Disclose Now, Don’t Pay Later

New policy on tax shelters should help corporates avoid penalities -- if they own up.
Tim ReasonFebruary 8, 2002

As part of its ongoing effort to crack down on tax shelters, the Internal Revenue Service has agreed to waive penalties for companies that voluntarily disclose questionable items in their returns before April 23.

Companies that spill the beans about a tax shelter–and about the person who promoted or recommended it–can avoid the 20 percent penalty on any resulting understatement of tax. “In a big corporate tax shelter, that can be a very large sum of money,” says Herbert N. Beller, an attorney with Sutherland Asbill & Brennan LLP, in Washington, D.C. Beller is chair-elect of the American Bar Association’s Section of Taxation, which applauded the IRS’s move.

Existing regulations that require companies to disclose tax shelters “may not provide enough teeth,” says Beller. In fact, advocates of new legislation to curb abuse cite recent IRS court defeats, including the recent Compaq Computer Corp. case, as evidence that the laws need to be rewritten.

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Under the waiver program, companies that disclose a shelter or questionable tax practice do not lose their right to defend the tax strategy in question if it is challenged in an audit, explains Beller, although “it does shine a spotlight on the transaction.” He adds that since most large companies face a regular audit cycle, the disclosure provides protection against the IRS’s somewhat inconsistent application of penalties if the item is disallowed. “Sooner or later,” he says, “these taxpayers will likely do battle with the IRS over these types of transactions. The benefit of disclosing is that they don’t have to worry about a penalty.”

With the new carrot, however, comes a reinforced stick. When the disclosure initiative was announced, Larry Langdon, commissioner of the IRS’s Large and Midsized Business Division, also sent out an internal memo to agency personnel, noting that failure to disclose tax shelters under existing regulations could make it more difficult for a company to claim that it acted with reasonable cause and good faith to avoid the 20 percent penalty–a traditional and widely used exception to existing tax-shelter regulations.

Coming Clean

Reports of a questionable tax shelter to the IRS must include:

  • shelter description, how it was used, and tax years affected by it
  • the name and address of the tax-shelter promoter
  • if requested, all documents related to the shelter, including promotional materials and internal company memoranda
  • a penalty-of-perjury statement attesting to the truth of the disclosure, signed by a company officer with personal knowledge of the facts

Source: Internal Revenue Service