406 Federal Register / Vol. 60, No. 2 / Wednesday, January 4, 1995 / Proposed Rules

(1) Section 1.475(a)–2 (concerning

marking a security to market upon

disposition) applies to dispositions

occurring on or after January 4, 1995.

(2) Section 1.475(b)–4 (concerning the

identification requirements for

obtaining an exemption from mark-tomarket treatment) applies to

identifications made on or after January

4, 1995.

Margaret Milner Richardson,

Commissioner of Internal Revenue.

[FR Doc. 95–13 Filed 01–03–95; 8:45 am]

BILLING CODE 4830–01–U

26 CFR Part 1

[IA–55–94]

RIN 1545–AT13

Accuracy-related Penalty

AGENCY: Internal Revenue Service (IRS),

Treasury.

ACTION: Notice of proposed rulemaking

and notice of public hearing.

SUMMARY: This document contains

proposed regulations which provide

guidance as to when a taxpayer may rely

upon the advice of others as evidence of

reasonable cause and good faith within

the meaning of section 6664(c) of the

Internal Revenue Code of 1986 for

purposes of avoiding the accuracyrelated penalty of section 6662, and

what constitutes reasonable cause and

good faith within the meaning of section

6664(c) as it applies to the substantial

understatement penalty of section

6662(b)(2) with respect to tax shelter

items of a corporation. The proposed

regulations implement changes to the

accuracy-related penalty under section

6662 that were made by Title VII of the

Uruguay Round Agreements Act (the

Act) implementing the Uruguay Round

of the General Agreement on Tariffs and

Trade. Finally, this document provides

notice of a public hearing on the

proposed amendments to the

regulations.

DATES: Written comments must be

received by April 7, 1995. The IRS

intends to hold a public hearing on

these proposed regulations on April 28,

1995, beginning at 10 a.m. Persons

wishing to speak at the hearing must

submit outlines of their comments by

April 7, 1995.

ADDRESSES: Send submissions to:

Internal Revenue Service, Attn:

CC:DOM:CORP:T:R (IA–55–94), room

5228, POB 7604, Ben Franklin Station,

Washington, DC 20044. The public

hearing will be held in the IRS

Auditorium, Internal Revenue Building,

1111 Constitution Avenue, NW,

Washington, DC.

FOR FURTHER INFORMATION CONTACT:

Concerning the regulations, David L.

Meyer, 202–622–6232; concerning

submissions, Christina Vasquez, 202–

622–6803. (These are not toll-free

numbers).

SUPPLEMENTARY INFORMATION:

Background

Section 6662 of the Internal Revenue

Code (Code) imposes an accuracyrelated penalty on certain

underpayments of tax. Section 6664(c)

provides that no accuracy-related

penalty is imposed with respect to any

portion of an underpayment if it is

shown that there was a reasonable cause

for such portion and that the taxpayer

acted in good faith with respect to such

portion.

Under current regulations interpreting

sections 6662 and 6664, a taxpayer’s

good faith reliance on the advice

(including an opinion) of a professional

tax advisor may be taken into account

for purposes of determining whether the

taxpayer will be subject to an accuracyrelated penalty. See, e.g., §§ 1.6662–

4(g)(4)(ii) and 1.6664–4(b).

Section 6662(b)(2) of the Code

imposes a penalty for a substantial

understatement of income tax. An

understatement is substantial if it

exceeds the greater of 10 percent of the

tax required to be shown on the

taxpayer’s return for the taxable year, or

$5,000 ($10,000 in the case of a

corporation other than an S corporation

or a personal holding company). An

understatement is defined as the excess

of (1) the amount of tax required to be

shown on the taxpayer’s return, over (2)

the amount of tax imposed which is

shown on the return, reduced by any

rebate.

The Code provides that the amount of

an understatement is reduced to the

extent that certain conditions are met.

For example, section 6662(d)(2), prior to

amendment by the Act (Pub. L. 103–

465), provided that an understatement is

reduced by the portion of the

understatement attributable to a tax

shelter item of the taxpayer (the section

6662 tax shelter rule) if: (1) there is

substantial authority for the taxpayer’s

treatment of the tax shelter item; and (2)

the taxpayer reasonably believed (at the

time its return was filed) that its

treatment of such item was more likely

than not the proper treatment.

