American Taxation Association

1
American Taxation Association February 27th,
2004 Denver, Colorado SOX 404 Tax Shelter
Disclosure Regulations
2
Sarbanes-Oxley 404 Tax Role
Robert Lund Director-Tax Services
3
Executive Summary of SOX 404

• Annual report must contain a report from
  management on internal control that
• States managements responsibility for
  establishing and maintaining an adequate internal
  control structure and procedures for financial
  reporting, and
• Contain managements assessment, as of the end of
  the fiscal year of the effectiveness of the
  internal control structure and procedures for
  financial reporting

4
Executive Summary of S-O 404

• External auditor must attest to and report on
  management's assertion concerning its assessment
  of internal control
• Effective Date
• The Act does not impose a deadline for the
  creation of rules to implement 404. If adopted,
  would apply to companies whose fiscal years end
  on or after June 15, 2004. ( Who Knows ?)

5
Internal Control

• Focus is on reliability of financial reporting
• Committee of Sponsoring Organizations (COSO) of
  the Treadway Commission provides detailed
  internal control criteria and defines five
  components of internal control

6
Internal Control, continued
Control Environment The control environment sets the tone of an organization, influencing the control consciousness of its people
Risk Assessment Every entity faces a variety of risks from external and internal sources that must be assessed both at the entity and the activity level
Control Activities These policies procedures help ensure management directives are carried out
Information and Communication Pertinent information must be identified, captured and communicated in a form and timeframe that supports all other control components
Monitoring Internal control systems need to be monitored a process that assesses the quality of the systems performance over time
7
Managements Assessment of Effectiveness Should

• Cover each of the five components of internal
  control and include
• An inventory and documentation of significant
  controls consistent with managements assertion
  (see next slide)
• An evaluation of the design effectiveness of
  controls
• An evaluation of the operating effectiveness of
  controls based on testing or other procedures
• Include documentation of the results of the
  evaluation
• Provide for communication of findings to the
  auditor or to others, if applicable

8
Management Supporting the Evaluation

• Determining which controls are significant
• Controls that address significant classes of
  transactions, account balances, disclosures and
  related assertions
• Consider likelihood that control failure could
  cause misstatements and the potential magnitude

9
Management Supporting the Evaluation

• Should include
• Fraud programs and controls
• Controls on which other controls are dependent
  (e.g., general controls)
• Controls over significant non-routine
  transactions, journal entries, and accounts
  involving judgments and estimates
• Controls over closing process and preparing F/S

10
Management Evaluating Operating Effectiveness

• Procedures must be sufficient to verify operating
  effectiveness
• testing of controls by internal audit or others
  under the direction of management
• use of service organization reports
• self-assessment processes
• Inquiry alone is not adequate
• Procedures performed and controls and locations
  selected are affected by risk assessment and
  monitoring processes
• All significant controls and locations must be
  evaluated annually

11
Auditors Consideration of Managements Evaluation

• Inadequate documentation of controls may result
  in a significant deficiency or a material
  weakness
• Absence of sufficient evidence to support
  assertion constitutes a material weakness

12
Tax Involvement with Section 404

• Significant Transactions and Activities
• Tax is often a significant activity subject to
  significant financial risk and substantial
  disclosure considerations

13
Tax Involvement with Section 404

• Significant Activities and Risk
• Tax is based on self-assessment
• Unlike typical accounts payable
• Tax functions are often decentralized
• Estimates and judgments are often utilized in tax
  reserve analysis computations.

14
Tax Integration with S-O 404

• Scope and Depth of Tax Transactions
• Tax impacts nearly every line on the income
  statement and balance sheet

15
Tax is Embedded in Every Aspect of Business
Customs duties Transfer pricing issues
PROFIT AND LOSS ACCOUNT Sales X Purchases (X) Manu
facturing (X) Overheads (X) Financing (X) Profit
X Tax charge X Profit after tax X
Location and exploitation of intellectual
property Cross border issues
VAT and sales taxes Cross border issues
Location of activities
BALANCE SHEET Tangible assets X Intangible
assets X Net current assets X X Capital X Reserve
s X Funding debt X X
Trade debts Liabilities
Profit repatriation flows Monetising tax assets
Property taxes Employee taxes International
executive taxation
Treasury Foreign exchange Funding
Tax considerations may impact areas of S-O 404
attest and advisory services
16
Tax Integration with S-O 404

