Source: http://www.irs.gov/Businesses/Coordinated-Issue---Losses-Claimed-and-Income-to-be-Reported-from-Sale-In-Lease-Out-(SILO)
Timestamp: 2013-05-26 00:56:22
Document Index: 241728932

Matched Legal Cases: ['§ 168', '§ 162', '§ 163', '§ 6662', '§ 6662', '§ 6707', '§ 168', '§ 162', '§ 163', '§ 6662', '§ 6664', '§ 6662', '§ 6664', '§ 6707', '§ 6011', '§ 168', '§ 168', '§ 168', '§ 167', '§ 470', '§ 849', '§ 470', '§ 6662', '§ 6707', '§ 1', '§ 6662', '§ 6662', '§ 6662', '§ 1', '§ 1', '§ 6707', '§ 1', '§ 6662', '§ 6664', '§ 1', '§ 6662', '§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 6662', '§ 6662', '§ 6662', '§ 6662', '§ 6662', '§ 6662', '§ 6662', '§ 6662', '§ 6662', '§ 6662', '§ 6662', '§ 6662', '§ 6011', '§ 6662', '§ 6664', '§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 168', '§ 467', '§ 849', '§ 470', '§ 849', '§ 6662', '§ 6707', '§ 6662', '§ 6662']

Coordinated Issue - Losses Claimed and Income to be Reported from Sale In/Lease Out (SILO)
UIL 9300.38-00
Whether a taxpayer entering into a transaction described in either of the situations discussed below is entitled to deduct currently depreciation under § 168 of the Internal Revenue Code of 1986, as amended, and to amortize transaction costs resulting from its participation in the transaction under § 162, or whether the taxpayer failed to acquire and retain “significant and genuine attributes” of a traditional owner, including “the benefits and burdens of ownership” of the property for U.S. federal income tax purposes.
Whether all or a portion of the Equity Investment (as hereafter defined) made by the taxpayer should be treated under the substance over form doctrine as a financing arrangement.
Whether a taxpayer entering into SILO transaction is entitled to deduct interest expense resulting from its participation in the transaction under § 163, or whether the deductions are disallowed on grounds that no amount is paid for the use or forbearance of money.
Whether § 6662, the Accuracy-Related Penalty on Underpayments, § 6662A, the Accuracy-Related Penalty on Understatements with Respect to Reportable Transactions, or § 6707A, the Penalty for Failure to Include Reportable Transaction Information with the Return, apply to SILO transactions.
A taxpayer entering into a SILO transaction is not e ntitled to deduct currently depreciation under § 168, or generally to amortize transaction costs resulting from its participation in the transaction under § 162, because such taxpayer does not acquire and retain “significant and genuine attributes” of a traditional owner, including “the benefits and burdens of ownership” of the property for U.S. federal income tax purposes.
A taxpayer entering into a SILO transaction is not entitled to deduct depreciation because with respect to all or a portion of its Equity Investment the SILO is a financing arrangement rather than a true sale -leaseback.
A taxpayer entering into a SILO transaction is not entitled to deduct interest expense resulting from its participation in the transaction under § 163, as no amount is paid for the use or forbearance of money.
a. For tax years ending on or before October 22, 2004, the accuracy-related penalty under § 6662 should be asserted against a taxpayer entering into a SILO transaction only if the taxpayer is unable to establish reasonable cause and good faith under § 6664(c)(1) and the applicable regulations. b. For tax years ending after October 22, 2004, the accuracy-related penalties under §§ 6662 and 6662A should be asserted against a taxpayer entering into a SILO transaction only if the taxpayer is unable to establish reasonable cause and good faith under §§ 6664(c)(1) and (d), respectively, and the applicable regulations. The penalty for failure to include reportable transaction information under § 6707A should be asserted against a taxpayer entering into a SILO transaction if the taxpayer failed to disclose the transaction under the § 6011 regulations.
Described below are transactions in which a U.S. taxpayer (“X”) enters into a purported sale-leaseback transaction with a tax-exempt entity (“FP”), substantially all of whose payment obligations are economically defeased.1 BK1, BK2, BK3, and BK4 are banks. None of these parties is related to any other party, unless otherwise indicated.
On the closing date of January 1, 2003 ("Closing Date"), X and FP enter into a purported sale -leaseback transaction under which FP sells the property to X, and X immediately leases the property back to FP under a lease (“Lease”). The purchase and sale agreement and Lease are nominally separate legal documents. Both agreements, however, are executed pursuant to a comprehensive participation agreement (“Participation Agreement”), which provides that the parties’ rights and obligations under any of the agreements are not enforceable before the execution of all transaction documents.
The Lease requires FP to make rental payments over the term of the Lease (“Lease Term”). As described below, the Lease also provides that under certain conditions, X has the option (“Service Contract Option”) to require FP to identify a party (“Service Recipient”) willing to enter into a contract with X to receive services provided using the leased property (“Service Contract”) that commences immediately after the expiration of the Lease Term. The Service Recipient must meet certain financial qualifications, including credit rating and net capital requirements, and provide defeasance or other credit support to satisfy certain of its obligations under the Service Contract. If FP cannot locate a qualified third party to enter into the Service Contract, FP or an affiliate of FP must enter into the Service Contract. The aggregate of the Lease Term plus the term of the Service Contract (“Service Contract Term”) is less than 80 percent of the assumed remaining useful life of the property.2
On Closing Date, the property has a purported fair market value of $105x and X makes a single payment of $105x to FP. To fund the $105x payment, X provides $15x in equity and borrows $81x from BK1 and $9x from BK2. Both loans are nonrecourse and provide for payments during the Lease Term. Accrued but unpaid interest is capitalized as additional principal. As of the Closing Date, the documents reflect that the sum of the outstanding principal on the loans at any given time will be less than the projected fair market value of the property at that time. The amount and timing of the debt service payments equal or closely match the amount and timing of the Lease payments due during the Lease Term.