The substantial understatement

penalty was first adopted in section 323

of the Tax Equity and Fiscal

Responsibility Act of 1982, Pub. L. 97–

248. At that time, Congress believed that

the new standards would ‘‘assure that

taxpayers who take highly aggressive

filing positions are penalized while

those who endeavor in good faith to

self-assess are not penalized’’ and that,

with respect to tax shelters, ‘‘if the

principal purpose of a transaction is the

reduction of tax, it is not unreasonable

to hold participants to a higher standard

than ordinary taxpayers.’’ H.R. Conf.

Rep. No. 97th Cong., 2d Sess. 575–76

(1982), 1982–2 C.B.650. More recently,

Congress has been concerned that the

substantial understatement penalty has

not been effectively deterring corporate

tax shelter transactions and thus, in

Section 744 of the Act, eliminated the

section 6662 tax shelter rule as it

applies to corporations. As a result of

this change, ‘‘the standards applicable

to corporate tax shetlers are tightened’’

and ‘‘in no instance [will] this

modification result in a penalty not

being imposed where a penalty would

have been imposed under prior law.’’ S.

Rep. No. 412, 103d Cong., 2d Sess. 165

(1994); H.R. Rep. No. 826, 103d Cong.,

2d Sess. 198–99 (1994). The change is

effective for transactions occurring after

December 8, 1994.

The proposed regulations set forth in

this document address issues related to

the section 6662 tax shelter rule and the

reasonable cause exception of section

6664. This guidance includes, but is not

limited to, rules that reflect the

amendment of section 6662 by the Act.

Explanation of Provisions

Reliance on Tax Advisor

The proposed regulations set forth

general rules clarifying when a taxpayer

may be considered to have reasonably

relied in good faith upon advice

(including an opinion provided by a

professional tax advisor). These rules

apply to all taxpayers and to both tax

shelter items and non-tax shelter items.

In particular, the rules apply in

determining whether reasonable cause

and good faith exist for purposes of

section 6664(c) and also apply in

determining whether a taxpayer other

than a corporation is considered to have

reasonably relied in good faith on an

opinion in order to satisfy the

‘‘reasonable belief’’ requirement of the

section 6662 tax shelter rule.

In general, the proposed regulations

require advice to be based on all

material facts (including, for example,

the taxpayer’s purposes for entering into

a transaction) and to relate applicable

law to such facts in reaching its

conclusion. The advice must not be

based upon unreasonable factual or

legal assumptions (including

assumptions as to future events), nor
Federal Register / Vol. 60, No. 2 / Wednesday, January 4, 1995 / Proposed Rules 407

unreasonably rely on the

representations, findings or agreements

of the taxpayer or any other person.

Reasonable Cause for Tax Shelter Items

of a Corporation

The proposed regulations provide

additional guidance with respect to the

application of the reasonable cause

exception of section 6664(c) to a

substantial understatement penalty

attributable to a tax shelter item of a

corporation. These changes apply only

to corporations. Accordingly, no

inference is intended with respect to the

application of section 6664(c) to a

substantial understatement penalty

attributable to a tax shelter item of a

taxpayer other than a corporation.

Treasury and the IRS invite comments

as to the need for clarification of the

application of this exception to such

items.

The proposed regulations provide that

a corporation’s legal justification may be

taken into account, as appropriate, in

establishing that the corporation acted

with reasonable cause and in good faith

in its treatment of a tax shelter item only

if there is substantial authority for the

treatment of the item and the

corporation reasonably believes in good

faith that such treatment is more likely

than not the proper treatment. For this

purpose, legal justification includes any

justification relating to the treatment or

characterization under the Federal tax

law of the tax shelter item or of the

entity, plan or arrangement that gave

rise to the item. Thus, a taxpayer’s belief

(whether independently formed or

based on the advice of others) as to the

merits of the taxpayer’s underlying

position is a legal justification.

