Revenue Procedure 2019-42: I.R.S. Provides Updated Guidance on Adequate Disclosure by SANDRA BROWN and GARY MARKARIAN
On December 2, 2019, the Internal Revenue Service released Rev. Proc. 2019-42, which applies to any income tax return filed on 2019 tax forms for the 2019 tax year, including 2019 tax forms for short taxable years beginning in 2020 if filed before the forms for 2020 are available. This updated revenue procedure, which updates Rev. Proc. 2019-09, 2019-02 I.R.B. 292, identifies circumstances under which disclosures on a taxpayer’s income tax return, with respect to an item or position, is adequate for the purpose of reducing the understatement of income tax under I.R.C. § 6662(d), and for the purpose of avoiding the tax return preparer penalty under I.R.C. § 6694(a).
I.R.C. § 6662(a) allows the I.R.S. to impose a 20% penalty for any portion of an underpayment of tax required to be shown on a return. I.R.C. § 6662(d) defines a substantial understatement of income tax as an understatement that exceeds the greater of 10 percent of the tax required to be shown on the return for the taxable year or $5,000.00. Section 6662(d) provides for special rules in classifying a substantial understatement for corporations and taxpayers claiming a Section 199A deduction.
I.R.C. § 6662(d)(2)(B)(ii) states that the amount of the understatement shall be reduced by the portion of the understatement attributable to any item if the relevant facts affecting the item’s tax treatment are adequately disclosed in the return and requires there be a reasonable basis for the tax treatment of the item.
I.R.C. § 6694(a) focuses on tax preparers that prepare returns or refund claims which have an understatement of liability due to an unreasonable position where the tax preparer knew or reasonably should have known of the position. In such cases, the tax preparer shall pay a penalty for each return or claim, amounting to the greater of $1,000 or 50% of the income received for preparing the return which included the unreasonable position. I.R.C. § 6694(a)(2) defines an unreasonable position as one that does not have substantial authority for the position or was not properly disclosed and did not have a reasonable basis. A position with respect to a tax shelter is unreasonable unless it is reasonable to believe that the position would more likely than not be sustained on the merits.
This updated revenue procedure provides guidance for determining when disclosure on the return is adequate for the purposes of I.R.C. § 6662(d)(2)(B)(ii) and I.R.C. § 6694(a)(2)(B) without the need to provide the I.R.S. with additional, separate disclosures. Section 4.02 of the revenue procedure lists those items which are acceptable for disclosure on the return without the need for a separate disclosure, including: (1) Form 1040, Schedule, Itemized Deductions; (2) Certain Trade or Business Expenses; (3) Differences in book and income tax reporting; and (4) Foreign Tax Items. For a disclosure to be adequate, the taxpayer must: (1) include all required information; (2) file all applicable forms; and, (2) be able to verify the amounts entered on the forms. Additional disclosures of facts related to, or positions taken with respect to, issues involving any of the listed items is unnecessary. However, the updated revenue procedure does caution that the disclosure of such items on a return may still provide no relief from I.R.C. § 6662 accuracy-related penalties if the item is not properly substantiated or the taxpayer fails to keep adequate books and records with respect to the item or position in issue.
The items and positions which are not included in the updated revenue procedure will require a separate and more robust disclosure to be considered adequate. Specifically, non-listed items require that the disclosure be made on a properly completed Form 8275 or 8275-R, and as appropriate, attached to the return for the 2019 tax year. For corporate returns, a complete and accurate disclosure of a tax position on the appropriate year’s Schedule UTP, Uncertain Tax Position Statement, will be treated as if the corporation filed a Form 8275 or Form 8275-R regarding the tax position, but filing a Form 8275 or Form 8275-R will not be treated as if the corporation filed a Schedule UTP.
Sandra R. Brown is a principal at Hochman Salkin, Toscher Perez P.C., and specializes in representing individuals and organizations who are involved in criminal tax investigations, including related grand jury matters, court litigation and appeals, as well as representing and advising taxpayers involved in complex and sophisticated civil tax controversies, including representing and advising taxpayers in sensitive-issue audits and administrative appeals, as well as civil litigation in federal, state and tax court. Prior to joining the firm, Ms. Brown served as the Acting United States Attorney, the First Assistant United States Attorney and the Chief of the Tax Division of the Office of the U.S. Attorney (C.D. Cal).
Gary Markarian is an associate at Hochman Salkin Toscher Perez P.C., and a recent graduate of the joint JD/LL.M. Taxation program at Loyola Law School, Los Angeles. Mr. Markarian’s prior tax experience includes externships with the Tax Division of the U.S. Attorney’s Office (CDCA), the Office of Chief Counsel, IRS (LB&I), Los Angeles, and Loyola Law School’s Sales and Use Tax Clinic.