FP intends to utilize only a small portion of the proceeds of the purported saleleaseback for operational expenses or to finance or refinance the acquisition of new assets. Upon receiving the $105x purchase price payment, FP sets aside substantially all of the $105x to satisfy its lease obligations. FP deposits $81x with BK3 and $9x with BK4. BK3 usually is related to BK1, and BK4 usually is related to BK2. The deposits with BK3 and BK4 earn interest sufficient to fund FP’s rent obligations as described below. BK3 pays annual amounts equal to 90 percent of FP's annual rent obligation under the Lease (that is, amounts sufficient to satisfy X's debt service obligation to BK1). Although FP directs BK3 to pay those amounts to BK1, the parties treat these amounts as having been paid from BK3 to FP, then from FP to X as rental payments, and finally from X to BK1 as debt service payments. In addition, FP pledges the deposit with BK3 to X as security for FP's obligations under the Lease, while X, in turn, pledges its interest in FP's pledge to BK1 as security for X's obligations under the loan from BK1. Similarly, BK4 pays annual amounts equal to 10 percent of FP's rent obligation under the Lease (that is, amounts sufficient to satisfy X's debt service obligation to BK2). Although FP directs BK4 to pay these amounts to BK2, the parties treat these amounts as having been paid from BK4 to FP, then from FP to X as rental payments, and finally from X to BK2 as debt service payments.3 Although FP's deposit with BK4 is not pledged, the parties expect that the amounts deposited with BK4 will remain available to pay the remaining 10 percent of FP's annual rent obligation under the Lease. FP may incur economic costs, such as an early withdrawal penalty, in accessing the BK4 deposit for any purpose other than those contemplated by the interrelated arrangements.
FP is not legally released from its rent obligations. X's exposure to the risk that FP will not make the rent payments, however, is substantially limited by the arrangements with BK3 and BK4. In the case of the loan from BK1, X’s economic risk is remote due to the deposit arrangement with BK3. In the case of the loan from BK2, X’s economic risk is substantially reduced through the deposit arrangement with BK4. X's obligation to make debt service payments on the loans from BK1 and BK2 is completely offset by X's right to receive Lease rentals from FP. As a result, neither bank bears a significant risk of nonpayment.4
FP has an option (“Purchase Option”) to purchase the property from X on the last day of the Lease Term (“Exercise Date”). Exercise of the Purchase Option allows FP to repurchase the property for a fixed exercise price (“Exercise Price”) that, on the Closing Date, exceeds the parties’ projected fair market value of the property on the Exercise Date. The Purchase Option price is sufficient to repay X’s entire loan balances and X’s initial equity investment and provide X with a predetermined after-tax rate of return on its equity investment.
At the inception of the transaction, X requires FP to invest $9x of the $105x payment in highly rated debt securities (“Equity Collateral”), and to pledge the Equity Collateral to X to satisfy a portion of FP’s obligations under the Lease.5 Although the Equity Collateral is pledged to X, it is not among the items of collateral pledged to BK1 or BK2 in support of the nonrecourse loans to X. The Equity Collateral upon maturity, in some cases combined with the remaining balances of the deposits made with BK3 and BK4 and the interest on those deposits, fully funds the amount due if FP exercises the Purchase Option. This arrangement ensures that FP is able to make the payment under the Purchase Option without an independent source of funds. Having economically defeased both its rental obligations under the Lease and its payment obligations under the Purchase Option, FP keeps, as its fee for engaging in the transaction, the remaining $6x, subject to its obligation to pay the Termination Value (described below) upon the happening of certain events specified under the Lease.
Throughout the Lease Term, X has several remedies in the event of a default by FP, including a right to (1) take possession of the property or (2) cause FP to pay X specified damages (“Termination Value”). Likewise, throughout the Service Contract Term, X has similar remedies in the event of a default by the Service Recipient. On Closing Date, the amount of the Termination Value is slightly greater than the purchase price of the property. The Termination Value fluctuates over the Lease Term and Service Contract Term, but at all times is sufficient to repay X’s entire loan balances and X’s initial equity investment plus a predetermined after-tax rate of return. The BK3 deposit, the BK4 deposit and the Equity Collateral are available to satisfy the Termination Value during the Lease Term. If the sum of the deposits plus the Equity Collateral is less than the Termination Value, X may require FP to maintain a letter of credit. During the Service Contract Term, the Service Recipient will be required to provide defeasance or other credit support that would be available to satisfy the Termination Value. As a result, X in almost all events will recover its investment plus a pre-tax rate of return.
For tax purposes, X claims deductions for interest on the loans , amortization of transaction costs, and depreciation on the property. X does not include the optional Service Contract Term in the lease term for purposes of calculating the property’s recovery period under §§ 168(g)(3)(A) and 168(i)(3). X includes in gross income the rents received on the Lease. If the Purchase Option is exercised, X also includes the Exercise Price in calculating its gain or loss realized on disposition of the property. The form of the sale from FP to X may be a head lease for a term in excess of the assumed remaining useful life of the property and an option for X to purchase the property for a nominal amount at the conclusion of the head lease term. In some variations of this transaction, the Participation Agreement provides that if X refinances the nonrecourse loans, FP has a right to participate in the savings attributable to the reduced financing costs through renegotiation of certain terms of the transaction, including the Lease rents and the Purchase Option price.
The facts are the same as in Situation 1 except for the following. The Lease does not provide a Service Contract Option. In lieu of the Purchase Option described in Situation 1, FP has an option (“Early Termination Option”) to purchase the property from X on some fixed date (e.g., 30 months) before the end of the Lease Term (“ETO Exercise Date”). Exercise of the Early Termination Option allows FP to terminate the Lease and repurchase the property for a fixed exercise price (“ETO Exercise Price”) that on the Closing Date exceeds the projected fair market value of the property on the ETO Exercise Date. The Early Termination Option price is sufficient to repay X’s entire loan balances and X’s initial equity investment plus a predetermined after-tax rate of return on its equity investment. The balance of the Equity Collateral combined with the balance of the deposits made with BK3 and BK4 and the interest on those deposits fully fund the amount due under the Early Termination Option.6
If FP does not exercise the Early Termination Option, FP is required to obtain at its cost residual value insurance (“RVI”) for the benefit of X, pay rents for the remaining Lease Term, and return the property to X at the end of the Lease Term (“Return Option”). The RVI must be issued by a third party having a specified minimum credit rating and must provide that if the actual residual value of the property is less than a fixed amount (“Residual Value Insurance Amount”) at the end of the Lease Term, the insurer will pay X the shortfall. On the Closing Date, the Residual Value Insurance Amount is less than the projected fair market value of the property at the end of the Lease Term. If FP does not maintain the RVI coverage as required after the ETO Exercise Date, FP will default and be obligated to pay X the Termination Value. If FP does not exercise the Early Termination Option, the rents for the remaining Lease Term plus the Residual Value Insurance Amount are sufficient to provide X with a minimum after-tax rate of return on the property, regardless of the value of the property. As a practical matter, the Early Termination Option and the Return Option collar X’s exposure to changes in the value of the property. At the end of the Lease Term, FP also may have the option to purchase the property for the greater of its fair market value or the Residual Value Insurance Amount.7
For tax purposes, X claims deductions for interest on the loans , amortization of transaction costs, and depreciation on the property. X treats a portion of the property as qualified technological equipment within the meaning of § 168(i)(2). X depreciates that portion of the property over five years under § 168(g)(3)(C). X treats a portion of the property as software. X depreciates that portion of the property over 36 months under § 167(f)(1)(A).