Satisfaction of the substantial authority

and reasonable belief criteria is an

important factor to be considered in

determining whether the taxpayer acted

with reasonable cause and in good faith.

However, it is not necessarily

dispositive. A corporation will qualify

for the reasonable cause and good faith

exception only if, under all pertinent

facts and circumstances, it acted with

reasonable cause and in good faith.

The proposed regulations also provide

that facts and circumstances other than

a corporation’s legal justification may be

taken into account, as appropriate, in

determining whether it acted with

reasonable cause and in good faith,

regardless of whether the substantial

authority and reasonable belief

requirements are satisfied.

The provisions relating to the

reasonable cause and good faith

exception with respect to corporate tax

shelters apply only for purposes of the

substantial understatement penalty. No

inference is intended with respect to

how the reasonable cause exception

may apply to the negligence penalty of

section 6662(b)(1). The proposed

regulations do not alter the definitions

of tax shelter or tax shelter items

contained in § 1.6662–4(g)(2) and (3).

Conforming Changes

The proposed regulations would

amend the existing regulations under

section 6662 to reflect the changes made

by the Act and to clarify the definition

of reasonable belief under the section

6662 tax shelter rule.

In addition, the proposed regulations

clarify that the determination of

whether a corporate or non-corporate

taxpayer acted with reasonable cause

and in good faith with respect to an

underpayment that is related to an item

reflected on the return of a pass-through

entity is made on the basis of all

pertinent facts and circumstances,

including the taxpayer’s own actions, as

well as the actions of the pass-through

entity.

Proposed Effective Date

The amendments contained in this

notice are proposed to be effective for

returns the due date of which

(determined without regard to

extensions) is after the date on which

final regulations are published in the

Federal Register.

Special Analyses

It has been determined that this notice

of proposed rulemaking is not a

significant regulatory action as defined

in EO 12866. Therefore, a regulatory

assessment is not required. It has also

been determined that section 553(b) of

the Administrative Procedure Act (5

U.S.C. chapter 5) and the Regulatory

Flexibility Act (5 U.S.C. chapter 6) do

not apply to these regulations, and

therefore, a Regulatory Flexibility

Analysis is not required. Pursuant to

section 7805(f) of the Internal Revenue

Code, this notice of proposed

rulemaking will be submitted to the

Chief Counsel for Advocacy of the Small

Business Administration for comment

on its impact on small business.

Comments and Public Hearing

Before the adoption of these proposed

regulations, consideration will be given

to any written comments that are

submitted timely (a signed original and

eight (8) copies) to the IRS. All

comments will be available for public

inspection and copying in their entirety.

A public hearing will be held on April

28, 1995, in the IRS Auditorium,

Internal Revenue Building, 1111

Constitution Avenue, NW, Washington,

DC. Because of access restrictions,

visitors will not be admitted beyond the

building lobby more than 15 minutes

before the hearing starts.

The rules of 26 CFR 601.601(a)(3)

apply to the hearing.

Persons who wish to present oral

comments at the hearing must submit

written comments, an outline of the

topics to be discussed, and the time to

be devoted to each topic by April 7,

1995.

A period of 10 minutes will be

allotted to each person for making

comments.

An agenda showing the scheduling of

the speakers will be prepared after the

deadline for receiving outlines has

passed. Copies of the agenda will be

available free of charge at the hearing.

Drafting Information

The principal author of these

proposed regulations is David L. Meyer,

Office of Assistant Chief Counsel,

Income Tax and Accounting, IRS.

However, other personnel from the IRS

and Treasury Department participated

in their development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and

recordkeeping requirements.

Proposed Amendments to the

Regulations

Accordingly, 26 CFR part 1 is

proposed to be amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation

for part 1 continues to read in part as

follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 1.6662–0 is amended

by revising the entries for §§ 1.6662–

2(d) and 1.6662–4(g) to read as follows:

§ 1.6662–0 Table of contents.

* * * * *

§ 1.6662–2 Accuracy related penalty.

* * * * *

(d) Effective date.

(1) In general.

