Deduction of Contributions to IRC § 401(k) Plans Attributable to Compensation Paid After Year End Under IRC § 404(a)(6) Coordinated Issue Paper
COORDINATED ISSUE PAPER
DEDUCTION OF CONTRIBUTIONS TO I.R.C. § 401(k) PLANS
ATTRIBUTABLE TO COMPENSATION PAID AFTER YEAR END UNDER I.R.C. § 404(a)(6)
Revision Date: September 24, 2004
REVENUE RULING 2002-46 UPDATE
A Coordinated Issue Paper approved in 1995 addresses the facts described in Rev. Rul. 90-105, 1990-2 C.B. 69, dealing with the accelerated deduction of contributions to section 401(k) plans. Rev. Rul. 2002-46, 2002-2 C.B. 117, addresses a situation, arising in many current examinations, which is substantially similar to that described in Rev. Rul. 90-105, and is described below.
The taxpayer corporation has a plan with a qualified cash or deferred arrangement under section 401(k). The plan also provides for matching contributions in accordance with section 401(m). The corporate tax year end is June 30th and the plan’s year end is December 31st.
The taxpayer amended the plan to provide for a Board of Directors’ resolution specifying a minimum contribution for the plan year, to be allocated first toward elective deferrals and matching contributions, with any excess to be allocated to participants as of the end of the plan year, in proportion to compensation earned during the plan year.
Pursuant to this plan amendment, the Board of Directors adopted a resolution on June 15, 2001, setting a minimum contribution of $8,000,000 for the 2001 calendar plan year. By December 31, 2001 (the last day of the 2001 calendar plan year), the corporation had contributed $8,000,000 to the plan in accordance with the terms of the plan.
These amounts consisted of (1) $3,800,000 for elective deferrals and matching contributions attributable to compensation earned by plan participants before the end of taxable year ending June 30, 2001 (Pre-Year End Service Contributions), and (2) $4,200,000 for elective deferrals and matching contributions attributable to compensation earned by plan participants after the end of the taxable year ending June 30, 2001 (Post-Year End Service Contributions).
The taxpayer made each contribution attributable to compensation earned during each pay period contemporaneously with the issuance of wage payments for the pay period.
The corporation received an extension of time to March 15, 2002, to file the income tax return for its taxable year ending June 30, 2001 (2001 Taxable Year). On the income tax return for its 2001 Taxable Year, which was timely filed on March 1, 2002, the corporation claimed a deduction for the entire $8,000,000 for elective deferrals and matching contributions made to the plan during the 2001 calendar plan year, relating to both Pre-Year End Service Contributions and Post-Year End Service Contributions.
The total amount contributed and claimed by the taxpayer as a deduction did not exceed 15 percent of the total compensation otherwise paid or accrued during its 2001 Taxable Year to participants under the plan (and thus did not exceed the applicable percentage limitation for that year under section 404(a)(3)(A)(i)).
Whether contributions made during the section 404(a)(6) grace period, to a qualified cash or deferred arrangement within the meaning of section 401(k) or to a defined contribution plan as matching contributions within the meaning of section 401(m), are deductible by an employer for a taxable year, if the contributions are designated as satisfying a liability established before the end of that taxable year but are attributable to compensation earned by plan participants after the end of that taxable year.
[Typically, the taxpayer refers to the liability as a “Minimum Employer Contribution (MEC)” or “Specified Minimum Employer Contribution (SMEC),” or other similar phrase or acronym.]
Section 404(a) provides in relevant part that if contributions are paid to a profit-sharing or stock bonus plan and are otherwise deductible under chapter 1 of the Code, those contributions are deductible under section 404 (subject to certain limitations) in the taxable year of the employer when paid, and are not deductible under any other section of chapter 1 of the Code.
Section 404(a)(6) provides in relevant part that, for this purpose, "a taxpayer shall be deemed to have made a payment on the last day of the preceding taxable year if the payment is on account of such taxable year and is made not later than the time prescribed by law for filing the return for such taxable year (including extensions thereof)."
