Back Taxes: New Tax Shelter Regulations under Sec. 4965

The IRS has issued final, temporary and proposed regulations relating to returns accompanying payment of excise taxes under Code Sec. 4965, as well as addressing filing and disclosure requirements related to these excise taxes under Code Secs. 6011, 6033 and 6071.

T.D. 9334
Code Sec. 4965, which was added by the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) (P.L. 109-222), imposed two new excise taxes that affect a broad array of tax-exempt entities. An entity-level tax is now imposed on nonplan entities that are parties to prohibited tax shelter transactions; this tax applies to each tax year during which the nonplan entity is a party to such a transaction and has net income or proceeds attributable to the transaction that are properly allocable to that tax year. The other excise tax, a manager-level tax, is imposed on entity managers who approve the tax-exempt entity as a party to a prohibited tax shelter transaction and know or have reason to know that the transaction is a prohibited tax shelter transaction.

T.D. 9334 provides that nonplan entities liable for Code Sec. 4965 excise taxes and entity managers of nonplan entities liable for those taxes are required to file a return on Form 4720, Return of Certain Excise Taxes Under Chapters 41 and 42 of the Internal Revenue Code, on or before the date the entity's annual return is due. If the entity is not required to file such a return, the entity return is due on or before the 15th day of the fifth month after the end of the nonplan entity's accounting period for which the liability under Code Sec. 4965 was incurred. Entity managers of plan entities who are liable for Code Sec. 4965 taxes are required to file a return on Form 5330, Return of Excise Taxes Related to Employee Benefit Plans, on or before the 15th day of the fifth month following the close of the manager's tax year during which the entity entered into a prohibited tax shelter transaction.

These regulations are generally effective/applicable on July 6, 2007, and will cease to apply on July 6, 2010. However, a transition rule states that returns of Code Sec. 4965 taxes that are or were due on or before October 4, 2007, will be deemed timely if the return is filed and the tax is paid before that date.

T.D. 9335
The IRS also issued temporary regulations under Code Sec. 6033(a)(2) that provide rules regarding the form, manner and timing of disclosure requirements with respect to prohibited tax shelter transactions to which tax-exempt entities are parties. These regulations require that every tax-exempt entity to which Code Sec. 4965 applies that is a party to a prohibited tax shelter transaction must disclose to the IRS that the entity is a party to a prohibited tax shelter transaction and the identity of any other party to the transaction known to the tax-exempt entity.

The temporary regulations issued in T.D. 9335 define a tax-exempt party to a prohibited tax shelter transaction, and provide guidance with respect to the frequency of disclosure, who is to make the disclosure and the time and place for making the disclosure on Form 8886-T, Disclosure by Tax-Exempt Entity Regarding Prohibited Tax Shelter Transaction. A transition rule is provided for tax-exempt entities that entered into a prohibited tax shelter transaction after May 17, 2006, and before January 1, 2007. Disclosure is not required for any prohibited tax shelter transaction entered into by a tax-exempt entity on or before May 17, 2006.

Proposed Regulations
The texts of the temporary regulations in T.D. 9334 and T.D. 9335 also serve as the texts of proposed regulations. Temporary regulations providing guidance under Code Sec. 4965 have also been released.

Background. Notice 2006-65, I.R.B. 2006-31, 102, and Notice 2007-18, I.R.B. 2007-9, 608 (TAXDAY, 2007/02/08, I.1) provided guidance regarding prohibited tax shelter transactions under Code Sec. 4965, and requested comments regarding these provisions and the guidance. After consideration of the comments received, the IRS has issued proposed regulations.

Proposed Regulations. The proposed regulations define the terms "tax-exempt entity," "prohibited tax shelter transactions," "net income" and "reportable transactions," and clarify that a tax-exempt entity does not become a party to a prohibited tax shelter transaction solely because it invests in an entity that becomes involved in such a transaction. Furthermore, the regulations address the definition of the term "entity manager," and provide guidance regarding persons who could be deemed entity managers pursuant to a delegation of authority. The regulations also define the term "approve or otherwise cause," limiting the definition to affirmative actions of persons who have the authority to commit the entity to a transaction.

The level of tax imposed under Code Sec. 4965 depends on whether the entity knew or had reason to know that it was becoming a party to a prohibited tax shelter transaction. Under the proposed regulations, receipt by an entity manager of a disclosure statement in advance of a transaction is a relevant factor but does not necessarily demonstrate that the entity or any of its managers knew or had reason to know that the transaction was a prohibited tax shelter transaction. The regulations also clarify that entity manager liability for these excise taxes is not joint and several.

Notice 2007-18 provided that allocation of net income and proceeds is determined according to normal tax accounting rules. This rule is included in the proposed regulations.

Effective Dates. When finalized the regulations under Code Sec. 4965are proposed to be applicable for tax years ending after July 6, 2007. Taxpayers may rely on these proposed regulations for periods ending on or before such date.