(2) Special rules for tax shelter items.

* * * * *

§ 1.6662–4 Substantial understatement of

income tax.

* * * * *

(g) Items relating to tax shelters.

(1) In general.

(i) Non-corporate taxpayers.

(ii) Corporate taxpayers.

(A) In general.

(B) Special rule for transactions occurring

prior to December 9, 1994.

(iii) Disclosure irrelevant.

(iv) Cross-reference.
408 Federal Register / Vol. 60, No. 2 / Wednesday, January 4, 1995 / Proposed Rules

(2) Tax shelter.

(i) In general.

(ii) Principal purpose.

(3) Tax shelter item.

(4) Reasonable belief.

(i) In general.

(ii) Facts and circumstances; reliance on

tax advisor.

* * * * *

Par. 3. Section 1.6662–2 is amended

by:

1. Redesignating the text of paragraph

(d) following the heading as paragraph

(d)(1), adding a new heading for newly

designated paragraph (d)(1), and

revising the second sentence of newly

redesignated paragraph (d)(1).

2. Adding a new paragraph (d)(2).

The additions and revisions read as

follows:

§ 1.6662–2 Accuracy-related penalty.

* * * * *

(d) Effective date—(1) In general.

* * * Except as provided in the

preceding sentence and in paragraph

(d)(2) of this section, §§ 1.6662–1

through 1.6662–5 apply to returns the

due date of which (determined without

regard to extensions of time for filing) is

after December 31, 1989. * * *

(2) Special rules for tax shelter items.

Sections 1.6662–4(g)(1) and 1.6662–

4(g)(4) apply to returns the due date of

which (determined without regard to

extensions of time for filing) is after the

date on which final regulations are

published in the Federal Register.

Sections 1.6662–4(g)(1) and (4) (as

contained in 26 CFR Part 1 revised April

1, 1994) apply to returns the due date

of which (determined without regard to

extensions of time for filing) is on or

before the date on which final

regulations are published in the Federal

Register and after December 31, 1989,

subject to changes resulting from

Section 744 of Title VII of the Uruguay

Round Agreements Act, Pub. L. 103–465

(108 Stat, 4809).

Par. 4. Section 1.6662–4 is amended

by revising paragraphs (g)(1), (g)(4), and

(g)(5) to read as follows:

§ 1.6662–4 Substantial understatement of

income tax.

* * * * *

(g) Items relating to tax shelters—(1)

In general—(i) Non-corporate taxpayers.

Tax shelter items (as defined in

paragraph (g)(3) of this section) of a

taxpayer other than a corporation are

treated for purposes of this section as if

such items were shown properly on the

return for a taxable year in computing

the amount of tax shown on the return,

and thus the tax attributable to such

items is not included in the

understatement for the year, if—

(A) There is substantial authority (as

provided in paragraph (d) of this

section) for the tax treatment of that

item; and

(B) The taxpayer reasonably believed

at the time the return was filed that the

tax treatment of that item was more

likely than not the proper treatment.

(ii) Corporate taxpayers—(A) In

general. Except as provided in

paragraph (g)(1)(ii)(B) of this section, all

tax shelter items (as defined in

paragraph (g)(3) of this section) of a

corporation are taken into account in

computing the amount of any

understatement.

(B) Special rule for transactions

occurring prior to December 9, 1994.

The tax shelter items of a corporation

arising in connection with transactions

occurring prior to December 9, 1994 are

treated for purposes of this section as if

such items were shown properly on the

return if the requirements of paragraph

(g)(1)(i) are satisfied with respect to

such items.

(iii) Disclosure irrelevant. Disclosure

made with respect to a tax shelter item

of either a corporate or non-corporate

taxpayer does not affect the amount of

an understatement.

(iv) Cross-reference. See § 1.6664–4(e)

for certain rules regarding the

availability of the reasonable cause and

good faith exception to the substantial

understatement penalty with respect to

tax shelter items of corporations.

* * * * *

(4) Reasonable belief—(i) In general.

