Disclosures and Reporting:
Potentially Abusive Tax Shelters
IRS Form 8886 “Reportable Transaction Disclosure Statement, is the form by which disclosure is made as to a person’s participation in a reportable transaction (i.e., a listed transaction or an otherwise reportable transaction), or transaction of interest.
IRS Form 13976, “Itemized Statement Component of Advisee List,” is a form that may be used by a “material advisor” for compliance with list maintenance.
IRS Form 8918, “Material Advisor Disclosure Statement,” is the form that “material advisors” with respect to any reportable transaction use to disclose information about the transaction.
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Latest Developments:
Certain Monetized Installment Sales Transactions (August 3, 2023)
The Department of the Treasury and the IRS issued proposed regulations identifying certain monetized installment sales transactions and substantially similar transactions as listed transactions that must be reported to the IRS using IRS Form 8886. Material advisors and certain participants are also required to file disclosures with the IRS. The IRS listed monetized installment sales as part of its “dirty dozen” list of tax scams. The features of these transactions involve the following:
- A seller of appreciated property, or a person acting on the seller’s behalf, identifies a buyer who is willing to pruchase the property in exchange for cash or for other property.
- The seller enteres into an agreement to sell the property to an intermediary in exchange for an installment obligation which provides for interest payments from the intermediary to the seller.
- The seller then purportedly transfers the property to the intermediary, although the intermediary never takes title (or takes title only briefly before transferring title to the buyer in exchange for the buyer’s cash or property).
- The seller also obtains a loan with an agreement that provides for interest payments from the seller to the lender that equals the amount of interest that the intermediary pays the seller under the installment obligation.
- Both the installment agreement and the loan provide for interest due over the same periods, with principal due in a a balloon payment at or near the end of the installment agreement and loan.
- The sales proceeds received by the intermediary from the buyer, reduced by certain fees, are provided to the lender to fund the loan to the seller or transferred to an escrow account of which the lender is a beneficiary.
- The lender agrees to repay these amounts to the intermediary over the course of the term of the installment obligation.
- The seller then treats the sale as an installment sale under Section 453 on a federal income tax return for the year of the purported sale and defers recognition of the gain until the year in which the seller receives the principal balloon payment.
Micro-Captive Transactions, IR-2023-74 (April 10, 2023)
The Treasury Department and the IRS issued proposed regulations identifying certain micro-captive transactions as “listed transactions” and certain other micro-captive transactions as “transactions of interest.” As the notice reports, the IRS previously identified certain micro-captive transactions as “transactions of interest” in Notice 2016-66. Recent court decisions in the Sixth Circuit and the United States Tax Court ruled that the IRS lacked authority to identify listed transactions and transactions of interest by mere notice, such as Notice 2016-66, and must instead identify such transactions by following the notice and public comment procedures that apply to regulations.
The IRS does not agree with these decisions that the IRS lacks authority to identify “listed transactions” by notice; and they will continue to fight this in circuits outside of the 6th Circuit. The IRS will no longer take the position that transactions of interest can be identified without complying with notice and public comment procedures.
Our Country Home Enterprises, Inc. v. IRS, 145 T.C. No. 1 (July 13, 2015)
A company whose business involved the manufacture and sale of store fixtures and sale of antiques, with approximately 8 full-time employees, and an Indiana post office box, was a C corporation owned 100% by Mr. Blake. This company, Our Country Home Enterprises, Inc., and a few others, were approached by attorneys who were marketing the Sterling Plan, a single welfare benefit plan which purports to be an aggregation of separate multiple single employer welfare benefit plans under Section 419(e) of the Code. Benefits Strategies Group, Inc. served as the administrator. The Sterling Plan offers to pay various benefits to employees, primarily death benefits, medical and disability benefits during employment and after retirement. As a participating employer in the Sterling Plan, Our Country makes payments into plan, which are then used to “fund” the benefits that Our Country has promised to pay participating employees. When employers like Our Country adopted the Sterling Plan, those marketing the plan ensured that the plans expressly stated therein that the employers might want ot consult with their attorneys and accountants regarding participation in the plan.
Our Country adopted the Sterling Plan as of December 2, 2003, and on December 28, 2005, paid $450,000 to Fifth Third Bank, then acting as trustee, and treated the payment as an employer contribution to the welfare benefit plan. In filing returns commencing with the Form 1120 in 2005, Our Country failed to disclose its participation in the plan by filing IRS Form 8886. Instead, Our Country waited until January 25, 2010 to file a “protective” Form 8886 on an amended Form 1120 for the 2007 tax year, and the only change made to the return was to make the protective filing of Form 8886.