• Tax Subject Matter Requirement
• Tax content knowledge is necessary to evaluate
  tax-related internal controls
• Broad Range of Taxes (Income/Sales)

17
Tax Areas Requiring Internal Controls
Income Tax
Sales Use Taxes
Property Tax
Payroll Tax
Transfer Pricing
FAS109
VAT
Tax Incentives, Holidays, Credits
Non-US Income Tax
International Executive Tax
Excise Taxes
Comp Benefits
Customs
Unclaimed Property
The tax function extends beyond income tax
non-income tax areasmay account for a
disproportionately large share of the risk
18
Significance

• There is no formula to calculate significance,
  however, there are general guidelines
• Quantitative factors
• Value of transactions
• Volume of transactions
• Qualitative factors
• Risk of significant misstatement of a financial
  statement element in the absence of internal
  controls.
• Management ultimately decides significant
  controls.

19
Risk Indicators

• High Likelihood of Occurrence
• Non-routine
• Non-systematic
• Subjective
• Estimates
• Assumptions
• Interpretation
• Complex

• High Magnitude of Error
• Significant Class of Transaction
• Misstatement is material to financial statements

20
I. Obtain background information and high-level
understanding of tax functions

• Financial statements
• Organization charts (legal entity and corporate
  personnel)
• Internal memoranda tax correspondence files
• Income tax provision workpapers
• Prior years income tax returns and workpapers
• Tax audit history and reports
• History of significant transactions (MA, change
  of control, etc.)

21
II. Obtain general understanding of current
control environment and process

• Review tax department policies and procedures
  manuals
• Review tax workpaper and tax research
  documentation (look for process standards,
  work-flow tracking, documentation, etc.)
• Walk-through tax process and control procedures
• Management letter comments by audit firm
  concerning tax
• History of audit adjustments to tax accounts
• Internal audit review of tax functions
• Standard forms / checklists / dockets / workpaper
  formats used by tax department
• Forms for requesting and approving checks or
  electronic tax payments
• Reporting structure - business unit or financial
  accounting
• Identify and review systems for which tax
  department has responsibility

22
III. Determine which tax segments and functions
constitute significant control risks

• Significant class of transaction
• Strategic business risks
• Tax department functions that aggregate to
  material risk
• i.e., support to operating units or HR for sales
  use tax, payroll tax , etc.
• Consider degree to which tax functions are
  non-routine, non-systematic or subjective
• Consider level of complexity
• Consider materiality to financial statements
• Quantitative analysis
• Account balances current taxes
  payable/receivable, deferred tax assets
  liabilities, valuation allowance, effective tax
  rate, etc.
• Comparison of change from prior years

23
IV. Identify Relevant Locations for Significant
Segments

• Consider significant lines of business.
• Consider significant decentralized tax functions.
• Consider significant tax jurisdictions.

24
Possible Scoping Results Example
High
VAT
CB
Income
Sales
Magnitude of Error
Property
Payroll
Customs
Excise
Low
Likelihood of Occurrence
25
Are you Done? Questions to ask

• Have we identified all of the tax processes that
  have significant risk to the financial
  statements?
• Does the documentation of the tax process
  adequately represent and provide an understanding
  of the underlying tax process?
• Have we identified all of the significant risk to
  the financial statements inherent in the tax
  process?
• Do the identified and designed controls
  adequately mitigate the identified significant
  risk to the financial statements?

26
What Were Seeing in the Marketplace
27
What We're Seeing in the MarketplaceRealities

• Executives everywhere recognize the need for
  improved corporate governance and more
  transparent financial reporting
• Organizations are clearly focused on meeting the
  compliance requirements established by the
  Sarbanes-Oxley Act of 2002
• Non-SEC organizations are adopting similar
  measures as best practice standards
• Foreign registrants are feeling additional
  pressure from similar initiatives in other
  countries

28
What We're Seeing in the Marketplace Realities

• A paradox while boosting investor confidence,
  many CFOs claim they arent seeing return on
  investment
• Compliance is perceived as
• Expensive
• Diverting attention from the core business
• Overburdening limited resources to complete the
  labor-intensive project
• A one-time project approach for initial
  compliance versus focus on an ongoing,
  sustainable compliance process
• Sarbanes-Oxley is not the Y2K of accounting
  there will always be financial reporting
  requirements associated with Sarbanes-Oxley and
  future regulations