For purposes of section 6662(d) and

paragraph (g)(1)(i)(B) of this section

(pertaining to tax shelter items of noncorporate taxpayers), a taxpayer is

considered reasonably to believe that

the tax treatment of an item is more

likely than not the proper tax treatment

if (without taking into account the

possibility that a return will not be

audited, that an issue will not be raised

on audit, or that an issue will be

settled)—

(A) The taxpayer analyzes the

pertinent facts and authorities in the

manner described in paragraph (d)(3)(ii)

of this section, and in reliance upon that

analysis, reasonably concludes in good

faith that there is a greater than 50-

percent likelihood that the tax treatment

of the item will be upheld if challenged

by the Internal Revenue Service; or

(B) The taxpayer reasonably relies in

good faith on the opinion of a

professional tax advisor, if the opinion

is based on the tax advisor’s analysis of

the pertinent facts and authorities in the

manner described in paragraph (d)(3)(ii)

of this section and unambiguously states

that the tax advisor concludes that there

is a greater than 50-percent likelihood

that the tax treatment of the item will be

upheld if challenged by the Internal

Revenue Service.

(ii) Facts and circumstances; reliance

on professional tax advisor. All facts

and circumstances must be taken into

account in determining whether a

taxpayer satisfies the requirements of

paragraph (g)(4)(i) of this section.

However, in no event will a taxpayer be

considered to have reasonably relied in

good faith on the opinion of a

professional tax advisor for purposes of

paragraph (g)(4)(i)(B) of this section

unless the requirements of § 1.6664–

4(c)(1) are met. The fact that the

requirements of § 1.6664–4(c)(1) are

satisfied will not necessarily establish

that the taxpayer reasonably relied on

the opinion in good faith. For example,

reliance may not be reasonable or in

good faith if the taxpayer knew, or

should have known, that the advisor

lacked knowledge in the relevant

aspects of Federal tax law.

(5) Pass-through entities. In the case

of tax shelter items attributable to a

pass-through entity, the actions

described in paragraphs (g)(4)(i)(A) and

(B) of this section, if taken by the entity,

are deemed to have been taken by the

taxpayer and are considered in

determining whether the taxpayer

reasonably believed that the tax

treatment of an item was more likely

than not the proper tax treatment.

Par. 5. Section 1.6664–0 is amended

by revising the entries for §§ 1.6664–1(b)

and 1.6664–4 to read as follows:

§ 1.6664–0 Table of contents.

* * * * *

§ 1.6664–1 Accuracy-related and fraud

penalties; definitions and special rules.

* * * * *

(b) Effective date.

(1) In general.

(2) Reasonable cause and good faith

exception to section 6662 penalties.

* * * * *

§ 1.6664–4 Reasonable cause and good faith

exception to section 6662 penalties.

(a) In general.

(b) Facts and circumstances taken into

account.

(1) In general.

(2) Examples.

(c) Reliance on opinion or advice.

(1) Fact and circumstances; minimum

requirements.

(i) All facts and circumstances considered.

(ii) No unreasonable assumptions.

(iii) Law is related to actual facts.

(2) Definitions.

(i) Advice.
Federal Register / Vol. 60, No. 2 / Wednesday, January 4, 1995 / Proposed Rules 409

(ii) Material.

(d) Pass-through items.

(e) Special rules for substantial

understatement penalty attributable to

tax shelter items of corporations.

(1) In general; facts and circumstances.

(2) Reasonable cause based on legal

justification.

(i) Minimum requirements.

(A) Authority requirement.

(B) Belief requirement.

(ii) Legal justification defined.

(3) Minimum requirements not dispositive.

(4) Other factors.

(f) Transactions between persons described

in section 482 and net section 482

transfer price adjustments. [Reserved]

(g) Valuation misstatements of charitable

deduction property.

(1) In general.

(2) Definitions.

(i) Charitable deduction property.

(ii) Qualified appraisal.

(iii) Qualified appraiser.

* * * * *

Par. 6. Section 1.6664–1 is amended

by:

1. Redesignating the text of paragraph

(b) following the heading as paragraph

(b)(1), adding a heading for newly

designated paragraph (b)(1), and

revising the text of newly designated

paragraph (b)(1).