X includes in gross income the rents received on the Lease. If the Early Termination Option or an end -of-lease-term purchase option is exercised, X also includes the exercise price in calculating its gain realized on disposition of the property.8 In some variations of this transaction, if the Early Termination Option is not exercised, the Lease rents payable to X may increase for the portion of the Lease Term remaining after the ETO Exercise Date.
The substance of a transaction, not its form, governs its tax treatment. Gregory v. Helvering, 293 U.S. 465 (1935). In Frank Lyon Co. v. United States, 435 U.S. 561, 573 (1978), the Supreme Court stated that “[i]n applying the doctrine of substance over form, the Court has looked to the objective economic realities of a transaction rather than to the particular form the parties employed.” The Court evaluated the substance of the particular transaction in Frank Lyon to determine that it should be treated as a saleleaseback rather than a financing arrangement. The Supreme Court described the transaction in Frank Lyon as “a genuine multiple-party transaction with economic substance which is compelled or encouraged by business or regulatory realities, is imbued with tax-independent considerations, and is not shaped solely by tax-avoidance features that have meaningless labels attached.” Frank Lyon, 435 U.S. at 584. The Court subsequently relied on its approach in Frank Lyon to recharacterize a sale and repurchase of federal securities as a loan, finding that the economic realities of the transaction did not support the form chosen by the taxpayer. Nebraska Dep’t of Revenue v. Loewenstein, 513 U.S. 123 (1994).
A sale-leaseback will not be respected unless the owner/lessor acquires and retains “significant and genuine attributes” of a traditional owner, including “the benefits and burdens of ownership.” Coleman v. Commissioner, 16 F.3d 821, 826 (7th Cir. 1994) citing Frank Lyon, 435 U.S. at 582-84). Considering the totality of the facts and circumstances in the transactions described in Situations 1 and 2, X does not acquire presently the benefits and burdens of ownership, and consequently cannot claim tax benefits as the owner of the property. The transactions described above are, in substance, fundamentally different from the sale-leaseback transaction respected by the Court in Frank Lyon.
First, in Frank Lyon, the sales proceeds were used to construct the lessee's new headquarters. In contrast, in the transactions described above, substantially all of the $105x sales proceeds is immediately set aside by FP to satisfy its obligations under the Lease and to fund FP’s exercise of the Purchase Option or the Early Termination Option. As a condition to engaging in the transactions, FP economically defeases substantially all of its rent payment obligations and the amounts due under the Purchase Option or the Early Termination Option by establishing and pledging the deposit with BK3 and the Equity Collateral. Moreover, even though FP may not pledge the deposit with BK4, FP fully funds its remaining rent obligations with the BK4 deposit and may have limited rights to access the funds held in that deposit. Consequently, the only capital retained by FP is the remaining $6x portion of the sales proceeds that represents FP’s fee for engaging in the transaction.
Second, in Frank Lyon, the taxpayer bore the risk of the lessee's nonpayment of rent, which could have forced the taxpayer to default on its recourse debt. The Court concluded that the taxpayer exposed its business well-being to a real and substantial risk of nonpayment and that the long-term debt affected its financial position. Frank Lyon, 435 U.S. at 577. In contrast, in the transactions described above, economic defeasance renders the risk to X of FP's failure to pay rent remote. Moreover, because of the nonrecourse nature of the loans, the economic defeasance, X’s right to receive the Equity Collateral (which has been pledged only to X and not to the lenders) upon the exercise of the Purchase Option, and FP's obligation with respect to the Termination Value, a failure by FP to satisfy its lease obligations does not leave X at risk for repaying the loan balances or forfeiting its equity investment.9
Third, in Frank Lyon, the taxpayer’s return was dependent on the property’s value and the taxpayer’s equity investment was at risk if the property declined in value. The economic burden of any decline in the value of the property is integral to the determination of tax ownership. See, e.g., Swift Dodge v. Commissioner, 692 F.2d 651 (9th Cir. 1982). In the transactions described above, X bears insufficient risk of a decline in the value of the property to be treated as its owner for tax purposes. In Situation 1, regardless of any decline in the value of the property, X can recover its entire investment, repay both loans, and obtain a minimum after-tax rate of return on its equity investment by exercising the Service Contract Option. Similarly, in Situation 2, any decline in the value of the property will not prevent X from recovering its entire investment, repaying both loans and obtaining a minimum after-tax rate of return on its equity investment through the rents for the remaining Lease Term plus the Residual Value Insurance Amount under the Return Option. The failure of FP to satisfy its obligations under the Service Contract Option in Situation 1 or the Return Option in Situation 2 results in default and obligates FP to pay X the Termination Value. In each situation, the BK3 and BK4 deposits and Equity Collateral are available to fund FP’s obligations upon termination of the Lease. Thus, in both situations, the parties have substantially limited X’s risk of loss regardless of the value of the property upon termination of the Lease.
