Taking a Tax Disclosure Position to Avoid Penalties with 8275

Taking a Tax Disclosure Position to Avoid Penalties with 8275

Taking a Tax Disclosure Position on Form 8275

To Disclose on Form 8275 or Not to Disclose: That is the question that many US Taxpayers and their professional tax preparers must consider when it comes time for reporting a tax return position — that does not already have substantial authority — to the Internal Revenue Service.  The benefit of disclosing the information on Form 8275 to the IRS is that it puts the Taxpayer in a position to avoid penalties down the line if the IRS disagrees with the position. On the other hand, most taxpayers (understandably so) are not comfortable making a proactive disclosure to the IRS — since the chance of the IRS finding them — and disagreeing — with position is low. Let’s walk through the basics of a Form 8275 Disclosure

The Purpose of Form 8275

As provided by the Internal Revenue Service:

      • Form 8275 is used by taxpayers and tax return preparers to disclose items or positions, except those taken contrary to a regulation, that are not otherwise adequately disclosed on a tax return to avoid certain penalties.

      • The form is filed to avoid the portions of the accuracy-related penalty due to disregard of rules or to a substantial understatement of income tax for non-tax shelter items if the return position has a reasonable basis.

      • It can also be used for disclosures relating to the economic substance penalty and the preparer penalties for tax understatements due to unreasonable positions or disregard of rules.

What does this mean?

Let’s say there is a new law in place which does not have substantial authority behind it yet sufficient for taxpayer to make a firm position. If the taxpayer takes the position — and then it is rejected by the Internal Revenue Service — there is the concern that increased income may result in penalties such as underpayment penalties. Therefore, as long as the taxpayer takes a position that is not contrary to regulation (which is done in a separate form 8275-R), then even if the IRS rejects the position — Taxpayer may be able to avoid accuracy related penalties due to a substantial understatement.

Non-Tax Shelter Positions & Form 8275

It is important to note, that the purpose of the form specifically excludes tax shelter positions. That is because tax-shelter positions are referred to as reportable transactions — and required to be included on form 8886, which is a separate requirement.

Exceptions to Form 8275 Filing

Not all disclosures are required to include a form 8275. The Internal Revenue Service provides for certain exceptions and provides the following information:

Exception to filing Form 8275

  • Guidance is published annually in a revenue procedure in the Internal Revenue Bulletin that identifies circumstances when an item reported on a return is considered adequate disclosure for purposes of the substantial understatement aspect of the accuracy-related penalty and for avoiding the preparer’s penalty relating to understatements due to unreasonable positions.

Example Below:

      • “You do not have to file Form 8275 for items that meet the requirements listed in this revenue procedure. This revenue procedure can be found on the internet at IRS.gov.

      • Example: Generally, you will have met the requirements for adequate disclosure of a charitable contribution deduction if you complete the contributions section of Schedule A (Form 1040), supply all required information, and attach all related forms required pursuant to statute or regulation.”

What does this Mean?

It means that the idea behind the disclosure statement is to provide the IRS with an summary for a position which does not have substantial authority already. If there is already clear information such as information that is included in revenue procedure, then the Form 8275 may not be necessary.

Accuracy Related Penalty and Form 8275

It is important to understand what the accuracy penalty is, in order for the taxpayer to best understand whether the disclosure statement is a consideration.

As provided by the IRS:

Generally, the accuracy-related penalty is 20% of any portion of a tax underpayment attributable to:

        1. Negligence or disregard of rules or regulations;

        2. Any substantial understatement of income tax;

        3. Any substantial valuation misstatement under chapter 1 of the Internal Revenue Code;

        4. Any substantial overstatement of pension liabilities;

        5. Any substantial estate or gift tax valuation understatement;

        6. Any claim of tax benefits from a transaction lacking economic substance, as defined by section 7701(o), or failing to meet the requirements of any similar rule of law;

        7. Any undisclosed foreign financial asset understatement; or

        8. Any inconsistent estate basis.

*The penalty is 40% of any portion of a tax underpayment attributable to one or more gross valuation misstatements in (3), (4), or (5) above if the applicable dollar limitation under section 6662(h)(2) is met. The penalty also increases to 40% for failing to adequately disclose a transaction that lacks economic substance in (6) above. See Economic substance below. The penalty is 40% of any portion of an underpayment that is attributable to any undisclosed foreign financial asset understatement.

Economic Substance & Form 8275

As provided by the IRS:

      • To satisfy the disclosure requirements under section 6662(i), you may adequately disclose with a timely filed original return (determined with regard to extensions) or a qualified amended return (as defined under Regulations section 1.6664-2(c)(3)) the relevant facts affecting the tax treatment of the transaction.

      • Note.

        • If you filed a Schedule UTP (Form 1120), you may not need to file Form 8275 to satisfy the disclosure requirements of section 6662(i). See the Instructions for Schedule UTP (Form 1120).

Reasonable Cause Exception

As provided by the IRS:

      • Generally, no accuracy-related penalty will be imposed on any portion of an underpayment if you show that there was reasonable cause for that portion and that you acted in good faith with respect to that portion.

      • The reasonable cause and good faith exception does not apply to any portion of an underpayment attributable to a transaction that lacks economic substance under section 7701(o)

Adequate Disclosure

It is important that the taxpayer makes an adequate disclosure on Form 8275 in order to circumvent substantial understatement portions of the accuracy related penalties. In order to accomplish this goal, the position must have at least a reasonable basis. The IRS defined reasonable basis as follows:

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. If the return position is reasonably based on one of the authorities set forth in Regulations section 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 Regulations section 1.6662-4(d)(2).

  • For details, see Regulations sections 1.6662-4(d); 1.662-3(b)(3). If you failed to keep proper books and records or failed to substantiate items properly, you cannot avoid the penalty by disclosure

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