If any 
portion of an underpayment is attributable to a reportable transaction, 
as defined in Sec.  1.6011-4(b) (or Sec.  1.6011-4T(b), as applicable), 
then failure by the taxpayer to disclose the transaction in accordance 
with Sec.  1.6011-4 (or Sec.  1.6011-4T, as applicable) is a strong 
indication that the taxpayer did not act in good faith with respect to 
the portion of the underpayment attributable to the reportable 
transaction.
* * * * *

Mark E. Matthews,
Deputy Commissioner for Services and Enforcement.

    Approved: December 18, 2003.
Pamela F. Olson,
Assistant Secretary of the Treasury.
[FR Doc. 03-31899 Filed 12-29-03; 8:45 am]
BILLING CODE 4830-01-P