As the Tax Court put it, “Our Nation’s Federal income tax laws, coupled with the reality that all accessions to wealth are generally reduced significantly by the amount of Federal income taxes imposed thereon, sometimes inspire taxpayers to seek out ways to shelter their income from taxation. Taxpayers have no patriotic responsibility to pay an amount of Federal income tax greater than that which Congress imposes, and taxpayers may structure their business and personal affairs to take advantage of legitimate tax shelters that will reduce the amounts of Federal income tax that they would otherwise pay absent the use of the shelters. See Helvering v. Gregory, 69 F.2d 809, 810 (2d Cir. 1934), aff’d, 293 U.S. 465 (1935).” However, the Tax Court then warned, “Promoters of tax shelters obviously know that taxpayers generally desire to pay less Federal income tax rather than more, and such promoters regularly devise novel (and on many occasions highly technical) tax shelters which they represent are legitimate tax-saving strategies. As is true when seeking to enter into any novel or atypical venture, taxpayers seeking to implement a novel or an atypical tax-saving strategy should proceed with caution and with proper independent professional guidance.”
Going one step further, the Tax Court stated, “That which we call a rose by any other name would smell as sweet (from Romeo and Juliet, act 2)” but a taxpayer’s use of an illegitimate tax shelter marketed as a legitimate tax shelter will not. A taxpayer who uses an illegitimate tax shelter may, for example, eventually be called upon to pay not only the Federal income tax that the taxpayer would have paid had the tax shelter not been used, but significant amounts of interest and penalties to boot. While it would be nice if all tax shelters advertised as legitimate tax shelters were indeed legitimate, the fact of the matter is that not all marketed tax shelters are legitimate. Taxpayers who invest in tax shelters should be mindful that the statements of promoters as to the legitimacy of tax shelters carry no weight in the final say as to the true tax consequences that frlow from the shelters. For it is only a judiciary that can say definitively that the tax consequences that flow from a promoted tax-savings strategy are legitimate. Cf. Marbury v. Madison, 5 U.S. (1 Cranch) 137, 177 (1803)(“It is emphatically the province annd duty of the judicial department to say what the law is.”).
Here, the Sterling Plan was viewed as a plan that promotes the purchase of life insurance products and the payment of commissions thereon in the setting of a coupled tax-saving and tax-deferral strategy. The corporation essentially deducted the payments of the premiums on the life insurance policies through their deductions of their payments to the Sterling Plan, and the shareholder employees recognized no income corresponding to those deductions. The shareholder/employees, in fact, recognized no income at all from their participation in the Sterling Plan.
The IRS took the position that Old Country’s participation in the Sterling Plan amounts to a split-dollar life insurance arrangement, when the life insurance arrangement amounts to a “compensatory arrangementz’ under a three-prong approach set forth in Treas. Regs. Section 1.61-22(b)(2)(ii). The Tax Court agreed. The first prong, that the arrangement is one entered into in connection with the performance of services (and not as part of a group term life insurance plan). The second prong, whereby the employer or service recipient is paying all or a portion of the premiums. The third prong, the beneficiary of any death benefit is the one expected to be designated as the beneficiary, or the employee has an interest in the policy cash value of the life insurance contract. Section 79 of the Code makes it clear that “group-term” life insurance means that the amount of insurance provided to each employee is computed under a formula that precludes individual selection. Because the policies were necessarily derived from the underwriting criteria provided by that employee, and the insurance took into account the personal risks characteristics of the shareholder/employee, not group term. (Note, as to a different company that did not purchase life insurance, this would not be a split-dollar life insurance arrangement; instead, the Tax Court found that the purpose and operation of the Sterling Plan was to serve as a tax-free savings device for the shareholder/employees under the guise of possibly providing welfare benefits. A key feature noted by the Court was how the employee/shareholder held ultimate control over the funds that were paid by the company into the plan, such that he could receive “his” policy by causing his wholly owned company to terminate its participation in the plan, and he could change vesting schedule, or retirement age, and did.
Notably, the Tax Court did not consider the filing of a “protective” Form 8886 to be an “adequate disclosure” to then allow the taxpayer to claim reasonable cause or good faith, and defeat the application of the penalties. However, they did not argue that the amended return filed was a “qualified amended return” under 1.6664-2(c)(3).
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In the Abusive Tax Shelters practice area at the Tufts Law Firm, we consult with persons who have an interest in understanding their rights and obligations with respect to disclosure of participation in, or their role as a material advisor of, any reportable transaction, listed transaction, or transaction of interest. If you wish to engage us to consult with you about abusive tax shelters, or if you have questions about IRS Form 8886, IRS Form 13976, or Form 8918, please contact us.