Section 1.404(a)-1(b) of the Income Tax Regulations provides that, in order to be deductible under section 404(a), in the case of contributions that are otherwise deductible under section 162 or 212, the contributions must be an ordinary and necessary expense during the taxable year in carrying on a trade or business or for the production of income and must be compensation for services actually rendered. A contribution which is otherwise deductible under section 162 or 212 is deductible under section 404(a) if it is paid or incurred for purposes of those sections, in addition to satisfying the other requirements for deductibility under those sections.
Section 461(a) and section 1.461-1(a)(2) of the regulations together provide that an accrual method taxpayer should deduct expenses for the taxable year in which all the events have occurred which determine the fact of liability, the amount thereof can be determined with reasonable accuracy, and economic performance has occurred with respect to the liability. No accrual shall be made in any case in which all of the events have not occurred which fix the liability, nor if the amount of the liability cannot be determined with reasonable accuracy, nor if economic performance has not occurred with respect to the liability. (Treasury Regulations Section 1.461-1(a)(2).)
Rev. Rul. 90-105 applies section 404(a)(6), as interpreted by Rev. Rul. 76-28, 1976-1 C.B. 106, to a situation involving a contribution to a 401(k) plan made after the end of the taxable year. Rev. Rul. 90-105 holds that contributions to a qualified cash or deferred arrangement within the meaning of section 401(k) or to a defined contribution plan as matching contributions within the meaning of section 401(m) are not deductible by the employer for a taxable year, if the contributions are attributable to compensation earned by plan participants after the end of that taxable year. See also Rev. Rul. 76-28 (providing that a contribution made after the close of an employer's taxable year will be deemed to have been made on account of the preceding taxable year under section 404(a)(6) if, among other conditions, the payment is treated by the plan in the same manner as the plan would treat a payment actually received on the last day of such preceding taxable year of the employer), and Lucky Stores, Inc. v. Commissioner, 153 F.3d 964 (9th Cir. 1998), cert. denied, 526 U.S. 1111 (1999) (indicating, in the context of a defined benefit plan, that the plain meaning of section 404(a)(6) precludes deduction in the preceding taxable year of grace period contributions that are required under collective bargaining agreements for work performed after the end of that preceding taxable year).
Several courts in addition to the Lucky Stores court, supra, have considered whether grace period contributions made pursuant to collective bargaining agreements, for work performed after the end of the taxable year, are “on account of” the preceding tax year within the meaning of section 404(a)(6). The courts have uniformly held that grace period contributions attributable to work performed in the subsequent tax year are not deductible in the prior tax year under section 404(a)(6). See Airborne Freight Corp. v. United States, 153 F.3d 967 (9th Cir. 1998); American Stores Co. v. Commissioner, 108 T.C. 178 (1997), aff’d, 170 F.3d 1267 (10th Cir. 1999), cert. denied, 528 U.S. 875 (1999); and Vons Companies, Inc. v. United States, 55 Fed. Cl. 709 (March 28, 2003).
The courts in Lucky Stores and Vons Companies relied on the plain meaning of section 404(a)(6) to conclude that the statute precludes an employer from deducting, for its current taxable year, payments attributable to compensation earned by plan participants after the end of that taxable year. The courts noted that contributions to the plans which were made based on hours, days, or weeks worked after the close of the taxable year were not made on account of that taxable year, but rather, were made on account of the year in which the work was performed. Although these cases involved contributions to collectively-bargained multiemployer defined benefit plans rather than section 401(k) plan contributions, this aspect of the reasoning therein is equally applicable to section 401(k) plan contributions because, in both situations, contributions made by an employer relate to specific work performed by an employee for a particular period of time.
The facts addressed in Rev. Rul. 2002-46 are the same as the facts in Rev. Rul. 90-105, except for the addition of the plan amendment and the board resolution setting a minimum contribution for the plan year. Rev. Rul. 2002-46 concludes that these factual differences do not change the result. The plan amendment and the board resolution setting a minimum contribution for the plan year establish a liability, prior to the end of the corporation's taxable year, to make that contribution. However, the corporation's Post-Year End Service Contributions still are attributable to compensation earned by plan participants after the end of the taxable year. Neither the plan amendment nor the board resolution bears on when that compensation is earned. Thus, for example, the Post-Year End Service Contributions in the circumstances described are still on account of that subsequent taxable year rather than on account of the taxpayer’s 2001 Taxable Year, and therefore cannot be deemed paid at the end of the 2001 Taxable Year under section 404(a)(6). The holding of Rev. Rul. 90-105 applies to the facts of Rev. Rul. 2002-46, and the Post-Year End Service Contributions are not deductible for the corporation’s 2001 Taxable Year.