Fourth, the combination of FP’s Purchase Option and X’s Service Contract Option in Situation 1, and FP’s Early Termination Option and continued rent and RVI obligations under the Return Option in Situation 2, significantly increase the likelihood that FP will exercise its Purchase Option in Situation 1 and its Early Termination Option in Situation 2 even if the fair market value of the property is less than the Purchase Option Exercise Price or ETO Exercise Price, respectively, because both options are fully funded and the excess of the exercise price over the leased property’s fair market value may not fully reflect the costs to FP of modifying, interrupting, or relocating its operations. See Kwiat v. Commissioner, T.C. Memo. 1992-433 (ostensible lessor did not possess the benefits and burdens of ownership because reciprocal put and call options limited the risk of economic depreciation and the benefit of possible appreciation); see also Aderholt Specialty Co. v. Commissioner, T.C. Memo. 1985-491; Rev. Rul. 72-543, 1972-2 C.B. 87. In contrast, in Frank Lyon, the lessee’s decision regarding the exercise of its purchase option was not constrained by the lessor’s right to exercise a reciprocal option similar to the Service Contract Option or the Return Option described in Situations 1 and 2, respectively. Similarly, X’s opportunity to recognize a return through refinancing of the BK1 and BK2 loans is also limited in those cases in which FP has a right to participate in any savings attributable to reduced financing costs, such as through renegotiation of the Lease rents and the Purchase Option price. See Hilto n v. Commissioner, 74 T.C. 305 (1980), aff’d, 671 F.2d 316 (9th Cir. 1982) (arrangement whereby lessor and lessee shared the savings from any refinancing of lessor’s nonrecourse debt was a factor supporting holding to disregard form of sale-leaseback transaction).
Moreover, these transactions differ materially from Frank Lyon in other respects. In Situations 1 and 2, unlike in Frank Lyon, no regulatory realities require or encourage the transaction structure adopted by the participants. Further, in Frank Lyon, no additional deductions were created. In these transactions, however, depreciation deductions unavailable to FP are transferred to X as the transaction is structured by the participants, thereby creating new deductions that would not exist outside Situations 1 and 2.
In the transactions described above, X does not have a meaningful interest in the risks and rewards of the property. Thus, X does not acquire the benefits and burdens of ownership of the property and does not become the owner of the property for U.S. federal income tax purposes.
In substance, the transactions described above are merely a transfer of tax benefits to X, coupled with X’s investment of the Equity Collateral for a predetermined after-tax rate of return. X obtains, at most, a contingent future interest in the property, which will commence, if ever, only when FP fails to exercise its “purchase option.”
Substance Over Form: The Financing Arrangement Argument
The government's primary position is that SILO transactions do not result in the transfer of tax ownership of property and that, at most, a contingent future interest is acquired by the taxpayer.10 Consistent with this characterization of the transaction, X can be viewed as the lender in a financing transaction involving a portion of the Equity Investment. The “proceeds” of the loan would in most cases equal the Equity Collateral amount ($9x), with the remaining $6x of the Equity Investment characterized as a fee that compensates FP for its participation in the transaction. Amortization deductions for this and other transaction costs should be disallowed currently except to the extent taxpayer can establish what portion of the costs are allocable to the deemed loan.
Borrowing: Section 163
Section 163(a) generally allows taxpayers a deduction for all interest paid or accrued within the taxable year on indebtedness. Case law generally defines the term “interest” to mean the amount that one has contracted to pay for the use or forbearance of money. See, e.g., Old Colony R. Co. v. Commissioner, 284 U.S. 552 (1932); Deputy v. duPont, 308 U.S. 488 (1940).
In both Situations 1 and 2, the portion of the purchase payment attributable to the Series A Lender borrowing must be disregarded, because that "loan" is without substance. Neither X nor FP obtains use of those "borrowed" funds. Bridges v. Commissioner, 39 T.C. 1064, 1078-79 (1963), aff'd, 325 F.2d 180 (4th Cir. 1963). See Rev. Rul. 2002-69, 2002-2 C.B. 760. Under these circumstances, the loan from the Series A Lender is disregarded. Also, the loan from the Series B Lender may be disregarded, depending on the facts and circumstances surrounding the understanding that FP will use the deposit with Payment Undertaker B to defease portions of its Lease obligations, including any restrictions on FP’s interest in that deposit.
In certain cases, the Government may make an alternative argument that the Series B loan is in substance a loan between the Series B Lender and FP that in substance involves neither X nor the property. Further, where BK-1 and BK-2 and/or BK-3 and BK-4 are unrelated, the Government may argue in the alternative, that in substance any loan is a loan between BK-1 and BK-3, or between BK-2 and BK-4, which in substance involves neither X, FP nor the property.
The failure to convey tax ownership and the absence of genuine debt are particularly evident in SILO transactions that contain the features described below.
A. Single Entity and Special Purpose Corporation Transactions.
As distilled to its core, under this variant of the SILO structure:
(i) Single Entity, in its capacity as Lender, transfers an amount as a loan to X, which then uses the amount as part of the purchase price or head lease payment to FP; (ii) FP transfers that amount to the Single Entity in the latter’s capacity as Payment Undertaker; (iii) As Payment Undertaker, Single Entity obligates itself to use the amount to make Lease rent payments to X; and (iv) X instructs Single Entity, acting as Payment Undertaker, to apply those Lease payments to satisfy X’s obligation to Single Entity in the latter’s capacity as Lender.
The circularity of the funds flow and the self-canceling nature of rights and obligations of the Single Entity are grounds for challenging the substance of this transaction.
Transactions involving a special purpose corporation (“SPC”), often set up as a direct subsidiary of the Lender, are not substantially different from the Single Entity structure. In the SPC structure, the SPC subsidiary or affiliate of Lender may act as Payment Undertaker. Often, the amount paid by FP to SPC for acting as Payment Undertaker, and SPC’s obligation to pay Lease rent, are the only asset and liability, respectively, of SPC. Thus, there are no competing creditor claims that could interfere with the automatic satisfaction of the purported rent and debt claims.11
B. Form of Defeasance: Deposit Structure as Compared to Fee Structure.
As noted above, the recipient of funds from FP may act either as Payment Undertaker or a Depository. If the entity acts as a Depository, the documents would reflect an account held by Depository in the name of FP, and the amount on deposit would presumably remain an asset of FP, which, although it would be pledged to satisfy FP’s obligations under the Lease, would remain subject to the claims of FP’s creditors. If the recipient of the funds acts as Payment Undertaker, the payment from FP would take the form of a fee for Depository’s assuming the obligation to pay FP’s Lease obligations.
If the defeasance, which as discussed is typically embodied in a Payment Undertaking Agreement, provides for a “fee” paid by FP to Payment Undertaker rather than a “deposit” by FP with Payment Undertaker, the Government’s position is enhanced. This is because, in the event of bankruptcy of FP, a deposit with a depository bank, even if pledged to X, arguably might be subject to claims of FP’s creditors. In contrast, a fee payment, if respected as such under local law, may no longer be the property of FP and thus not subject to such claims. Moreover, under a Payment Undertaking Agreement as distinguished from some deposits, FP foregoes any right to access the amount paid to the Payment Undertaker and make use of those funds.