Comments Requested The IRS requests comments on these regulations, specifically regarding the clarity of the proposed rule and how it may be made easier to understand. A public hearing is not scheduled, but may be scheduled if requested in writing by a person who timely submits written comments. Comments and requests for a public hearing must be received by October 4, 2007. Submissions should be sent to CC:PA:LPD:PR (REG-142039-06; REG-139268-06), Room 5203, IRS, P.O. Box 7604, Ben Franklin Station, Washington, D.C., 20044. Submissions may also be hand-delivered between 8:00 a.m. and 4:00 p.m. to CC:PA:LPD:PR (REG-142039-06; REG-139268-06), Courier's Desk, IRS, 1111 Constitution Avenue, NW., Washington, D.C., or submitted electronically via the Federal eRulemaking Portal at http://www.regulations.gov (IRS-REG-142039-06; REG-139268-06).

T.D. 9334 , filed with the Federal Register on July 5, 2007.

Returns: Information returns: Excise taxes: Time for filing. --
Reg. §53.6071-1T and amendments of Reg. §§53.6011-1, 53.6071-1, 54.6011-1 and 54.6011-1T, relating to the requirement of a return to accompany payment of excise taxes under Code Sec. 4965 and the time for filing that return, are adopted.
AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

SUMMARY: This document contains final and temporary regulations providing guidance relating to the requirement of a return to accompany payment of excise taxes under section 4965 of the Internal Revenue Code (Code) and the time for filing that return. These regulations affect a broad array of tax-exempt entities, including charities, state and local government entities, Indian tribal governments and employee benefit plans, as well as entity managers of these entities. This action is necessary to implement section 516 of the Tax Increase Prevention and Reconciliation Act of 2005. The text of the temporary regulations also serves as the text of the proposed regulations set forth in the Proposed Rules section in this issue of the Federal Register.

DATES: Effective date. These regulations are effective on July 6, 2007.

Applicability date. For dates of applicability, see §§53.6071-1T(g) and 54.6011-1T(c) of these regulations.

FOR FURTHER INFORMATION CONTACT: Galina Kolomietz, (202) 622-6070, Michael Blumenfeld, (202) 622-1124, or Dana Barry, (202) 622-6060 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:



Background

The Tax Increase Prevention and Reconciliation Act of 2005, Public Law 109-222 (120 Stat. 345) (TIPRA), enacted on May 17, 2006, added section 4965 to the Code. Section 4965 affects a broad array of tax-exempt entities as defined in section 4965(c). Tax-exempt entities described in section 4965(c)(1), (2), or (3) (referred to herein as "non-plan entities") include entities described in section 501(c), religious or apostolic associations or corporations described in section 501(d), entities described in section 170(c), including states, possessions of the United States, the District of Columbia, political subdivisions of states and political subdivisions of possessions of the United States (but not including the United States), and Indian tribal governments within the meaning of section 7701(a)(40). Tax-exempt entities described in section 4965(c)(4), (c)(5), (c)(6), or (c)(7) (referred to herein as "plan entities") include tax-favored retirement plans, individual retirement arrangements, and savings arrangements described in section 401(a), 403(a), 403(b), 529, 457(b), 408(a), 220(d), 408(b), 530 or 223(d).

Section 4965 imposes two new excise taxes, one on the tax-exempt entity (the entity-level tax) and the other on certain of the tax-exempt entity's managers (the manager-level tax). The entity-level tax is imposed on non-plan entities that are parties to prohibited tax shelter transactions. The entity-level tax does not apply to plan entities. Prohibited tax shelter transactions are transactions that are identified by the IRS as "listed transactions" (within the meaning of section 6707A(c)(2)) and reportable transactions that are confidential transactions or transactions with contractual protection (as defined in section 6707A(c)(1) and §1.6011-4(b) of this chapter).

The entity-level tax applies to each taxable year during which the non-plan entity is a party to a prohibited tax shelter transaction and has net income or proceeds attributable to the transaction which are properly allocable to that taxable year. The amount of the entity-level tax depends on whether the non-plan entity knew or had reason to know that the transaction was a prohibited tax shelter transaction at the time the entity became a party to the transaction. If the non-plan entity did not know (and did not have reason to know) that the transaction was a prohibited tax shelter transaction at the time the entity became a party to the transaction, the tax is the highest rate of tax under section 11 (currently 35 percent) multiplied by the greater of: (i) The entity's net income with respect to the prohibited tax shelter transaction (after taking into account any tax imposed by Subtitle D, other than by this section, with respect to such transaction) for the taxable year or (ii) 75 percent of the proceeds received by the entity for the taxable year that are attributable to such transaction. If the non-plan entity knew or had reason to know that the transaction was a prohibited tax shelter transaction at the time the entity became a party to the transaction, the tax is the greater of (i) 100 percent of the entity's net income with respect to the transaction (after taking into account any tax imposed by Subtitle D, other than by this section, with respect to such transaction) for the taxable year or (ii) 75 percent of the proceeds received by the entity for the taxable year that are attributable to such transaction. In the case of a transaction that becomes a prohibited tax shelter transaction by reason of becoming a listed transaction after the non-plan entity has become a party to such transaction (subsequently listed transactions), the amount of tax is based on the net income or proceeds attributable to such transaction that are properly allocable to the period beginning on the date the transaction became listed or the first day of the entity's taxable year, whichever is later. No entity-level tax applies to any income or proceeds that are properly allocable to a period ending on or before August 15, 2006.