Moreover, since the Post-Year End Service Contributions are not on account of the taxpayer’s 2001 Taxable Year within the meaning of Code section 404(a)(6) and therefore are not deemed paid in that tax year under Code section 404(a), economic performance with respect to the liability fixed by the plan amendment and board resolution has not occurred in that tax year.
Rev. Rul. 2002-46 and Notice 2002-48, 2002-2C.B. 130, note that an alternative rationale for the holding in Rev. Rul. 90-105 was based on Treas. Reg. § 1.404(a)-(1)(b), which provides in pertinent part that contributions be “compensation for services actually rendered.” Under this alternative, the earlier ruling reasoned that, until the services giving rise to the compensation (and thus the contribution) were performed, the services were not “actually rendered” within the meaning of the regulation. Notice 2002-48 states that the Service will no longer rely on this alternative argument. The “compensation for services actually rendered” language in Treas. Reg. § 1.404(a)-(1)(b) is relevant only where the reasonableness of an employee’s compensation is in question, and is not an appropriate basis upon which to determine the timing of deductions for the contributions described in Rev. Rul. 90-105 or in Rev. Rul. 2002-46.
Rev. Rul. 2002-46 further holds that a change in a taxpayer’s treatment of contributions to a method consistent with the ruling is a change in method of accounting to which sections 446 and 481 apply. A taxpayer wishing to change its method of accounting for contributions to a method consistent with Rev. Rul. 2002-46 must follow the automatic change in method of accounting provisions in Rev. Proc. 2002-9, 2002-1 C.B. 327 (as modified and clarified by Announcement 2002-17, 2002-1 C.B. 561; modified and amplified by Rev. Proc. 2002-19, 2002-1 C.B. 696; and amplified, modified, and clarified by Rev. Proc. 2002-54, 2002-2 C.B. 432). As described below, different provisions apply to (i) the taxpayer’s first taxable year ending on or after October 16, 2002, and (ii) subsequent taxable years. See Rev. Rul. 2002-73, 2002-2 C.B. 805.
For a taxpayer’s first taxable year ending on or after October 16, 2002, the scope limitations in section 4.02 of Rev. Proc. 2002-9 do not apply, provided the taxpayer’s method of accounting for contributions is not an issue under consideration for taxable years under examination at the time the Form 3115 is filed with the National Office. One way for a taxpayer’s method of contributions to become an “issue under consideration” is when the Service issues an Information Document Request (IDR) requesting information about transactions described in, or transactions substantially similar to those described in, Rev. Rul. 90-105 or 2002-46.
For subsequent taxable years, the scope limitations in section 4.02 of Rev. Proc. 2002-9 do apply. Under these scope limitations, a taxpayer cannot file a Form 3115 with the National Office once it has been placed under examination (see sections 3.08 and 4.02 of Rev. Proc. 2002-9), unless the “window period” or director’s consent exception applies (see section 6.03 of Rev. Proc. 2002-9).
The following chart summarizes when a valid Form 3115 may be filed under these rules:
| First taxable year ending on or after 10/16/02
||Subsequent taxable years|
|Taxpayer is under exam, and method is an “issue under consideration”
|Taxpayer is under exam, and method is not (yet) an “issue under consideration”
|Taxpayer is not under exam|| Yes
* assuming no window period or director’s consent applies
Grace period contributions to a qualified cash or deferred arrangement within the meaning of section 401(k) or to a defined contribution plan as matching contributions within the meaning of section 401(m) are not deductible by the employer for a specific taxable year, if those contributions are attributable to compensation earned by plan participants after the end of such taxable year.
This conclusion applies regardless of whether the employer’s liability to make a minimum contribution is fixed before the close of that taxable year.