C. Percentage of Economic Defeasance of the Amount Borrowed by X.
In Rev. Rul. 2002-69, the amount of X’s borrowing that was defeased equaled 90 percent of the borrowing. The higher the percentage, the stronger is the Government’s position that there is, in substance, no bona fide borrowing. A 100 percent defeasance presents the better case for the Government with respect to this factor.
D. The nature or history of the property makes it highly unlikely that FP will not exercise its fixed Purchase Option at the end of the Lease term.
In some instances, the nature of the property or its historic connection to the community itself minimizes the possibility that FP will fail to exercise the fixed Purchase Option. Either of these factors would favor the Government.
While the foregoing features reinforce the conclusion that a SILO transaction does not result in a present transfer of tax ownership or the use or forbearance of money, this does not mean that a SILO transaction lacking one or more, or all, of these features must be respected. These factors only further enhance the Government’s litigating position. For the reasons discussed earlier, SILO transactions in general differ materially from the sale and leaseback transaction upheld in Frank Lyon, and taxpayers engaging in such transactions do not acquire the benefits and burdens of ownership of property and are not, therefore, entitled to the accompanying tax benefits.
The American Jobs Creation Act of 2004, P.L. 108-357, 118 Stat. 1418 (the “Act”), was enacted on October 22, 2004. Section 848 of the Act added new § 470, which suspends losses for certain leases of property to tax-exempt entities. These amendments generally are effective for leases entered into after March 12, 2004. See § 849(a) of the Act. The legislative history indicates that Congress intended no inference regarding “present-law tax treatment of transactions entered into prior to the effective date.” Moreover, the new provisions should not be read as “altering or supplanting the present-law tax rules providing that a taxpayer is treated as the owner of leased property only if the taxpayer acquires and retains significant and genuine attributes of an owner of the property.” See H.R. Rep. No. 755, 108th Cong., 2d Sess. at 660, 662-663 (2004). Accordingly, transactions entered into prior to the effective date of new § 470 are subject to common law requirements, and transactions subject to the new Code provision must first qualify as leases under those common law requirements, before the statute is applied.12
The Act also created § 6662A, which imposes an accuracy-related penalty on understatements with respect to reportable transactions, and § 6707A, which imposes a penalty for the failure to include reportable transaction i nformation with a return.
Whether penalties apply to underpayments attributable to the disallowance of deductions claimed by X as a result of its participation in a SILO transaction must be determined on a case-by-case basis, depending on the specific facts and circumstances of each case, including the documentary evidence of tax avoidance purpose.13 On February 11, 2005, the Service notified taxpayers that it considered SILOS to be tax avoidance transactions and identified SILOs, and substantially similar transactions, as listed transactions for purposes of Treas. Reg. § 1.6011-4(b)(2). See Notice 2005-13, 2005-9 I.R.B. 630 (February 28, 2005).
A significant matter relevant specifically to the potential assertion of the accuracy-related penalty attributable to a substantial understatement is whether the transaction constitutes a tax shelter as defined in § 6662(d)(2)(C)(iii). If the transaction is a tax shelter and meets the dollar thresholds for substantial understatement of income tax, a corporation’s only defense to the penalty based on substantial understatement will be a claim that it acted with reasonable cause and in good faith. I.R.C. §§ 6662(d)(2)(C)(i)and 6664(c). A transaction entered into on or after August 6, 1997, will cons titute a tax shelter if a significant purpose of the transaction is the avoidance or evasion of federal income tax. I.R.C. § 6662(d)(2)(C)(ii). If so, then, as explained below, the requirements of Treas. Reg. § 1.6664-4(f) should be carefully scrutinized to determine whether a corporate taxpayer had sufficient "reasonable cause" to avoid the accuracy-related penalty attributable to a substantial understatement. Because a SILO transaction is designed to transfer tax benefits to a U.S. Taxpayer, for all such transactions that were entered into on or after August 6, 1997, the position should be that a significant purpose of such transactions is the avoidance of federal income tax and SILO transactions are tax shelters.
With the preceding in mind, the application of the penalties should be based on an evaluation of the facts developed in view of the following legal standards:
The Failure to Include Reportable Transaction Information with Return
Section 1.6011-4(d) of the Income Tax Regulations requires a ta xpayer to file a disclosure statement of Form 8886, Reportable Transaction Disclosure Statement, for each reportable transaction in which the taxpayer participated. Section 1.6011-4(e)(1) provides that a reportable transaction disclosure statement is due when the taxpayer files an original or amended return that reflects the taxpayer’s participation in a reportable transaction. The taxpayer also must send a copy of the disclosure statement to the Office of Tax Shelter Analysis (OTSA) at the same time that the taxpayer first files a disclosure statement with a return.
If a transaction becomes listed after the filing of a taxpayer’s tax return and before the end of the period of limitations for the final return reflecting the tax consequences, tax strategy, or tax benefit, then a disclosure statement must be filed as an attachment to the taxpayer’s tax return next filed after the date the transaction is listed regardless of whether the taxpayer participated in the transaction in that year. Treas. Reg. § 1.6011-4(e)(2)(i).
Section 6707A imposes a penalty on a corporation in the amount of $200,000 for the failure to include information on a return with respect to a listed transaction. The penalty applies to returns and statements which are due after October 22, 2004, and cannot be rescinded by the Commissioner for any reason.
The § 6707A penalty should not be asserted until a taxpayer fails to provide the required disclosure statement with an original or amended return or fails to provide a copy to OTSA, if applicable, even if the return is filed after the due date.14 In addition, the penalty should not be asserted against taxpayers who filed a return prior to February 11, 2005, unless they failed to disclose the transaction on the tax return next filed.
Section 6662 imposes an accuracy-related penalty in an amount equal to 20 percent of the portion of an underpayment attributable to, among other things: (1) negligence or disregard of rules or regulations and (2) any substa ntial understatement of income tax. Treas. Reg. § 1.6662-2(c) provides that there is no stacking of the accuracy-related components. Thus, the maximum accuracy-related penalty imposed on any portion of an underpayment is 20 percent (40% for gross valuation misstatements), even if that portion of the underpayment is attributable to more than one type of misconduct. See D.H.L. Corp. v. Comm’r, T.C. Memo. 1998-461, aff’d in part and rev’d on other grounds, remanded by 285 F.3d 1210 (9th Cir. 2002).
