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PRACTITIONER ALERT--MUST SEND FORM 8886 TO OTSA SAYS UNITED STATES TAX COURT

01 / 30 / 2013

Soni, Inc. v. Commissioner, T.C.Memo 2013-30 (1/28/13)


Practitioners who have questioned whether or not it was sufficient to file IRS Form 8886 only at a corporate level (e.g., with the S corporation return), but not also at the shareholder level, are on alert now.  The United States Tax Court has ruled in Soni, Inc. v. Commissioner, that the taxpayers did NOT substantially comply with the disclosure requirements under Regs. 1.6011-4T when they sought to only have the IRS Form 8886 filed with an amended S corporation tax return.  The taxpayers failed to file IRS Form 8886 with the individual Form 1040s (which would be necessarily impacted by the K-1 issued out of that S corporation to the shareholders).  On top of that, the Tax Court further found that because the taxpayers could not also show that they had attempted to mail IRS Form 8886 to the OTSA, as also required under the disclosure rules, this, too, meant that their filing of IRS Form 8886 merely at the corporate level was insufficient (i.e., to avoid penalties).

At issue in that case was a defined benefit plan sponsored by a S corporation owned 50/50 by a husband and wife.  In 2004, the company sponsored a defined benefit plan, purchasing whole life insurance and flexible deferred annuity policies, and deducted $389,607 as a contribution to the plan, which then created a $404,001 loss that passed through to the shareholders, through a K-1.  No IRS Form 8886 was filed with the original S corporation tax return, nor with the shareholders Form 1040.  Some 2 years after the company had entered into the plan, the IRS issued Rev. Proc. 2004-20, announcing that this type of plan, funded with such life insurance, was a "listed transaction."

However, the taxpayers claimed that because they received a favorable IRS determination letter, as to the plan itself, after it was put into place, this ought to have exempted them from these penalties, or switch the burden of proof to the IRS, or at least create an argument that the taxpayers had substantially complied with the disclosure requirements.  The Tax Court disagreed.

The taxpayers then pointed to the fact that the S corporation had, in fact, filed an amended return, specifically to attach IRS Form 8886.  (It appears from the Tax Court decision that the IRS was prepared to argue that the IRS Form 8886 was not filled out properly, but the Tax Court did not have to reach that argument because the taxpayer failed to adhere to the separate disclosure requirements).  Thus, while the taxpayers were able to point to the corporation's filing of IRS Form 8886 on an amended return, they were not able to show that they also filed IRS Form 8886 with any original or amended IRS Form 1040.  They were not also able to show that they even attempted to submit IRS Form 8886 to the OTSA, as required by the disclosure rules.  Regs. 1.6011-4T.  The Tax Court pointed out that the taxpayers were on notice, that Rev. Proc. 2004-20 had been in effect for 17 months before they filed their 2004 Form 1040 in 2005, and thus, because they failed to even consult with an independent tax attorney or expert in defined benefit plans, this could not relieve them of the strict liability nature of the penalties that apply when there is non-compliance with the Form 8886 filing requirements.  The taxpayers were not eligible to show "reasonable cause" under the Regulations because these rules require as a precondition for this defense against application of penalties that there is proper disclosure made in accordance with the disclosure requirements under IRC Section 6011 and applicable regulations. 

At the Tufts Law Firm, Mr. Tufts is in a position to evaluate prior IRS Form 8886 filings, and discuss the impact that the Soni decision will undoubtedly have on taxpayers and their CPAs who perhaps are concerned that they have previously filed potentially defective Form 8886s, or alternatively, failed to sufficiently comply with the disclosure requirements.  Certainly, the Soni decision is clear that the "substantial compliance" doctrine will be viewed narrowly and will not be met if disclosures are not made properly.  Note, taxpayers and practitioners need to remain sensitive to the fact that the statute of limitations period does not begin to run when it comes to reportable transactions absent compliance with these rules.  See IRC Sec. 6501(c)(10)).

On this, the IRS provides this instruction:

Previously Undisclosed Listed Transactions

If you are required to disclose a listed transaction and fail to do so within the time and manner prescribed under section 6011 and the related regulations, then under section 6501(c)(10) the period to assess any tax with respect to the listed transaction will be extended beyond the normal assessment period until one year after the earlier of either:

  • The date you disclose the transaction by filing Form 8886 in the manner prescribed in Rev. Proc. 2005-26, 2005-17 I.R.B. 965, available at www.irs.gov/pub/irs-irbs/irb05-17.pdf (or subsequently published guidance), or

  • The date that a material advisor provides the information required under section 6112 in response to a request by the IRS under section 6112.

Section 6501(c)(10) is effective for tax years with respect to which the limitations period on assessment did not expire prior to October 22, 2004. Section 6501(c)(10) does not revive an assessment period that expired prior to October 22, 2004. For more information, see Rev. Proc. 2005-26.

If you are filing Form 8886 to disclose a previously undisclosed listed transaction for purposes of section 6501(c)(10), submit the form and a cover letter to the Internal Revenue Service Center where your original tax return was filed. Write across the top of page 1 of each Form 8886 the following statement: “Section 6501(c)(10) Disclosure” followed by the tax year and tax return to which the disclosure statement applies. For example, if the Form 8886 relates to your Form 1040 for the 2002 tax year, you must include the following statement: “Section 6501(c)(10) Disclosure; 2002 Form 1040” on the form. The cover letter must identify the tax return to which the disclosure statement relates and include the following statement signed under penalties of perjury by the taxpayer and, if applicable, the paid preparer of Form 8886: “Under penalties of perjury, I declare that I have examined this reportable transaction disclosure statement and, to the best of my knowledge and belief, this reportable transaction disclosure statement is true, correct, and complete. Declaration of preparer (other than the taxpayer) is based on all information of which the preparer has any knowledge.” Separate Forms 8886 and separate cover letters must be submitted for each tax year for which you participated in the undisclosed listed transaction. You must also submit a copy of the form and cover letter simultaneously to OTSA at the OTSA address indicated on page 4. See Rev. Proc. 2005-26 for additional guidance."