2. Adding paragraph (b)(2).

The additions and revisions read as

follows:

§ 1.6664–1 Accuracy-related and fraud

penalties; definitions and special rules.

* * * * *

(b) Effective date—(1) In general.

Sections 1.6664–1 through 1.6664–3

apply to returns the due date of which

(determined without regard to

extensions of time for filing) is after

December 31, 1989.

(2) Reasonable cause and good faith

exception to section 6662 penalties.

Section 1.6664–4 applies to returns the

due date of which (determined without

regard to extensions of time for filing) is

after the date on which the final

regulations are published in the Federal

Register. Section 1.6664–4 (as contained

in 26 CFR Part 1 revised April 1, 1994)

applies to returns the due date of which

(determined without regard to

extensions of time for filing) is on or

before the date on which the final

regulations are published in the Federal

Register and after December 31, 1989,

subject to changes resulting from

Section 744 of Title VII of the Uruguay

Round Agreements Act, Pub. L. 103–465

(108 Stat. 4809).

Par. 7. Section 1.6664–4 is amended

by:

1. Revising the last sentence of

paragraph (a).

2. Revising paragraph (b)(1).

3. Revising the introductory language

of paragraph (b)(2) and Example 1.

4. Redesignating paragraphs (c), (d)

and (e) as paragraphs (d), (f) and (g),

respectively.

5. Revising newly designated

paragraph (d).

6. Adding new paragraphs (c) and (e).

The revisions and additions read as

follows:

§ 1.6664–4 Reasonable cause and good

faith exception to section 6662 penalties.

(a) * * * Rules for determining

whether the reasonable cause and good

faith exception applies are set forth in

paragraphs (b) through (g) of this

section.

(b) Facts and circumstances taken

into account—(1) In general. The

determination of whether a taxpayer

acted with reasonable cause and in good

faith is made on a case-by-case basis,

taking into account all pertinent facts

and circumstances. (See paragraph (e) of

this section for certain rules relating to

a substantial understatement penalty

attributable to tax shelter items of

corporations.) Generally, the most

important factor is the extent of the

taxpayer’s effort to assess the taxpayer’s

proper tax liability. Circumstances that

may indicate reasonable cause and good

faith include an honest

misunderstanding of fact or law that is

reasonable in light of all of the facts and

circumstances, including the

experience, knowledge and education of

the taxpayer. An isolated computational

or transcriptional error generally is not

inconsistent with reasonable cause and

good faith. Reliance on an information

return or on the advice of a professional

tax advisor or an appraiser does not

necessarily demonstrate reasonable

cause and good faith. Similarly,

reasonable cause and good faith is not

necessarily indicated by reliance on

facts that, unknown to the taxpayer, are

incorrect. Reliance on an information

return, professional advice or other

facts, however, constitutes reasonable

cause and good faith if, under all the

circumstances, such reliance was

reasonable and the taxpayer acted in

good faith. (See paragraph (c) of this

section for certain rules relating to

reliance on the advice of others.) For

example, reliance on erroneous

information (such as an error relating to

the cost or adjusted basis of property,

the date property was placed in service,

or the amount of opening or closing

inventory) inadvertently included in

data compiled by the various divisions

of a multidivisional corporation or in

financial books and records prepared by

those divisions generally indicates

reasonable cause and good faith,

provided the corporation employed

internal controls and procedures,

reasonable under the circumstances,

that were designed to identify such

factual errors. Reasonable cause and

good faith ordinarily is not indicated by

the mere fact that there is an appraisal

of the value of property. Other factors to

consider include the methodology and

assumptions underlying the appraisal,

the appraised value, the relationship

between appraised value and purchase

price, the circumstances under which

the appraisal was obtained, and the

appraiser’s relationship to the taxpayer

or to the activity in which the property

is used. (See paragraph (g) of this

section for certain rules relating to

appraisals for charitable deduction

property.) A taxpayer’s reliance on

erroneous information reported on a

Form W–2, Form 1099 or other

information return indicates reasonable

cause and good faith, provided the

taxpayer did not know or have reason to

know that the information was

incorrect. Generally, a taxpayer knows

or has reason to know that the

information on an information return is

incorrect if such information is

inconsistent with other information

reported or otherwise furnished to the

taxpayer, or with the taxpayer’s

knowledge of the transaction. This

knowledge includes, for example, the

taxpayer’s knowledge of the terms of his

employment relationship or of the rate

of return on a payor’s obligation.