For purposes of § 6662, the term “underpayment” is defined as the amount by which any tax imposed exceeds the excess of the sum of the amount shown as the tax by the taxpayer on his return, plus amounts not so shown previously assessed (or collected without assessment), over the amount of rebates made. I.R.C. § 6664(a)(1), (2); Treas. Reg. § 1.6664-2(a)(1), (2).
Negligence includes any failure to make a reasonable attempt to comply with the provisions of the Internal Revenue Code or to exercise ordinary and reasonable care in the preparation of a tax return. See I.R.C. § 6662(c) and Treas. Reg. § 1.6662-3(b)(1). Negligence also includes the failure to do what a reasonable and ordinarily prudent person would do under the same circumstances. See Marcello v. Commissioner, 380 F.2d 499 (5th Cir. 1967), aff'g 43 T.C. 168 (1964); Neely v. Commissioner, 85 T.C. 934, 947 (1985).
Treas. Reg. § 1.6662-3(b)(1)(ii) provides that negligence is strongly indicated where a taxpayer fails to make a reasonable attempt to ascertain the correctness of a deduction, credit or exclusion on a return that would seem to a reasonable and prudent person to be "too good to be true" under the circumstances. If the facts establish that X reported losses from a transaction in which it merely purchased a future interest or engaged in a financing arrangement, then the accuracy-related penalty attributable to negligence may be applicable if X failed to make a reasonable attempt to ascertain the correctness of the claimed deductions.
The Tax Court sustained the application of the negligence penalty in Sheldon v. Commissioner, 94 T.C. 738 (1990), stating that the taxpayer, “intentionally entered into loss-producing repos in order to generate a nd claim tax benefits.” The Third Circuit, in sustaining the accuracy-related penalty on grounds of negligence in Neonatology Associates, P.A., v. Commissioner, 299 F. 3d 221 (3rd Cir. 2002), explicitly warned: “When, as here, a taxpayer is presented with what would appear to be a fabulous opportunity to avoid tax obligations, he should recognize that he proceeds at his own peril.”
A return position that has a reasonable basis is not attributable to negligence. Treas. Reg. § 1.6662-3(c). A reasonable basis is a relatively high standard of tax reporting, one significantly higher than not frivolous or not patently improper. Thus, the reasonable basis standard is not satisfied by a return position that is merely arguable or colorable. Conversely, under Treas. Reg. § 1.6662-3(b)(3), a return position is reasonable where based on one or more of the authorities listed in Treas. Reg. § 1.6662-4(d)(3)(iii), taking into account the relevance and persuasiveness of the authorities and subsequent developments, eve n if the position does not satisfy the substantial authority standard defined in Treas. Reg. § 1.6662-4(d)(2). Furthermore, the reasonable cause and good faith exception in Treas. Reg. § 1.6664-4 may relieve X from liability from the negligence penalty, even if the return position does not satisfy the reasonable basis standard. See Treas. Reg. § 1.6662-3(b)(3).
"Disregard of rules or regulations" includes any careless, reckless, or intentional disregard of rules and regulations. A disregard of rules or regulations is “careless” if the taxpayer does not exercise reasonable diligence in determining the correctness of a position taken on its return that is contrary to the rule or regulation. Additionally, a disregard of rules or regulations is “reckless” if the taxpayer makes little or no effort to determine whether a rule or regulation exists, under circumstances demonstrating a substantial deviation from the standard of conduct observed by a reasonable person. Additionally, disregard of the rules or regulations is “intentional” where the taxpayer has knowledge of the rule or regulation that it disregards. Treas. Reg. § 1.6662-3(b)(2).
"Rules or regulations" includes the provisions of the Internal Revenue Code and revenue rulings or notices issued by the Internal Revenue Service and published in the Internal Revenue Bulletin. Treas. Reg. § 1.6662-3(b)(2). Therefore, if the facts indicate that a taxpayer took a return position contrary to any published notice or revenue ruling, the taxpayer may be subject to the accuracy-related penalty for an underpayment attributable to disregard of rules or regulations, if the return position was taken subsequent to the issuance of a notice or revenue ruling.
The accuracy-related penalty for disregard of rules or regulations will not be imposed on any portion of an underpayment due to a position contrary to rules or regulations if: (1) the position is disclosed on a properly completed Form 8275 or Form 8275-R (the latter is used for a position contrary to regulations) and (2), in the case of a position contrary to a regulation, the position represents a good faith challenge to the validity of a regulation. This adequate disclosure exception applies only if the taxpayer has a reasonable basis for the position and keeps adequate records to substantiate items correctly. Treas. Reg. § 1.6662-3(c)(1). Moreover, a taxpayer who takes a position contrary to a revenue ruling or a notice has not disregarded the ruling or notice if the contrary position has a realistic possibility of being sustained on its merits. Treas. Reg. § 1.6662-3(b)(2).
A substantial understatement of income tax exists for a taxable year if the amount of understatement exceeds the greater of 10 percent of the tax required to be shown on the return or $5,000 ($10,000 in the case of corporations other than S corporations or personal holding companies). I.R.C. § 6662(d)(1).15 An understatement generally means the excess of the correct tax over the tax reported on an income tax return. I.R.C. § 6662(d)(2). This excess is determined without regard to items to which § 6662A applies.16 The reportable transaction understatement calculated under § 6662A(b)(1), however, is added to the understatement calculated under § 6662(d)(2) for purposes of determining whether an understatement is substantial under § 6662(d)(1).
Under § 6662A(e)(1)(B), in the case of an understatement, the addition to tax under § 6662(a) applies only to the excess of the amount of the substantial understatement over the aggregate amount of the reportable transaction understatements. Accordingly, the § 6662(a) accuracy-related penalty on underpayments attributable to a substantial understatement of income tax does not apply to an underpayment attributable to an understatement on which the § 6662A penalty is imposed.
In the case of items of corporate taxpayers attributable to tax shelters, § 6662(d) does not provide any grounds on which to reduce the understatement. I.R.C. § 6662(d)(2)(C)(ii). Therefore, if a corporate taxpayer has a substantial understatement that is attributable to a tax shelter item, the accuracy-related penalty applies to the understatement unless the reasonable cause and good faith exception applies. Section 6662A imposes an accuracy-related penalty in an amount equal to 20 percent of a reportable transaction understatement and applies to tax years ending after October 22, 2004. In addition, a higher 30-percent penalty applies to a reportable transaction understatement if a taxpayer does not adequately disclose, in accordance with regulations prescribed under § 6011, the relevant facts affecting the tax treatment of the item giving rise to the reportable transaction understatement.