The transaction described in Revenue Ruling 2002-46 is substantially similar to the transaction described in Rev. Rul. 90-105, 1990-2 C.B. 69. Under Notice 2003-76, 2003-49 I.R.B. 1181 (restating and updating Notice 2000-15, 2000-1 C.B. 826, and Notice 2001-51, 2001-2 C.B. 190), transactions that are the same as or substantially similar to transactions described in that notice (including transactions described in Rev. Rul. 90-105) are tax avoidance transactions and are identified as "listed transactions" for purposes of § 1.6011-4(b)(2) of the Income Tax Regulations and § 301.6111-2(b)(2) of the Procedure and Administration Regulations. Those provisions impose certain requirements on taxpayers that participate in listed transactions, and on promoters of listed transactions.
Since the transactions which are described in Rev. Ruls. 90-105 and 2002-46 are “listed transactions,” examination teams developing an adjustment based on these rulings must, pursuant to LMSB directive, determine whether the accuracy related penalty under section 6662 applies (unless the taxpayer timely disclosed its participation in the transaction pursuant to the penalty initiative set forth in Announcement 2002-2). See Memorandum dated December 20, 2001, from then LMSB Commissioner Larry Langdon to all LMSB Executives, Managers and Examiners, the subject of which is “Consideration of Penalties in Listed Transactions and Other Abusive Tax Shelter Cases,” and Memorandum dated August 21, 2003, from LMSB Commissioner Deborah Nolan and then SB/SE Commissioner Dale Hart to all LMSB and SB/SE Executives, Managers and Agents, the subject of which is “Coordination of Listed Transactions.” The decision to assert or not assert a section 6662 penalty must be reviewed by the appropriate Director of Field Operations. Whether a section 6662 penalty applies is determined on a case-by-case basis, as described in the following section.
PENALTIES UNDER I.R.C. § 6662
The application of a section 6662 penalty to an understatement attributable to the disallowance of accelerated section 401(k) deductions is based on the specific facts and circumstances of the case, under the legal standards governing application of the penalty.
a. The Accuracy-Related Penalty
I.R.C. § 6662 imposes an accuracy‑related penalty in an amount equal to 20 percent of the portion of an underpayment attributable to, among other things: (1) negligence or disregard of rules or regulations or (2) any substantial understatement of income tax. See Treas. Reg. §§ 1.6662-1 through 1.6662-4. Treas. Reg. § 1.6662‑2(c) provides that there is no stacking of the accuracy‑related penalty components. Thus, the maximum accuracy‑related penalty which may be imposed on any portion of an underpayment is 20 percent, even if that portion of the underpayment is attributable to more than one type of misconduct (e.g., negligence and substantial understatement); See DHL Corporation v. Commissioner, T.C. Memo. 1998-461, aff’d in part and rev’d on other grounds, remanded by, 285 F.3d 1210 (9th Cir. 2002).
b. Negligence or Disregard of Rules or Regulations
Negligence includes any failure to make a reasonable attempt to comply with the provisions of the Internal Revenue Code or to exercise ordinary and reasonable care in the preparation of a tax return. See I.R.C. § 6662(c) and Treas. Reg. § 1.6662‑3(b)(1). Negligence also includes the failure to do what a reasonable and ordinarily prudent person would do under the same circumstances. See Marcello v. Commissioner, 380 F.2d 499, 506 (5th Cir. 1967); Neely v. Commissioner, 85 T.C. 934, 947 (1985).
A return position that has a reasonable basis is not attributable to negligence. A reasonable basis is a relatively high standard of tax reporting, one significantly higher than not frivolous or not patently improper. Thus, the reasonable basis standard is not satisfied by a return position that is merely arguable or colorable. Conversely, under Treas. Reg. § 1.6662-3(b)(3), a return position generally is considered reasonable where it is based on one or more of the authorities listed in Treas. Reg. § 1.6662-4(d)(3)(iii), taking into account the relevance and persuasiveness of the authorities and subsequent developments, even if the position does not satisfy the substantial authority standard defined in Treas. Reg. § 1.6662-4(d)(2). Moreover, the reasonable cause and good faith exception in Treas. Reg. § 1.6664-4 may relieve the taxpayer from liability for the negligence penalty, even if the return position does not satisfy the reasonable basis standard. See Treas. Reg. § 1.6662-3(b)(3). Treas. Reg. § 1.6662‑3(b)(1)(ii) provides that negligence is strongly indicated “where a taxpayer fails to make a reasonable attempt to ascertain the correctness of a deduction, credit or exclusion on a return that would seem to a reasonable and prudent person to be ‘too good to be true’ under the circumstances.”