29
What We're Seeing in the Marketplace Challenges
Internal External
Satisfying managements need for a high level of confidence to support assertions Creating a sustainable compliance process Considering all sections of Sarbanes-Oxley Integrating all internal control activities Achieving return on the compliance investment Changing regulations Sarbanes-Oxley PCAOB AICPA SEC (including accelerated filer requirements) Others The COSO-ERM Framework is evolving
30
What We're Seeing in the MarketplaceResearch
Findings

• In November 2003, we commissioned a survey of
  175 chief executive officers and chief financial
  offers at top U.S. companies key findings from
  the survey include
• A majority (68) believe SOX has boosted investor
  confidence in corporate America
• 70 rank SOX 404 compliance as a high or higher
  priority relative to other major business issues
• Nearly all (97) report being on or ahead of
  schedule with SOX readiness - however, only 31
  had completed more than 50 of their SOX 404
  preparation as of the survey date
• Respondents report the most difficulty overall
  with documentation and testing of internal
  controls

31
What We're Seeing in the MarketplaceA Forward
Look

• Companies are focusing on the regulatory demands
  and how to meet compliance deadlines - in
  documenting ICFR, they are amassing large amounts
  of information about their business processes,
  risks and controls
• Some senior executives have begun to look beyond
  immediate compliance efforts to leverage into
  long-term business value others will follow
• Leading companies are beginning to extract value
  from the heightened control environment by using
  compliance efforts as a foundation to
• Strengthen, streamline and automate internal
  controls
• Increase an enterprise-wide understanding of all
  risks operational, financial reporting and
  compliance and how to control them
• Improve and redesign business processes while
  maintaining appropriate awareness and control of
  risks

32
What We're Seeing in the MarketplaceRisk
Performance Optimization
Risk Performance Optimization In leading edge
companies, ICFR control documentation and
evaluation is being leveraged as a foundation for
risk and performance optimization
33
Tax Shelter Disclosure
Darice Henritze Partner International Tax
Services
34
Treasury Shelter Regulations

• Under 6011, 6111 and 6112
• February 28, 2000 original temporary and
  proposed regulations issued
• August 11, 2000 revised temporary and proposed
  regulations issued
• August 2, 2001 further revised temporary and
  proposed regulations issued
• March 20, 2002 Treasury announced simplified
  initiative
• June 14, 2002 further revised temporary and
  proposed regulations issued
• October 17, 2002 further revised temporary and
  proposed regulations issued
• February 28, 2003 final regulations issued
• December 29, 2003 final regulations amended
• Under 6662 and 6664
• December 31, 2002 proposed regulations issued
• December 29, 2003 final regulations issued

35
Final Section 6011 Disclosure Regulations
36
Effective Dates

• Generally effective for transactions entered into
  on or after February 28, 2003
• For transactions entered into on or after January
  1, 2003 and before February 28, 2003, taxpayers
  may apply either the final regulations or the
  October 2002 temporary regulations
• For transactions entered into before January 1,
  2003, see the temporary regulations in effect at
  that time
• Conditions of confidentiality Transactions
  entered into on or after December 29, 2003 (may
  be applied retroactively by taxpayers)

37
Taxpayers

• Applies to ALL TAXPAYERS (means any person
  described in 7701(a)(1), including S
  corporations and consolidated groups)
• Also includes, e.g., partners and S corporation
  shareholders
• Special Rules Reporting Shareholders of Certain
  Foreign Corporations

38
NOT JUST FOR INCOME TAXES

• IRS can identify transactions entered into on or
  after January 1, 2003, as listed transactions
  for estate, gift, employment taxes pension and
  exempt organization excise taxes

39
Definition of Transaction

• Includes all the factual elements relevant to
  the expected tax treatment of any investment,
  entity, plan, or arrangement, and includes any
  series of steps carried out as part of the plan.