The Reasonable Cause and Good Faith Exception
The accuracy-related penalty under § 6662 does not apply with respect to any portion of an underpayment with respect to which it is shown that there was reasonable cause and that X acted in good faith. I.R.C. § 6664(c)(1). The determination of whether X acted with reasonable cause and in good faith is made on a case-by-case basis, taking into account all pertinent facts and circumstances. Treas. Reg. § 1.6664-4(f)(1). Generally, the most important factor is the extent of X's effort to assess its proper tax liability. Treas. Reg. § 1.6664-4(b)(1). A corporation's legal justification may be taken into account in establishing that the corporation acted with reasonable cause and in good faith in its treatment of a tax shelter item, but only if there is substantial authority within the meaning of Treas. Reg. § 1.6662-4(d) for the treatment of the item and the corporation reasonably believed, when the return was filed, that such treatment was more likely than not the proper treatment. Treas. Reg. § 1.6664-4(f)(2)(i)(B).
The reasonable belief standard is met if:
the corporation analyzed pertinent facts and relevant authorities to conclude in good faith that there would be a greater than 50 percent likelihood (“more likely than not”) that the tax treatment of the item would be upheld if challenged by the IRS; or
the corporation reasonably relied in good faith on the opinion of a professional tax advisor who analyzed all the pertinent facts and authorities, and who unambiguously states that there is a greater than 50 percent likelihood that the tax treatment of the item will be upheld if challenged by IRS. (See Treas. Reg. § 1.6664-4(c) for requirements with respect to the opinion of a professional tax advisor upon which the foregoing discussion elaborates).
Satisfaction of the minimum requirements for legal justification is an important factor in determining whether a corporation acted with reasonable cause and in good faith, but not necessarily dispositive. See Treas. Reg. § 1.6664-4(f)(3). For example, the taxpayer’s participation in a tax shelter lacking a significant business purpose or whether the taxpayer claimed benefits that are unreasonable in comparison to the taxpayer’s investment should be considered in your determination. Failure to satisfy the minimum standards will, however, preclude a finding of reasonable cause and good faith based (in whole or in part) on a corporation’s legal justification. See Treas. Reg. § 1.6664-4(f)(2)(i).
Other facts and circumstances may also be taken into account regardless of whether the minimum requirements for legal justification are met. See Treas. Reg. § 1.6664-4(f)(4).
For X to be considered to have reasonably relied in good faith on advice to establish legal justification as reasonable cause, all the requirements of Treas. Reg. § 1.6664-4(c) must be satisfied. The advice must be based upon all pertinent facts and circumstances and 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 X or any other person. Treas. Reg. § 1.6664-4(c)(1)(ii). Further, where a tax benefit depends on nontax factors, X also has a duty to investigate such underlying factors. The Taxpayer cannot simply rely on statements by another person, such as a promoter. See Novinger v. Commissioner, T.C. Memo. 1991-289; Goldman v. Commissioner, 39 F.3d 402 (2d Cir. 1994) (taxpayers cannot reasonably rely for professional advice on someone they know to be burdened with an inherent conflict of interest). Further, if the tax advisor is not versed in these nontax matters, mere reliance on the tax advisor does not suffice. See Addington v. United States, 205 F.3d 54 (2d Cir. 2000); Collins v. Commissioner, 857 F.2d 1383 (9th Cir. 1988).
Although a professional tax advisor’s lack of independence is not alone a basis for rejecting a taxpayer's claim of reasonable cause and good faith, the fact that a taxpayer knew or should have known of the advisor's lack of independence is strong evidence that the taxpayer may not have relied in good faith upon the advisor's opinion. Goldman v. Commissioner, 39 F.3d 402 (2nd Cir. 1994); Pasternak v. Commissioner, 990 F.2d 893, 903 (6th Cir. 1993)(finding reliance on promoters or their agents unreasonable, as “advice of such persons can hardly be described as that of ‘independent professionals’”); Roberson v. Commissioner, 98-1 U.S.T.C. 50,269 (6th Cir. 1998) (court dismissed taxpayer’s purported reliance on advice of tax professional because professional’s status as “promoter with a financial interest” in the investment); Rybak v. Commissioner, 91 T.C. 524, 565 (1988) (negligence penalty sustained where taxpayers relied only upon advice of persons who were not independent of promoters); Illes v. Commissioner, 982 F.2d 163 (6th Cir. 1992) (taxpayer found negligent; reliance upon professional with personal stake in venture not reasonable); Gilmore & Wilson Construction Co. v. Commissioner, 99-1 U.S.T.C. 50,186 (10th Cir. 1999) (taxpayer liable for negligence since reliance on representations of the promoters and offering materials unreasonable); Neonatology Associates, P.A. v. Commissioner, 299 F.3d 221 (3rd Cir. 2002)(reliance may be unreasonable when placed upon insiders, promoters, or their offering materials, or when the person relied upon has an inherent conflict of interest that the taxpayer knew or should have known about).
Similarly, the fact that a taxpayer consulted an independent tax advisor is not, standing alone, conclusive evidence of reasonable cause and good faith if additional facts suggest that the advice is not dependable. Edwards v. Commissioner, T.C. Memo. 2002-169; Spears v. Commissioner, T.C. Memo. 1996-341, aff’d, 98-1 U.S.T.C. ¶ 50,108 (2d Cir. 1997). For example, a taxpayer may not rely on an independent tax advisor if the taxpayer knew or should have known that the tax advisor lacked sufficient expertise, the taxpayer did not provide the advisor with all necessary information, the information the advisor was provided was not accurate, or the taxpayer knew or had reason to know that the transaction was “too good to be true.” Baldwin v.Commissioner, T.C. Memo. 2002-162; Spears v. Commissioner, T.C. Memo. 1996-341, aff’d. 98-1 U.S.T.C. ¶ 50,108 (2d Cir. 1997).