The phrase "disregard of rules and regulations" includes any careless, reckless, or intentional disregard of rules and regulations. A disregard of rules or regulations is “careless” if the taxpayer does not exercise reasonable diligence in determining the correctness of a return position that is contrary to the rule or regulation. A disregard is “reckless” if the taxpayer makes little or no effort to determine whether a rule or regulation exists, under circumstances demonstrating a substantial deviation from the standard of conduct observed by a reasonable person. A disregard of the rules and regulations is “intentional” where the taxpayer knows of the rule or regulation that it disregards. Treas. Reg. § 1.6662-3(b)(2).
The term "rules and regulations" includes provisions of the Internal Revenue Code, Treasury regulations, and revenue rulings or notices issued by the Internal Revenue Service and published in the Internal Revenue Bulletin. Treas. Reg. § 1.6662‑3(b)(2). Therefore, if the facts indicate that a taxpayer took a return position contrary to any published notice or revenue ruling, the taxpayer may be subject to the accuracy‑related penalty for an underpayment attributable to disregard of rules and regulations, if the return position was taken subsequent to the issuance of the notice or revenue ruling. However, a taxpayer who takes a position 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. Treas. Reg. § 1.6662‑3(b)(2). Taxpayers claiming accelerated section 401(k) deductions, as described in this CIP (hereinafter referred to as the “Section 401(k) Accelerator Transaction”), took a return position contrary to Revenue Ruling 90-105. If a taxpayer took this return position subsequent to 1999, when the decisions in Lucky Stores, Inc., and American Stores Co. v. Commissioner, supra, became final, it is questionable whether this contrary return position had a “realistic possibility” of being sustained on its merits. Therefore, unless the taxpayer can demonstrate reasonable cause and good faith, under Treas. Reg. § 1.6664-4, as described infra, the penalty for negligence may be applicable.
c. Substantial Understatement of Income Tax
A substantial understatement of income tax exists for a taxable year if the amount of understatement exceeds the greater of 10 percent of the tax required to be shown on the return or $5,000 ($10,000 in the case of corporations other than S corporations or personal holding companies). I.R.C. § 6662(d)(1). If a corporate taxpayer has a substantial understatement that is attributable to a tax shelter item, the accuracy‑related penalty applies to the understatement, unless the reasonable cause and good faith exception applies. I.R.C. § 6662(d)(2)(C)(ii). A tax shelter item is any plan or arrangement a significant purpose of which is the avoidance or evasion of federal income tax. I.R.C. § 6662(d)(2)(C)(iii).
The Section 401(k) Accelerator Transaction is an arrangement by which the taxpayer claims an accelerated deduction for contributions to a qualified retirement plan made during the section 404(a)(6) grace period which are not on account of the taxable year for which the deduction is claimed, as required by section 404(a)(6). The Section 401(k) Accelerator Transaction is a promoted transaction and the promoter materials highlight that the principal benefit of the Section 401(k) Accelerator Transaction is the saving of federal income tax. The saving of federal income tax is accomplished without any payment other than the amount agreed upon as the fee for the professional services of the promoter to implement the strategy. Accordingly, the Section 401(k) Accelerator Transaction is a plan or arrangement the principal purpose of which is to avoid federal income tax. The accelerated deduction is the means of achieving the principal purpose of avoiding federal income tax. Thus, the Section 401(k) Accelerator Transaction is a tax shelter and the Section 401(k) Accelerated Deduction is a tax shelter item. See I.R.C. § 6662(d)(2)(C)(iii); Treas. Reg. §§ 1.6662-4(g)(2) and (3). In addition, the Service has determined that the Section 401(k) Accelerator Transaction is a tax avoidance transaction and a listed transaction. See Notice 2003-76, 2003-49 I.R.B. 1181 and Rev. Rul. 2002-46, 2002-29 I.R.B. 117. Therefore, whether the substantial understatement penalty applies is analyzed under the special rules applicable to items attributable to a tax shelter. To avoid the accuracy-related penalty, a corporate taxpayer must demonstrate reasonable cause and good faith under I.R.C. § 6664(c)(1).
