Chief Counsel Advice 201045022
In Chief Counsel Advice (CCA), IRS has provided guidance on when taxpayers who participated in certain loss transactions are obligated to disclose their participation to IRS. The CCA also supplied information and illustrations on what constituted adequate disclosure for purposes of Reg. §1.6011-4.
Background. Every taxpayer that has participated in a “reportable transaction” within the meaning of Reg. §1.6011-4(b) and is required to file a tax return must attach a completed Form 8886, Reportable Transaction Disclosure Statement, to its return for the tax year. (Reg. §1.6011-4(a)) For this purpose, the term “taxpayer” includes an individual, trust, estate, partnership, association, company, or corporation (including an S corporation), and also includes an affiliated group of corporations that joins in the filing of a consolidated return. (Reg. §1.6011-4(c)(1))
A reportable transaction is a transaction described in Reg. §1.6011-4(b)(2) through Reg. §1.6011-4(b)(7). The term “transaction” includes all the factual elements relevant to the expected tax treatment of any investment, entity, plan, or arrangement, and also includes any series of steps carried out as part of a plan.
Under Reg. §1.6011-4(b)(5)(i), a loss transaction is any transaction resulting in the taxpayer claiming a loss under Code Sec. 165 of at least:
... $10 million in any single tax year, or $20 million in any combination of tax years for corporations;
... $10 million in any single tax year, or $20 million in any combination of tax years for partnerships that have only corporations as partners (looking through any partners that are themselves partnerships), whether or not any losses flow through to one or more partners;
... $2 million in any single tax year or $4 million in any combination of tax years for all other partnerships, whether or not any losses flow through to one or more partners;
... $2 million in any single tax year or $4 million in any combination of tax years for individuals, S corporations, or trusts, whether or not any losses flow through to one or more beneficiaries or shareholders; or
... $50,000 in any single tax year for individuals or trusts, whether or not the loss flows through from an S corporation or partnership, if the loss arises with respect to a Code Sec. 988 transaction (i.e. relating to foreign currency transactions).
In determining these threshold amounts, the amount of a Code Sec. 165 loss is adjusted for any salvage value and insurance or compensation received. However, a Code Sec. 165 loss does not take into account offsetting gains or other income or limitations. The full amount of a Code Sec. 165 loss is taken into account for the year in which the loss is sustained, regardless of whether all or part of it enters into the computation of a net operating loss (NOL) or net capital loss carried to another year, and it does not include any portion of a loss attributable to a capital loss carried from another year that is treated as a deemed capital loss under Code Sec. 1212. A Code Sec. 165 loss also includes an amount deductible under a provision that treats a transaction as a sale or other disposition, or otherwise results in a deduction under Code Sec. 165. Rev Proc 2004-66, 2004-50 IRB 966 provides that certain losses aren't taken into account in determining whether a transaction is a reportable transaction for purposes of the disclosure rules.
A taxpayer is treated as having participated in a loss transaction if the taxpayer's tax return reflects a Code Sec. 165 loss in an amount that equals or exceeds the above threshold amounts. A taxpayer who is a partner, S corporation shareholder, or trust beneficiary and who had a Code Sec. 165 loss that flowed through to the taxpayer from the entity has participated in a loss transaction if the loss reflected on the taxpayer's tax return equals or exceeds the applicable threshold amount.
In order to meet Reg. §1.6011-4 's disclosure requirements, the Form 8886 must describe the expected tax treatment, potential tax benefits, and tax result protection associated with the transaction, and it must provide sufficient details for IRS to understand the tax structure and identify the parties involved. Under Reg. §1.6011-4(f)(2), a taxpayer who is uncertain as to whether a transaction must be disclosed may file a Form 8886 on a protective basis. Protective disclosures are treated the same by IRS as other disclosure statements, and they must satisfy the same disclosure requirements in order to be considered effective. Although the instructions to Form 8886 indicate that only one transaction may be reported per form, multiple transactions may be reported on a single form if they are the same or substantially similar.
Facts. IRS provided four hypothetical situations that were intended to reflect common situations and information routinely included by taxpayers on Forms 8886. In two of the situations, IRS provided guidance on whether the taxpayers had disclosure obligations under Reg. §1.6011-4 as a result of claiming losses under Code Sec. 165. In the other two situations, IRS considered whether the hypothetical taxpayers' disclosure statements were complete under Reg. §1.6011-4(d).