(2) Examples. The following examples

illustrate this paragraph (b). They do not

involve tax shelter items. (See paragraph

(e) of this section for certain rules

relating to the substantial

understatement penalty in connection

with the tax shelter items of

corporations.)

Example 1. A, an individual calendar year

taxpayer, engages B, a professional tax

advisor, to give A advice concerning the

deductibility of certain state and local taxes.

A provides B with full details concerning the

taxes at issue. B advises A that the taxes are

fully deductible. A, in preparing his own tax

return, claims a deduction for the taxes.

Absent other facts, and assuming the facts

and circumstances surrounding B’s advice

and A’s reliance on such advice satisfy the

requirements of paragraph (c) of this section,

A is considered to have demonstrated good

faith by seeking the advice of a professional

tax advisor, and to have shown reasonable

cause for any underpayment attributable to

the deduction claimed for the taxes.

However, if A had sought advice from

someone that A knew, or should have

known, lacked knowledge in the relevant

aspects of Federal tax law, or if other facts

demonstrate that A failed to act reasonably or

in good faith, A would not be considered to

have shown reasonable cause or to have

acted in good faith.

* * * * *
410 Federal Register / Vol. 60, No. 2 / Wednesday, January 4, 1995 / Proposed Rules

(c) Reliance on opinion or advice—(1)

Facts and circumstances; minimum

requirements. All facts and

circumstances must be taken into

account in determining whether a

taxpayer has reasonably relied in good

faith on advice (including the opinion of

a professional tax advisor) as to the

treatment of the taxpayer (or any entity,

plan or arrangement) under Federal tax

law. However, in no event will a

taxpayer be considered to have

reasonably relied in good faith on

advice unless the requirements of this

paragraph (c)(1) are satisfied. The fact

that these requirements are satisfied will

not necessarily establish that the

taxpayer reasonably relied on the advice

(including the opinion of a professional

tax advisor) in good faith. For example,

reliance may not be reasonable or in

good faith if the taxpayer knew, or

should have known, that the advisor

lacked knowledge in the relevant

aspects of Federal tax law.

(i) All facts and circumstances

considered. The advice must be based

upon all material facts and

circumstances, including, for example,

the taxpayer’s purposes (and the relative

weight of such purposes) for entering

into a transaction and for structuring a

transaction in a particular manner.

(ii) No unreasonable assumptions.

The advice must not be based on

unreasonable factual or legal

assumptions (including assumptions as

to future events) and must not

unreasonably rely on the

representations, statements, findings or

agreements of the taxpayer or any other

person. For example, the advice must

not be based upon a representation or

assumption which the taxpayer knows

or has reason to know is unlikely to be

true, such as an inaccurate

representation or assumption as to the

taxpayer’s purposes for entering into a

transaction or for structuring a

transaction in a particular manner.

(iii) Law is related to actual facts. The

advice must be based on the law as it

relates to the actual facts.

(2) Definitions—(i) Advice. Advice is

any communication, including the

opinion of a professional tax advisor,

setting forth the analysis or conclusion

of a person, other than the taxpayer,

provided to (or for the benefit of) the

taxpayer and on which the taxpayer

relies, directly or indirectly, with

respect to the imposition of the section

6662 accuracy-related penalty. Advice

does not have to be in any particular

form.

(ii) Material. A fact is material if it

reasonably could be expected, based

upon information available at the time

the advice is given, to be relevant to the

proper tax treatment of the item or the

taxpayer’s exposure to the accuracyrelated penalty under section 6662.

