IRS updates procedures for making adequate tax return disclosures

The IRS updated its annual guidance on what is a sufficient disclosure made by a taxpayer for the purpose of reducing or avoiding substantial understatement or return preparer penalties.

Under Section 6662, the IRS can impose an addition to tax of 20% for the portion of an underpayment of tax required to be shown on a taxpayer’s return. This penalty may apply in various situations, including when negligence is involved and when the understatement is shown to be substantial. The understatement is considered substantial for individuals when it exceeds the greater of 10% of the amount of tax required to be shown or $5,000. For C corporations, the understatement is substantial if the understatement exceeds the lesser of 10% of the amount of tax required to be shown on the return (or, if greater, $10,000), or $10 million.

The understatement penalty in Section 6662(a) may be reduced if the taxpayer can show either (a) that there was substantial authority for the position taken or (b) that there was a reasonable basis for the position, and that position was properly disclosed. The specific requirements for what constitutes substantial authority are described in Treas. Reg. Sec. 1.6662-4(d). Tax positions that lack substantial authority must have a reasonable basis and be properly disclosed on Form 8275, “Disclosure Statement”; on Form 8275-R, “Regulation Disclosure Statement”; or by procedures outlined in the annual revenue procedure.

In Rev. Proc. 2016-13, released Jan. 25, the IRS reiterated that certain positions, described in Section 4.02 of the Rev. Proc., must be properly disclosed based on either the procedures outlined in the revenue procedure, or through the filing of Forms 8275 or 8275-R. Taxpayers required to file Schedules M-1 or M-3 “must reasonably apprise the [IRS] of the potential controversy concerning the tax treatment of the item.” If those schedules don’t apprise the IRS, Forms 8275 or 8275-R must be used to adequately disclose the item.

The revenue procedure also states that a complete and accurate disclosure of a tax position made by a taxpayer on the appropriate year’s Schedule UTP, “Uncertain Tax Position Statement,” will be treated as if the taxpayer had filed Forms 8275 or 8275-R. However, the filing of Forms 8275 or 8275-R will not be treated as if the taxpayer had filed Schedule UTP.

Finally, the revenue procedure states that even if a taxpayer meets the literal disclosure requirements set forth in the revenue procedure, the disclosure will have no effect for purposes of reducing the Section 6662 accuracy-related penalty if the position lacks a reasonable basis, can be attributed to a tax shelter item or is not properly substantiated.

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