40
Reportable Transactions

• Listed, or substantially similar, transaction
• Conditions of confidentiality
• Contractual protection
• Section 165 loss
• Significant book/tax difference
• Brief asset holding period

41
Listed Transactions

• Currently 31 listed transactions identified in
  IRS notices and other published guidance
• Rev. Rul. 2004-4 Issued January 23, 2004
• Notice 2004-8 Issued December 31, 2003
• Notice 2003-81 Issued December 4, 2003
• Notice 2003-77 Issued November 19, 2003 and
  clarified December 1, 2003
• Notice 2003-76 Listed transactions as of
  November 15, 2003
• Substantially similar
• Same or similar types of tax consequences, and
  either factually similar or based on same or
  similar tax strategy
• Broadly construed in favor of disclosure

42
Listed Transactions

• Rev. Rul. 2004-4 Prohibited Allocations of
  Securities in an S Corporation
• Notice 2004-8 Abusive Roth IRA Transactions
• Notice 2003-81 - Tax Avoidance Using Offsetting
  Foreign Currency Option Contracts
• Notice 2003-77 Transfers to Trusts to Provide
  for the Satisfaction of Contested Liabilities
• Notice 2003-55 Lease Strips and Other Stripping
  Transactions (superseding Notice 95-53)
• Notice 2003-54 Common Trust Fund Straddle
• Notice 2003-47 Transfers of Compensatory Stock
  Options to Related Persons
• Notice 2003-24 Welfare Benefit Fund
• Notice 2003-22 Offshore Deferred Compensation
  Arrangements
• Revenue Ruling 2003-6  Certain S Corporation
  ESOPs

43
Listed Transactions (continued)

• Notice 2002-70 Certain Reinsurance Arrangements
  
• Notice 2002-65 Passthrough Entity Straddle Tax
  Shelter
• Revenue Ruling 2002-46 401k Accelerators
• Notice 2002-50 Partnership Straddle Tax Shelter
• Notice 2002-35 Notional Principal Contracts
• Notice 2001-21 Inflated Basis CARDS
  Transactions
• Notice 2001-45 302 Basis-Shifting
  Transactions
• Notice 2001-17 Certain 351 Transactions 
• Notice 2001-16 Intermediary Transactions
• Notice 2000-61 Guam Trust
• Notice 2000-60 Certain Stock Compensation
  Transactions
• Notice 2000-44 Inflated Partnership Basis
  Transactions
• Revenue Ruling 2000-12 Debt Straddles

44
Listed Transactions (continued)

• Treasury Regulation 1.7701(1)-3 Fast Pay or
  Step-Down Preferred Transactions
• Notice 99-59 BOSS Transactions
• Revenue Ruling 99-14 Lease-In /Lease-Out or
  LILO Transactions
• Treasury Regulation 1.643(a)-8 Certain
  Distributions from Charitable Remainder Trusts
• ASA Investerings Partnership v. Commissioner --
  Transactions similar to those described in the
  ASA Investerings litigation and in ACM
  Partnership v. Commissioner, 157 F.3d 231 (3rd
  Cir. 1998)
• Notice 98-5, part II Foreign Tax Credit
  Transactions
• Notice 95-34 Certain Trusts Purported to be
  Multiple Employer Welfare Benefit Funds Exempted
  from the Limits of 419 and 419A
• Revenue Ruling 90-105 Certain Accelerated
  Deductions for Contributions to a Qualified Cash
  or Deferred Arrangement or Matching Contributions
  to a Defined Contribution Plan

45
Listed TransactionsParticipants

• Taxpayers tax return reflects tax consequences
  or a tax strategy described in IRS guidance
  identifying the transaction as listed, or
• Taxpayer knows or has reason to know that
  taxpayers tax benefits are derived directly or
  indirectly from tax consequences or a tax
  strategy described in IRS guidance identifying
  the transaction as listed

46
Conditions of ConfidentialityTransactions prior
to December 29, 2003

• Generally facts and circumstances test
• Situations where treated as confidential
• Taxpayers disclosure of tax treatment or tax
  structure of transaction is limited by
  understanding or agreement with or for the
  benefit of anyone who provides oral or written
  statement to the taxpayer concerning potential
  tax consequences of the transaction
• Taxpayer knows or has reason to know that
  taxpayers use or disclosure of information is
  otherwise restricted for the benefit of any
  person other than taxpayer who provides a
  statement concerning potential tax consequences
  e.g., transaction is claimed to be proprietary or
  exclusive

47
Conditions of ConfidentialityTransactions Prior
to December 29, 2003

• Presumption of non-confidentiality if express
  written authorization is provided from every
  person who makes a statement to the taxpayer as
  to the potential tax consequences
• The taxpayer (and each employee, representative,
  or other agent of the taxpayer) may disclose to
  any and all persons, without limitation of any
  kind, the tax treatment and tax structure of the
  transaction and all materials of any kind
  (including opinions or other tax analyses) that
  are provided to the taxpayer relating to such tax
  treatment and tax structure.