d. The Reasonable Cause Exception
The accuracy‑related penalty does not apply to any portion of an underpayment with respect to which it is shown that there was reasonable cause and the taxpayer acted in good faith. I.R.C. § 6664(c)(1). Whether a taxpayer acted with reasonable cause and in good faith is determined on a case‑by‑case basis, taking into account all pertinent facts and circumstances. See Treas. Reg. § 1.6664-4(b)(1) and (f)(1). All relevant facts, including the nature of the tax investment, the complexity of the tax issues, issues of independence of a tax advisor, the competence of a tax advisor, the sophistication of the taxpayer, and the quality of an opinion, must be developed to determine whether the taxpayer was reasonable and acted in good faith. Generally, the most important factor is the extent of the taxpayer's effort to assess the taxpayer's proper tax liability. Treas. Reg. § 1.6664‑4(b)(1) ); see also Larson v. Commissioner, T.C. Memo 2002-295. Special rules, described below, apply to items of a corporation attributable to a tax shelter resulting in a substantial understatement.
On December 30, 2003, Treasury and the Service amended the section 6664 regulations to provide that the failure to disclose a reportable transaction, on Form 8886, “Reportable Transaction Disclosure Statement,” is a strong indication that the taxpayer did not act in good faith with respect to the portion of an underpayment attributable to a reportable transaction, as defined under section 6011. Treas. Reg. § 1.6664-4(e). While this amendment applies to returns filed after December 31, 2003, with respect to transactions entered into on or after January 1, 2003, the logic of this provision applies to reportable transactions occurring prior to that effective date. Failure to comply with the disclosure provisions of the law is a strong indication of bad faith.
Taxpayers may argue they are not liable for the accuracy-related penalty because they relied on the advice of professional tax advisors. However, reliance on the advice of a professional tax advisor does not necessarily demonstrate reasonable cause and good faith. Reliance on professional advice constitutes reasonable cause and good faith if, under all the circumstances, such reliance was reasonable and the taxpayer acted in good faith. Treas. Reg. § 1.6664-4(b)(1). In no event will a taxpayer be considered to have reasonably relied in good faith on advice unless all the requirements of Treas. Reg. § 1.6664-4(c)(i) are satisfied. The fact that the taxpayer satisfies the regulation will not necessarily establish that the taxpayer reasonably relied on the advice of a professional tax advisor or other advisor in good faith, however. For example, if the taxpayer knew, or should have known, that the advisor lacked knowledge in the relevant aspects of Federal tax law, reliance may not be reasonable or in good faith. Treas. Reg. § 1.6664-4(c)(1).