Situation 1. In Year 1, Partnership X, which had two corporate partners that each have equal interests in the partnership, entered into four transactions, which were not part of a series of steps carried out as part of a plan, that yielded Code Sec. 165 losses of $30 million, $9 million, $12 million, and $30 million. Only the first $30 million loss was a loss described in Rev Proc 2004-66, Sec. 4, and none of the losses arose with respect to a Code Sec. 988 transaction. The results of these transactions are reflected both on the taxpayer's and partners' returns for Year 1.
The losses from each transaction were considered separately, and weren't aggregated for purposes of determining whether the threshold amount was met or exceeded, since the transactions weren't a series of steps carried out as part of a plan. The first $30 million loss wasn't taken into account since it was a loss described under Rev Proc 2004-66, Sec. 4. As such, the transaction giving rise to that loss wasn't a reportable transaction to Partnership X and didn't need to be disclosed on a Form 8886. The $9 million loss fell under the threshold amount applicable to partnerships with corporate partners, so it wasn't from a reportable transaction. The $12 million and other $30 million losses were both reportable transactions with respect to Partnership X because they exceeded the applicable $10 million, single-year threshold amount. With respect to the corporate partners, the $12 million loss transaction wasn't a reportable transaction because their respective $6 million shares fell under the threshold amount; but the second $30 million loss transaction was a reportable transaction since their $15 million shares exceeded the threshold amount.
If the 3rd and 4th transactions were the same or substantially similar, Partnership X can disclose them on a single Form 8886. Otherwise, the taxpayer must file two forms.
Situation 2. Partnership Y has two individual partners, A with a 90% interest, and B with a 10% interest. Items of income, gain, loss, deduction and credit are allocated in accord with their interests. In Year 2, Partnership Y enters into two transactions and incurs Code Sec. 165 losses of $3 million and $2 million. Neither of the losses were described in Rev Proc 2004-66, Sec. 4, nor did they arise with respect to a Code Sec. 988 transaction. The results of these transactions were reflected on Partnership Y's return and the individual partners' returns for Year 2.
Both of these losses exceed the $2 million, single-year threshold amount applicable to partnerships with individual partners, so they were both reportable transactions with respect to Partnership Y. Again, the transactions can be disclosed on a single Form 8886 only if they are the same or substantially similar. A's $2.7 million loss from the first transaction exceeds the $2 million threshold amount for individuals and was accordingly a reportable transaction, and A's $1.8 million loss from the second transaction falls under the threshold amount and wasn't a reportable transaction. B's $300,000 and $200,000 losses both fell under the threshold amount, so neither transaction was a reportable transaction for B.
Situation 3. Partnership Z is the top-tier entity of a tiered investment partnership with some partners that were not corporations. Put another way, the taxpayer was a partnership that was a partner in another partnership that was a partner in yet another partnership. In Year 3, Partnership's Z's lower-tier entities engaged in several transactions that yielded Code Sec. 165 losses in excess of $2 million. Some, but not all, of the transactions resulted in losses that were losses described in Rev Proc 2004-66 (i.e. not subject to the disclosure requirements). Partnership Z attached a protective disclosure form to its return for Year 3 in which it stated, without providing any further details, that “due to the nature and volume of Taxpayer's activities, it is not practical to determine whether the applicable reportable loss thresholds are exceeded for any specific transaction or to determine with certainty whether any specific transaction has met any of the exceptions provided in Rev Proc 2004-66.” Partnership Z's lower-tier entities attached similar disclosures to their returns.
Partnership Z's disclosure statement failed to describe the expected tax treatment and potential tax benefits associated with the transaction(s) or provide sufficient details for IRS to understand the tax structure and identify the parties involved. So, neither Partnership's disclosure form nor those of its lower-tier entities satisfied the requirements of Reg. §1.6011-4(d).
Situation 4. Partnership W is a partnership with no corporate partners. In Year 4, Partnership W incurred a $50 million Code Sec. 165 loss on the sale of property that wasn't excluded under Rev Proc 2004-66. Partnership W attached a Form 8886 to its Year 4 tax return that merely stated that it “claimed losses under Code Sec. 165 in excess of the $2 million threshold,” without disclosing the actual amount of the loss or filling out lines 5 through 8 of the form.
Partnership W's disclosure statement failed to describe the full extent of the tax benefit claimed from the Code Sec. 165 loss or identify and describe the transaction in sufficient detail. So, Partnership W's disclosure failed to comply with the requirements of Reg. §1.6011-4(d).
References: For information on disclosure requirements and reportable transactions, see FTC 2d/FIN ¶S-4427.1 et seq.; United States Tax Reporter ¶60,114.02; TaxDesk ¶817,002; TG ¶71808.