48
Conditions of ConfidentialityTransactions on or
after December 29, 2003

• New definition for conditions of confidentiality
• Advisor who is paid the minimum fee places a
  limitation on disclosure by the taxpayer of the
  tax treatment or tax structure of transaction and
  the limitation protects the confidentiality of
  the advisors tax strategies
• Proprietary or exclusive assertion is not a
  limitation on disclosure if the advisor confirms
  that the taxpayer may disclose the tax treatment
  or tax structure
• May be applied retroactively by taxpayer to
  transactions entered into on or after January 1,
  2003

49
Conditions of ConfidentialityTransactions on or
after December 29, 2003

• Minimum fee
• 250,000 if taxpayer is a corporation (or a
  partnership or trust in which all partners,
  owners or beneficiaries are corporations)
• 50,000 for all other taxpayers
• Determining minimum fee
• Includes all fees for a tax strategy or for
  services for advice (whether or not tax advice)
  or for the implementation of a transaction
• Very broad, includes services to analyze,
  implement, and document the transaction and
  services to prepare returns if fees are
  excessive. . .BUT
• Does NOT include an amount paid to an advisor in
  that persons capacity as a party to the
  transaction

50
Contractual Protection

• Facts and circumstances determination
• Taxpayer or a related party (section 267(b) or
  707(b)) has the right to a full or partial refund
  of fees if all or a portion of tax consequences
  are not sustained, or
• Fees are contingent on taxpayers realization of
  tax benefits from the transaction

51
Contractual ProtectionExceptions

• Party has a right to terminate transaction upon
  the happening of an event affecting taxation
• Refundable or contingent fees if statement
  concerning potential tax consequences is made
  only after the taxpayer has entered into the
  transaction and reported consequences of the
  transaction on a filed tax return, and person
  making statement has not previously received fees
  from the taxpayer relating to the transaction

52
Section 165 Loss

• Corporations 10M in one tax year, or 20M in
  tax year transaction entered into and 5
  succeeding tax years
• Partnerships with only corporate partners
• 10M / 20M
• Other Partnerships 2M / 4M
• S Corporations, Individuals Trusts
• 2 M / 4 M
• Individuals Trusts 50,000 for section 988
  foreign currency transaction losses

53
Section 165 Loss (continued)

• A section 165 loss includes
• Any amount deductible under section 165
• Any deduction treated by the Code as resulting
  from a sale or other disposition
• A loss resulting from the sale or exchange of a
  partnership interest under section 741
• A loss resulting from a section 988 transaction

54
Section 165 Loss (continued)

• Do not take into account offsetting gains, or
  other income or limitations (such as capital loss
  limitations)
• However, section 165 loss is adjusted for salvage
  value and any insurance or other compensation
  received

55
Section 165 Loss Some Exceptions Rev. Proc.
2003-24

• Sale of a capital asset with a qualifying basis
  that is not an interest in a passthrough entity,
  is not part of a straddle, and has not been
  separated from any portion of income it generates
• Qualifying basis cash, 358, 1014, 1015
  (if donor had qualifying basis), or 1031(d)
• Mark-to-market losses, provided taxpayer computes
  loss using a qualifying basis
• Loss from hedging transaction or mixed straddle

56
Book/Tax Difference Taxpayers

• Only applies to
• Taxpayers that are reporting companies under
  Securities Exchange Act of 1934 (and related
  entities), or
• Business entities with at least 250 million in
  gross assets for book purposes at the end of the
  financial accounting period ending with or within
  the entitys tax year in which the transaction
  occurs (assets of all related business entities
  are aggregated)

57
Significant Book/Tax Difference

• Book/tax difference from the transaction exceeds
  10M on a gross basis
• Offsetting items are not netted for either tax or
  book purposes
• Book income determined using U.S. GAAP for
  worldwide income, unless the taxpayer, in the
  ordinary course of business, consistently keeps
  books on another basis
• Transactions only among members of consolidated
  group are disregarded
• If members of consolidated group, plus third
  party, participate in the transaction, aggregate
  group items

