GT Alert

Taxpayers Who Wish to Accomplish Penalty Reduction or Full Abatement Should Consider the IRS Settlement Initiative

December 2005

  View or download the PDF version of this Alert.

On October 27, 2005, the Internal Revenue Service announced a Settlement Initiative for taxpayers involved in abusive tax avoidance transactions to resolve their tax disputes with the IRS. The initiative is the culmination of a 30-month IRS strategy to restore enforcement and to deter abusive tax shelter deals. Intensified civil and criminal promoter investigations, targeted summons enforcement actions and litigation, and a more robust oversight program of tax professionals, have played a key role in the effort to combat abusive tax-avoidance transactions. Taxpayers have until January 23, 2006 to notify the Internal Revenue Service of their intent to participate in the IRS’s Settlement Initiative.

The Settlement Initiative, described in Announcement 2005-80, provides an opportunity for taxpayers to voluntarily resolve their civil tax disputes with the IRS. This initiative is applicable to sixteen listed and five other “potentially abusive transactions.” Under the initiative, taxpayers must concede the improper tax benefits they have previously claimed, in exchange for limited tax relief for transaction costs and, more importantly, a potential for the waiver of stiff civil tax penalties.

The Settlement Initiative is applicable to twenty-one transactions, which are further divided into three groups for penalty determination purposes: Group 1, which consists of six listed transactions, Group 2, which consists of ten listed transactions, and Group 3, which consists of five other transactions. Group 1 includes tax avoidance and losses using inflated basis, intermediary transactions, tax avoidance using offsetting foreign currency contracts, the common trust fund straddle tax shelter, and distributions of encumbered property. Group 2 includes abusive Roth IRA transactions, transactions involving employee stock ownership plan-owned S corporations, transactions involving distributions by charitable remainder trusts, and certain trust arrangements seeking exemption from section 419, among others. Group 3 consists of five transactions about which the IRS is concerned, but which have not been formally “listed;” three of them are considered abusive by the IRS, but two, involving conservation easements and donations of patents and other intellectual property, could be legitimate or abusive, depending on the facts. All eligible transactions carry the same settlement terms, with the exception of the applicable penalty level, depending upon the tax-shelter’s grouping, as described above.

Participation in the Settlement Initiative requires that: 1) the taxpayer concede 100% of the transaction’s tax benefits; 2) the taxpayer treat as an ordinary loss the full transaction costs claimed on the tax return, including promoter and professional fees; and 3) a penalty of a quarter of the maximum applicable penalty (either 20% or 40%), for Group 2 and 3 transactions, or one-half of the maximum applicable penalty for Group 1 transactions. No such penalty is due if the taxpayer either made a voluntary disclosure under Announcement 2002-2, or filed his tax return pursuant to a written tax opinion that was provided by a tax advisor meeting certain tests and which concludes at a confidence level of more than 50% (“more likely than not”) that the significant tax issues would be resolved in the taxpayer’s favor. A tax opinion provided to a taxpayer as part of the package sold by the promoter will not qualify for complete elimination of a penalty. Taxpayers who paid transaction costs, including promoter and professional fees, will be allowed an ordinary loss to the extent the fees can be substantiated.

The IRS has stated that participation in the Settlement Initiative is voluntary and that it offers a “quick, quiet, and cost-effective way” for taxpayers to settle the transactions the IRS considers abusive. “We think this is a win-win situation,” Commissioner Mark Everson remarked, “Taxpayers can put it behind them and we can clear out our inventory.”

The obvious incentive for taxpayers to participate in the Initiative is the potential significant reduction of penalties. However, the IRS retains the right to withhold the penalty exemption in cases where the taxpayer received an independent “more likely than not” tax advisor opinion letter, if the IRS, in its sole discretion, believes the penalty is still warranted. Though the IRS has seemingly lightened its stance against tax opinions, it is not clear what factors the IRS will consider when exercising this broad discretion. In light of the controversy surrounding the implementation of the new regulations under Circular 230, and in the wake of the government’s appellate victory in Long Term Capital Holdings,1 the future of the benefit afforded by tax opinion letters has been uncertain. Participants in the Settlement Initiative, however, have an opportunity to benefit from the IRS’s apparent generous position for independent “more likely than not” tax opinions.

In order to participate in the Settlement Initiative, the taxpayer must file Form 13750, Election to Participate in Announcement 2005-80 Settlement Initiative, with the IRS indicating the intent to participate in the settlement program, which includes the information necessary to determine the taxpayer’s eligibility as well as a calculation of the taxes, interest and applicable penalties. If a taxpayer’s tax benefits are derived from a partnership subject to the TEFRA uniform partnership audit rules, the taxpayer will be required to submit Form 13751 waiving the right to request consistent settlement terms with other partners. Full payment, or a payment plan acceptable to the IRS, of all taxes, interest and penalties is required as a condition to settling and executing a Closing Agreement with the IRS.

The Settlement Initiative will not affect conventional IRS resolution procedures available to taxpayers, either with Compliance, Appeals Fast Track or the traditional Appeals review process for those who do not elect the Initiative. John Klotsche, senior advisor to the IRS Commissioner, and David Robison, chief of the IRS Appeals Division, have cautioned taxpayers that those not opting to take advantage of the Initiative should expect to litigate their cases, including the likely application of the maximum penalty.

IRS Commissioner Everson noted that “[p]eople entered into these deals often at the behest of lawyers and accountants peddling flaky tax products … [the IRS is] offering taxpayers a quick, quiet and cost effective way to put these deals behind them.” Everson also stated, however, that this initiative “is not amnesty … [a]nybody who comes forward here is going to pay the full tax and a penalty. These are tough terms compared to what’s been done by this agency in the past.”

As of the date the Initiative was announced, the IRS had already identified more than 4,000 taxpayers involved in the 21 transactions. The IRS planned to identify additional participants through examination of tax returns, as well as the agency’s promoter audit program. The Settlement Initiative, however, is applicable to all taxpayers, whether or not they have been previously identified by the IRS and even if their cases are pending in examination or the Appeals process. (Taxpayers litigating the merits of their transaction in court may not participate in the Initiative but may offer the same settlement terms for consideration.) Taxpayers who may have filed an amended return reversing a transaction substantially similar to that in the Initiative, or who have already resolved their case in full without a Closing Agreement or Form 870-AD, may still take advantage of the Initiative. Moreover, the IRS has declared that it will view the 21 eligible transactions broadly. Taxpayers with transactions not specified in the Initiative may still come forward before January 23, 2006, as any taxpayer who is interested in participating and who files an election will enjoy a “strong presumption” that the transaction is eligible, according to Klotsche.

Footnotes

1 Long Term Capital Holdings v. United States, 330 F. Supp. 2d 122 (D. Conn. 2004). (aff’d in unpublished opinion, 2005 U.S. App. Lexis 20988 (2nd Cir. 2005))

This Alert was written by G. Michelle Ferreira in the Silicon Valley office and Barbara T. Kaplan in the New York office. The authors would like to thank Aruna Parthasarathy for her contribution to this Alert. Please contact Ms. Ferreira at 650.289.7855 or Ms. Kaplan at 212.801.9250 or your Greenberg Traurig liaison if you have any questions regarding the subject matter of this Alert.

© 2005 Greenberg Traurig

Additional Information:

For more information, please review our Tax Practice description, or feel free to contact one of our attorneys.

• Tax Practice Area
• Tax Attorneys