(d) Pass-through items. The

determination of whether a taxpayer

acted with reasonable cause and in good

faith with respect to an underpayment

that is related to an item reflected on the

return of a pass-through entity shall be

made on the basis of all pertinent facts

and circumstances, including the

taxpayer’s own actions, as well as the

actions of the pass-through entity.

(e) Special rules for substantial

understatement penalty attributable to

tax shelter items of corporations—(1) In

general; facts and circumstances. The

determination of whether a corporation

acted with reasonable cause and in good

faith in its treatment of a tax shelter

item (as defined in § 1.6662–4(g)(3)) is

based on all pertinent facts and

circumstances. Paragraphs (e)(2), (3) and

(4) of this section set forth rules which

apply, in the case of a penalty

attributable to a substantial

understatement of income tax (within

the meaning of section 6662(d)), in

determining whether a corporation

acted with reasonable cause and in good

faith with respect to a tax shelter item.

(2) Reasonable cause based on legal

justification—(i) Minimum

requirements. A corporation’s legal

justification (as described in paragraph

(e)(2)(ii) of this section) may be taken

into account, as appropriate, in

establishing that the corporation acted

with reasonable cause and in good faith

in its treatment of a tax shelter item only

if the authority requirement of

paragraph (e)(2)(i)(A) of this section and

the belief requirement of paragraph

(e)(2)(i)(B) of this section are satisfied

(the minimum requirements). Thus, a

failure to satisfy the minimum

requirements will preclude a finding of

reasonable cause and good faith based

(in whole or in part) on the

corporation’s legal justification.

(A) Authority requirement. The

authority requirement is satisfied only if

there is substantial authority (within the

meaning of § 1.6662–4(d)) for the tax

treatment of the item.

(B) Belief requirement. The belief

requirement is satisfied only if, based on

all facts and circumstances, the

corporation reasonably believed, at the

time the return was filed, that the tax

treatment of the item was more likely

than not the proper treatment. For

purposes of the preceding sentence, a

corporation is considered reasonably to

believe that the tax treatment of an item

is more likely than not the proper tax

treatment if (without taking into account

the possibility that a return will not be

audited, that an issue will not be raised

on audit, or that an issue will be

settled)—

(1) The corporation analyzes the

pertinent facts and authorities in the

manner described in § 1.6662–

4(d)(3)(ii), and in reliance upon that

analysis, reasonably concludes in good

faith that there is a greater than 50-

percent likelihood that the tax treatment

of the item will be upheld if challenged

by the Internal Revenue Service; or

(2) The corporation reasonably relies

in good faith on the opinion of a

professional tax advisor, if the opinion

is based on the tax advisor’s analysis of

the pertinent facts and authorities in the

manner described in § 1.6662–4(d)(3)(ii)

and unambiguously states that the tax

advisor concludes that there is a greater

than 50-percent likelihood that the tax

treatment of the item will be upheld if

challenged by the Internal Revenue

Service. (See paragraph (c) of this

section for certain rules governing

reliance upon the opinion of a

professional tax advisor.)

(ii) Legal justification defined. For

purposes of this paragraph (e), legal

justification includes any justification

relating to the treatment or

characterization under the Federal tax

law of the tax shelter item or of the

entity, plan or arrangement that gave

rise to the item. Thus, a taxpayer’s belief

(whether independently formed or

based on the advice of others) as to the

merits of the taxpayer’s underlying

position is a legal justification.

(3) Minimum requirements not

dispositive. Satisfaction of the minimum

requirements of paragraph (e)(2) of this

section is an important factor to be

considered in determining whether a

corporation acted with reasonable cause

and in good faith, but is not necessarily

dispositive.

(4) Other factors. Facts and

circumstances other than a corporation’s

legal justification may be taken into

account, as appropriate, in determining

whether the corporation acted with

reasonable cause and in good faith with

respect to a tax shelter item regardless

of whether the minimum requirements

of paragraph (e)(2) of this section are

satisfied.

* * * * *

Margaret Milner Richardson,

Commissioner of Internal Revenue.

[FR Doc. 95–120 Filed 1–3–95; 8:45 am]

BILLING CODE 4830–01–U