58
Significant Book/Tax DifferenceOther Persons

• Foreign Persons
• Only U.S. assets taken into account in
  determining whether gross asset test is met
• Only transactions giving rise to Effectively
  Connected Income (or losses, etc.) are taken into
  account
• Disregarded Entity
• Treat income, loss, etc. as items of owner
• Disregard transactions between entity and owner
• Partner
• Items allocated to partner for tax purposes, but
  to entity for book purposes, are treated as items
  of partner

59
Significant Book/Tax DifferenceSome Exceptions
Rev. Proc. 2003-25

• Tax income or gain is reported before or without
  book income or gain
• Book loss or expense is reported before or
  without tax loss or deduction
• Depreciation, percentage depletion, cost
  depletion, and intangible drilling costs
• Capitalization and amortization under sections
  195, 248, and 709

60
Brief Asset Holding Period

• Asset held for 45 days or less, and
• Transaction results in taxpayer claiming a tax
  credit exceeding 250,000
• Exception
• Transactions resulting in a foreign tax credit
  for taxes imposed in respect of a dividend that
  are not disallowed under 901(k).

61
Reporting Shareholders Special Participation
Rules

• Reporting shareholder means
• US shareholder under 551(a) in a foreign
  personal holding company under 552 Form 5471
• US shareholder under 951(b) in a controlled
  foreign corporation under 957 Form 5471, or
• 10 percent shareholder of a qualified electing
  fund under 1295 Form 8621

62
Reporting Shareholders Special Participation
Rules

• Rules for listed transactions, loss transactions,
  and brief asset holding period transactions
• Treat reporting shareholder as participant if
  the foreign corporation would be treated as
  participating if it were a domestic corporation
  filing a tax return that reflects the items from
  the transaction
• Does not need to have US tax benefits or
  consequences

63
Reporting Shareholders Special Participation
Rules

• Rules for conditions of confidentiality
  transactions and contractual protection
  transactions
• Treat reporting shareholder as participant if
  the foreign corporation would be treated as
  participating if it were a domestic corporation
  filing a tax return that reflects the items from
  the transaction
• Reportable transaction only if
• Confidentiality Limitation concerns U.S.
  federal income tax treatment or structure
• Contractual protection Refund or contingent
  fees based on U.S. federal income tax benefits or
  consequences

64
Reporting Shareholders Special Participation
Rules

• For the book/tax difference reportable
  transaction
• Treat reporting shareholder as participant if
  the foreign corporation would be treated as
  having a US 10 million book/tax difference for
  an item from the transaction if it were a
  domestic corporation and
• The transaction reduces or eliminates an income
  inclusion that would otherwise be required under
  section 551, 951, or 1293.

65
Exceptions to the Disclosure Regulations

• Angel list transactions
• Notice 2001-18
• With the exception of listed transactions, the
  disclosure regulations do not apply to regulated
  investment companies (RICs)

66
When Disclosure Is Made

• General Rule File disclosure statement (Form
  8886) with tax return (or amended return for
  transactions entered into on or after December
  29, 2003) for each tax year for which the
  taxpayer participates
• Also send copy to Office of Tax Shelter Analysis
  (OTSA) when Form 8886 first filed with return
• Transaction becomes listed after return filed and
  before statute of limitations closes for the
  final return that is affected by the transaction
  Attach Form 8886 to taxpayers next filed tax
  return
• Includes loss carrybacks

67
Document Retention

• Retain copy of all documents and other records
  related to a transaction subject to disclosure
  that are material to an understanding of the tax
  treatment or tax structure of the transaction
  including
• Marketing materials, written analysis used in
  decision-making, correspondence and agreements
  with advisors and other parties, analysis of tax
  benefits, documents concerning business purpose,
  internal e-mails
• Retain these materials until the expiration of
  the statute of limitations for the final tax year
  for which disclosure was required

68
Office of Tax Shelter AnalysisInfluence/Relations
hips
Director of Practice
National Office Counsel
LMSB Commissioner
LMSB Counsel
OTSA Review Committee
OTSA
Senior Legal Counsel
Corp. Tax Shelters
IssueTechnicalAdvisers
5 Industry Directors
Area Counsel
(includes tech. specialists)
Guidance CoordinatingCommittee
Territory Managers
Associate Area
Team Managers
Counsel for PFTG
Litigation Vehicles
Audits
Published Guidance
--- Coordination Functions
69
Super IDRs (Continued)