[Note: The American Jobs Creation Act of 2004 (the "AJCA") added new sections 6662A and 6707A to the Code. These provisions respectively (i) increase the amount of accuracy-related penalties with respect to undisclosed Listed Transactions and (ii)impose new penalties for failures to make disclosures required under section 6011(including undisclosed Listed Transactions.) The amendments to the accuracy-related penalties embodied in section 6662A are applicable to taxable years ending after the effective date of the AJCA (October 22, 2004). New section 6707A applies to returns or statements the due date for which is after the effective date of the AJCA (again, October 22, 2004). SILOs constitute Listed Transactions. See Notice 2005-13. This Coordinated Issue Paper will be supplemented to describe those changes in the law in greater detail when those provisions will affect returns, statements or taxable years under examination.]
Use of the term “sale-leaseback transaction” and certain other descriptive terms in the recitation of facts below does not imply that the Internal Revenue Service agrees with the tax characterizations claimed by participants in SILO transactions. FP either meets the definition of a tax-exempt entity under § 168(h)(2) or possesses attributes, such as net operating losses, that render FP tax-indifferent.
Earlier transactions might provide for a “replacement lease” rather than a Service Contract. In these transactions, FP can be obligated to secure a replacement lessee for a renewal lease term.
Transaction documents may direct FP to make rent payments directly to the lending institutions so long as the purported loans have unpaid balances.
The arrangement by which FP sets aside the funds necessary to meet its obligations under the Lease may take a variety of forms other than a deposit arrangement involving BK3 and BK4. These arrangements include a loan by FP to X, BK1 or BK2; a letter of credit collateralized with cash or cash equivalents; a payment undertaking agreement; a sinking fund arrangement; a guaranteed investment contract; or financial guaranty insurance.
In some SILOs FP prepays all or nearly all of its lease rent to the taxpayer, but the taxpayer defers inclusion of the amount as income, using present-value concepts, under § 467. This prepayment could be made on the Closing Date, removing the need for third-party financing and traditional debt defeasance accounts, or it could be made later on during the lease term.
The arrangement by which the return of X’s equity investment plus a predetermined after-tax return on such investment is provided may take a variety of forms other than an investment by FP in highly-rated debt securities. For example, FP may be required to obtain a payment undertaking agreement from an entity having a specified minimum credit rating.
In some instances, the ETO amount is sufficient to repay FP rent that FP overpaid or prepaid during the initial lease term. In transaction documents, this amount may be referred to as the Excess of Basic Rent Payments over Basic Rent Allocations or Basic Rent Payments in Excess of Basic Rent Allocations. It is combined with the equity and loan balances to fund the ETO.
In the event FP has not exercised its Early Termination Option, the Equity Collateral will be available to fund this end-of-lease term option price, to the extent the funds have not been used to satisfy other Lease obligations, including rent. In general, following the ETO Exercise Date, FP will not have access to the Equity Collateral until the end of the Lease term, and there will be either unpaid balances on the original third-party loans or new loans refinancing those balances.
Some taxpayers apparently have entered into transactions designed to defer or exclude this gain. For example, one type of transaction involves a foreign corporation that acquires an option to purchase X’s residual interest and a subsequent payment by X to the foreign corporation that is not considered subpart F income subject to current U.S. income taxation.
As discussed further in the analysis of X's interest deduction, the purported borrowings from BK-1 and BK-2 should be considered without substance. In certain cases, however, the Government may make an alternative argument that the Series B loan is in substance a loan between the Series B Lender and FP that in substance involves neither X nor the property. Further, where BK-1 and BK-3 and/or BK-2 and BK-4 are unrelated, the Government may argue in the alternative that in substance any loan is a loan between BK-1 and BK-3, and/or between BK-2 and BK-4, which in substance involves neither X, FP nor the property.
In certain cases, taxpayer should not be considered as having even a contingent future interest in property. For example, circumstances such as the nature of the property might indicate that FP is compelled to exercise a purchase option. In other cases, circumstances including the narrowness of the “collar” might indicate that taxpayer’s return is substantially fixed. In either instance, taxpayer’s interest might best be described as that of a creditor.
In another variant of the SILO transaction, the treasury of a foreign government acts as lender, and FP is an instrumentality of the foreign government. These transactions, therefore, could entail not only a relationship or identity between the lender and the deposit taker, but lessee financing.
Leases or purported leases of Qualified Transportation Property described in §§ 849(b)(1) and (2) of the Act are not subject to new Code § 470. Moreover, the federal tax benefits relating to Qualified Transportation Property are to be sustained. See Notice 2005-13, 2005-9 I.R.B 630 (Feb. 28, 2005). This view is in accord with the position taken by the Department of the Treasury Acting Deputy Assistant Secretary (Tax Policy) in his letter to the Department of Transportation Secretary, dated February 15, 2005. By contrast, leases or purported leases subject to the general effective date set forth in § 849(a) of the Act are subject to common law requirements for a valid lease regardless of when such transactions have been or are entered into. Sections 849(b)(1) and (2) of the Act provide:
(1) IN GENERAL.-- The amendments made by this part shall not apply to qualified transportation property.
(2) QUALIFIED TRANSPORTATION PROPERTY. -- For purposes of paragraph (1), the term "qualified transportation property" means domestic property subject to a lease with respect to which a formal application --
(A) was submitted for approval to the Federal Transit Administration (an agency of the Department of Transportation)after June 30, 2003 and before March 13, 2004,(B) is approved by the Federal Transit Administration before January 1, 2006, and (C) includes a description of such property and the value of such property.
On January 14, 2002, in Announcement 2002-2, 2002-1 C.B. 562, the Service announced a disclosure initiative to encourage taxpayers to disclose their tax treatment of tax shelters and other items for which the imposition of the accuracy-related penalty may be appropriate if there is an underpayment of tax. In return for a taxpayer disclosing any item in accordance with the provisions of this announcement before April 23, 2002, the Service agreed to waive the accuracy-related penalty under § 6662(b)(1), (2), (3), and (4) for any underpayment of tax attributable to that item.
See Notice 2005-11, 2005-7 I.R.B. 493 (Feb. 14, 2005), for further interim guidance relating to § 6707A.
The Act amended § 6662(d)(1)(B) for tax years beginning after October 22, 2004. Under § 6662(d)(1)(B), as amended, a corporation has a substantial understatement of income tax for the taxable year if the amount of the understatement exceeds the lessor of 10 percent of the tax required to be shown on the return (or, if greater, $10,000), or $10,000,000.
Section 6662A applies only to tax years ending after October 22, 2004.