For a taxpayer's reliance on advice to be sufficiently reasonable so as to negate possible liability for the accuracy‑related penalty, the Tax Court has stated that a taxpayer must satisfy the following three‑prong test: (1) the advisor was a competent professional who had sufficient expertise to justify reliance, (2) the taxpayer gave the advisor the necessary and accurate information, and (3) the taxpayer actually relied in good faith on the advisor's judgment. Neonatalogy Associates P.A. v. Commissioner, 115 T.C. 43 (2000), aff’d, 299 F.3d 221 (3d Cir. 2002). Moreover, the advice must be based upon all pertinent facts and circumstances and the law as it relates to those facts and circumstances. For example, the advice must take into account the taxpayer's purpose (and the relative weight of such purpose) for entering into a transaction and for structuring a transaction in a particular manner. Treas. Reg. § 1.6664-4(c)(1)(i). Further, where a tax benefit depends on non-tax factors, the taxpayer also has a duty to investigate such underlying factors. The taxpayer cannot simply rely on statements by another person, such as a promoter. See Novinger v. Commissioner, T.C. Memo. 1991‑289. Moreover, if the tax advisor is not versed in the non-tax factors, mere reliance on the tax advisor does not suffice. See Addington v. United States, 205 F.3d 54 (2d Cir. 2000); Freytag v. Commissioner, 89 T.C. 849 (1987), aff'd, 904 F.2d 1011 (5th Cir. 1990), aff’d on other issues, 501 U.S. 868 (1991); Collins v. Commissioner, 857 F.2d 1383 (9th Cir. 1988). Finally, the reliance itself must be objectively reasonable in the sense that the taxpayer supplied the professional with all the necessary information to assess the tax matter and that the professional himself does not suffer from a conflict of interest or lack of expertise that the taxpayer knew of or should have known about. See Treas. Reg. § 1.6664-4(c); Neonatology Associates, P.A., v. Commissioner, 299 F.2d 221 (3rd Cir. 2002) (citing Ellwest Stereo Theatres of Memphis, Inc. v. Commissioner, T.C. Memo. 1995-610.) It is well established that taxpayers generally cannot "reasonably rely" on the professional advice of a tax shelter promoter. See Goldman v. Commissioner, 39 F.3d 402, 408 (2d Cir. 1994).
Whether a corporation acted with reasonable cause and good faith is determined by considering all pertinent facts and circumstances. Treas. Reg. § 1.6664‑4(f)(1). A corporation's legal justification may be taken into account, as appropriate, in establishing that the corporation acted with reasonable cause and in good faith in its treatment of a tax shelter item, but only if there is substantial authority within the meaning of Treas. Reg. § 1.6662‑4(d) for the treatment of the item and the corporation reasonably believed, when the return was filed, that such treatment was more likely than not the proper treatment. Treas. Reg. § 1.6664‑4(f)(2)(i)(B). Under § 1.6664-4(f)(2)(i), a failure to satisfy these minimum requirements will preclude a finding of reasonable cause and good faith based (in whole or in part) on a corporation’s legal justification. While satisfaction of the minimum requirements for legal justification is an important factor in determining whether a corporation acted with reasonable cause and in good faith, it is not necessarily dispositive. See Treas. Reg. § 1.6664-4(f)(3).
The regulations provide that in meeting the requirement of reasonably believing that the treatment of the tax shelter item was more likely than not the proper treatment, the corporation may reasonably rely in good faith on the opinion of a professional tax advisor, if the opinion is based on the tax advisor's analysis of the pertinent facts and authorities in the manner described in Treas. Reg. § 1.6662‑4(d)(3)(ii). The latter regulation provides that the weight accorded an authority depends on its relevance, persuasiveness, and the type of document providing the authority. That is, a case or revenue ruling or other authority having only some facts in common with the tax treatment at issue is not particularly relevant if the authority may be materially distinguished on its facts, or is otherwise inapplicable to the tax treatment in issue. For example, an authority that merely states a conclusion ordinarily is less persuasive than one that reaches its conclusion by cogently applying the pertinent law to the facts.
In addition to the above, Treas. Reg. § 1.6664-4(e)(2)(i)(B)(2) requires that the opinion unambiguously state that the tax advisor concludes that there is a greater than 50‑percent likelihood that the tax treatment of the item will be upheld if challenged by the Service. Therefore, the tax advisor's opinion should be reviewed to determine whether the taxpayer has met these requirements. Corporate taxpayers which do not provide the advice on which they relied cannot meet the requirements of Treas. Reg. § 1.6664-4(e)(2)(i)(B)(2), and the penalty for a substantial understatement, if otherwise applicable, should be asserted.
For transactions entered into on or after January 1, 2003. For transactions entered into prior to January 1, 2003, see Treas. Reg. § 1.6664-4(e) as contained in 26 CFR part 1, revised April 1, 2003. See Treas. Reg. § 1.6664-1(b)(2)(ii) for the rule on effective dates. Note that former § 1.6664-4(e) is identical to current § 1.6664-4(f).
Index for Coordinated Issue Papers - LMSB