• Requires taxpayer to describe any listed
  transactions entered into during the year under
  examination
• Requests, inter alia
• All legal opinions and memoranda provided by any
  party that promoted, solicited, or recommended
  participation in the transaction
• All internal documents used by the taxpayer in
  its decision making process

70
Announcement 2002-63

• Guidelines regarding Tax Accrual Workpapers
• Generally, for tax returns filed after July 1,
  2002 (but before for listed, if not disclosed)
• Listed and Disclosed workpapers from
  transaction
• 2 or more Listed
• Listed but not Disclosed
• Chief Counsel Notice CC-2003-012

all workpapers
71
New Penalty Guidelines
If listed transaction examiner MUST consider
6662 and submit to Director of Field Operations
(DFO) If other potentially abusive tax shelter
must coordinate with Office of Tax Shelter
Analysis (OTSA ) If examiner considers 6662
DFO must approve imposition of penalty
72
Section 1.6662-3 for Reportable Transactions
(Dec. 29, 2003)

• Effective date Returns filed after December 31,
  2002, for transactions entered into on or after
  January 1, 2003
• Disregard of Regulation
• Disclosure under Reg. section 1.6011-4 also
  required
• Position contrary to Rev. Rul. or Notice
• No realistic possibility test
• Section 6662 disclosure required
• Reg. section 1.6011-4 disclosure also required

73
Section 1.6664-4 for Reportable Transactions
(Dec. 29, 2003)

• Effective Date Returns filed after December 31,
  2002, for transactions entered into on or after
  January 1, 2003
• Disregard of regulations
• To rely on opinion that the regulation is
  invalid, must have section 6662 disclosure and
  must have disclosure under Reg. section 1.6011-4
• Failure to disclose a reportable transaction
  under Reg. section 1.6011-4 is strong
  indication that the taxpayer did not act in good
  faith for the portion of the underpayment
  attributable to the reportable transaction, which
  would bar relief under section 6664(c)

74
Proposed Legislative Changes

• Background
• Charity Aid Recovery and Empowerment (CARE) Act
  of 2002 (H.R. 7) (June 18, 2002)
• Tax Shelter Transparency Act (June 18, 2002)
• Small Business and Farm Economic Recovery Act
  (September 17, 2002)
• Economic Recovery Act of 2003 (S. 414) (Feb.
  14, 2003)
• CARE Act of 2003 (S. 476) (Feb. 27, 2003)
• Doggett Bill (H.R. 1555) (April 2, 2003)
• Jobs and Growth Reconciliation Tax Act of 2003
  (S. 1054, previously S.2) (May 8, 2003)
• Current Bills
• Tax Incentives Act of 2003 (S. 1149) (May 23,
  2003) currently in the Senate
• Working Families Tax Credit Act of 2003 (H.R.
  2286) (June 2, 2003) currently in the House
  Committee of Ways and Means
• American Jobs Creation Act of 2003 (H.R. 2896)
  (July 25, 2003) currently in the House
  Committee on Ways and Means
• Jumpstart Our Business Strength JOBS Act (S.
  1637) (Chairmans Mark October 1, 2003)
• Tax Shelter Transparency and Enforcement Act (S.
  1937) Introduced in Senate Finance Committee
  November 24, 2003
• Tax Shelter Transparency and Enforcement Act (S.
  1937) Introduced in Senate Finance Committee
  (November 24, 2003)
• Highway Reauthorization and Excise Tax
  Simplification Act of 2004 Senate Finance
  Committee (February 2, 2004)
• Tax Administration Good Government Act of 2004
  Senate Finance Committee (February 2, 2004)

75
Proposed Legislative Change (S. 1149)New 6707A
Failure to Disclose Reportable Transaction

• Penalty for large entity corporation may be
  200,000 for listed transaction and 100,000 for
  other reportable transactions
• Almost strict liability penalty
• Discretion of OTSA to rescind
• Does not apply to failure to disclose listed
  transactions
• Applies only to unintentional mistakes of fact
• No rights to appeal OTSAs decision
• If rescinded, included in annual report from IRS
  to Congress
• Disclosed to SEC with new 6662A Accuracy Penalty
• Slightly different version of penalty in H.R. 2896

76
Proposed Legislative Change (S. 1149 H.R.
2896)New Accuracy-Related Penalty for
Reportable Transaction Understatements (6662A)

• Increased Penalty for Undisclosed Reportable
  Transactions 30
• No Section 6011 disclosure
• Listed
• Strict Liability
• Other
• Almost Strict Liability (OTSAs discretion on
  6707A)
• 20 Penalty with Disclosure / Heightened
  Requirements
• Disclosure 6664(d) substantial authority and
  MLTN
• Penalty Based on an Understatement at highest
  rate
• Opinion Letters Restricted

77
Proposed Legislative Change (S. 1149 H.R. 2896)
Limited Reliance on Opinions of Tax Advisors
forReportable Transaction Understatement Penalty

• Cannot rely on opinion for reasonable belief if
  either
• Advisor material advisor who either
• Participates (or is related to a person who
  participates) in organization, management,
  promotion, or sale of the transaction
• Is compensated by another material advisor or
• Has a contingent fee arrangement OR
• Opinion is
• Based on unreasonable facts and assumptions
• Based on unreasonable reliance on reps or
• Doesnt identify and consider all relevant facts

78
Proposed Legislative Change (was in S. 1054 but
is not in current Energy Bill in H.R. 2286)
Substantial Understatement and Preparer
Penalty for Nonreportable Transactions

• Accuracy Penalty Non-Reportable Transaction
• New Standards
• Thresholds for Corporations Exceeds the lesser
  of (1) the greater of 10 or 10,000 or (2)
  10,000,000
• More Likely than Not
• Disclosure and Reasonable Basis
• Preparer Penalty Non-Reportable Transaction
• New Standards
• More Likely than Not
• Disclosure and Reasonable Basis
• Amounts

79
Proposed Legislative Change (was in S. 1054 but
is not in current Energy Bill in H.R. 2286)
Economic Substance Other Related Provisions

• Codifies economic substance
• Transaction changes taxpayers economic position
  in a meaningful way
• Substantial non-tax purpose for entering into
  transaction
• Transaction is a reasonable means of
  accomplishing that purpose
• 40 strict liability accuracy-related penalty (no
  economic substance) reduced to 20 if facts are
  adequately disclosed
• Other provisions
• No deduction on interest attributable to
  understatement related to reportable transaction
  or noneconomic substance transaction
• Non-disclosure of listed transaction automatic
  6-year statute on whole return

80
California Tax Shelter Legislation

• Disclosure by California taxpayer subject to
  California income or franchise tax
• Federal listed transaction entered into after
  February 28, 2000
• Other federal reportable transactions
• California-only transaction identified by the
  California Franchise Tax Board
• California announced 2 listed transactions on
  December 31, 2003
• Registration by tax shelter organizer
• List maintenance by tax shelter organizer, seller
  or material advisor

81
California Tax Shelter Legislation

• California Penalties
• Adopted many proposed Federal legislative changes
• Failure to disclose reportable transaction
• Listed transaction (30,000)
• Other reportable transaction (15,000)
• Additional accuracy-penalties for reportable
  transaction
• 20 (disclosed)
• 30 (not disclosed)
• - Noneconomic substance penalty
• 20 (relevant facts disclosed)
• 40 (relevant facts not disclosed)
• - Interest enhanced penalty
• Additional 100 of interest due on
  deficiency

82
California Tax Shelter Legislation

• Voluntary Compliance Initiative
• Available until April 15, 2004
• Applies to abusive tax avoidance transactions
  for tax years beginning before January 1, 2003
• Voluntary Compliance Initiative without appeal
• Must pay tax and interest
• Waiver of all penalties
• No criminal penalties
• No claims for refund
• Voluntary Compliance Initiative with appeal
• Must pay tax and interest
• Waiver of penalties except for accuracy-related
  penalties (20-40 )
• No criminal penalties
• California collected 30 million in the first
  week

83
Ramifications for Noncompliance

• Request by IRS for tax accrual work papers
• Increased scrutiny from higher IRS officials
• Mandatory consideration of accuracy-related
  penalties
• Failure to disclose reportable transaction is
  strong indication that taxpayer did not act in
  good faith, which precludes relief under section
  6664
• Proposed legislation
• Disclosure penalties
• Accuracy-related penalties
• Reporting to the Securities Exchange Commission
• Statute of limitations on assessments extended