The manager-level tax is imposed on entity managers (as defined in section 4965(d)) of all tax-exempt entities described in section 4965(c) who approve the entity as a party (or otherwise cause the entity to be a party) to a prohibited tax shelter transaction and know or have reason to know that the transaction is a prohibited tax shelter transaction. In the case of non-plan entities, the term entity manager means the person with authority or responsibility similar to that exercised by an officer, director or trustee, and, with respect to any act, the person having authority or responsibility with respect to such act. In the case of plan entities, the term entity manager means the person who approves or otherwise causes the entity to be a party to the prohibited tax shelter transaction. An individual beneficiary (including a plan participant) or owner of the tax-favored retirement plans, individual retirement arrangements, and savings arrangements described in section 401(a), 403(a), 403(b), 529, 457(b), 408(a), 220(d), 408(b), 530 or 223(d), may be liable as an entity manager if the individual beneficiary or owner has broad investment authority under the arrangement. The amount of the manager-level tax is $20,000 for each approval or other act causing the entity to be a party to a prohibited tax shelter transaction. The manager-level tax applies separately to each entity manager.

These final and temporary regulations are being issued concurrently with proposed regulations under sections 4965, 6033(a)(2) and 6011(g) published elsewhere in the Federal Register.



Explanation of Provisions

The regulations provide that non-plan entities (including exempt organizations and governments) that are liable for section 4965 excise taxes and entity managers of non-plan entities who are liable for section 4965 excise taxes as entity managers are required to file a return on Form 4720, "Return of Certain Excise Taxes Under Chapters 41 and 42 of the Internal Revenue Code." The entity return is due on or before the date the non-plan entity's annual return under section 6033(a)(1) (for example, Form 990, "Return of Organization Exempt From Income Tax") is due, if the non-plan entity is required to file such a return. In all other cases, the entity return is due on or before the 15th day of the fifth month after the end of the non-plan entity's accounting period for which the liability under section 4965 was incurred. In the case of a non-plan entity manager, the entity manager return is due on or before the 15th day of the fifth month following the close of the manager's taxable year during which the entity entered into a prohibited tax shelter transaction.

The regulations also provide that entity managers of plan entities who are liable for section 4965 taxes as entity managers are required to file a return on Form 5330, "Return of Excise Taxes Related to Employee Benefit Plans." For section 4965 taxes, the Form 5330 is due on or before the 15th day of the fifth month following the close of the manager's taxable year during which the entity entered into a prohibited tax shelter transaction.

The regulations provide a transition rule that returns of section 4965 taxes that are or were due on or before October 4, 2007 will be deemed timely if the return is filed and the tax is paid before that date.



Special Analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations. For the applicability of the Regulatory Flexibility Act (5 U.S.C. chapter 6), refer to the Special Analyses section of the preamble to the cross-referencing notice of proposed rulemaking published in the Proposed Rules section in this issue of the Federal Register. Pursuant to section 7805(f) of the Code, these regulations have been submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on their impact on business.



Drafting Information

The principal authors of these regulations are Galina Kolomietz and Dana Barry, Office of Division Counsel/Associate Chief Counsel (Tax Exempt and Government Entities). However, other personnel from the IRS and the Treasury Department participated in their development.



List of Subjects

26 CFR Part 53

Excise taxes, Foundations, Investments, Lobbying, Reporting and recordkeeping requirements.

26 CFR Part 54

Excise Taxes, Pensions, Reporting and recordkeeping requirements.



Amendments to the Regulations

Accordingly, 26 CFR parts 53 and 54 are amended as follows:



PART 53 --FOUNDATION AND SIMILAR EXCISE TAXES

Paragraph 1. The authority citation for part 53 continues to read in part as follows:

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



§53.6011-1 [Amended]

Par. 2. In §53.6011-1, paragraph (b) is amended by:

1. Removing from the first sentence, the language "or 4958(a)," and adding "4958(a), or 4965(a)," in its place.

2. Removing from the last sentence, the language "or 4958(a)," and adding "4958(a), or 4965(a)," in its place.

Par. 3. Section 53.6071-1 is amended by adding and reserving paragraph (g) and adding paragraph (h) to read as follows:



§53.6071-1 Time for filing returns.

* * * * *

(g) [Reserved]. For further guidance, see §53.6071-1T(g).

(h) Effective/applicability date. For the applicability date of paragraph (g) of this section, see §53.6071-1T(h).

Par. 4. Section 53.6071-1T is added to read as follows:



§53.6071-1T Time for filing returns (temporary).

(a) through (f) [Reserved]. For further guidance, see §53.6071-1(a) through (f).

(g) Taxes imposed with respect to prohibited tax shelter transactions to which tax-exempt entities are parties --(1) Returns by certain tax-exempt entities. A Form 4720, "Return of Certain Excise Taxes Under Chapters 41 and 42 of the Internal Revenue Code," required by §53.6011-1(b) for a tax-exempt entity described in section 4965(c)(1), (c)(2) or (c)(3) that is a party to a prohibited tax shelter transaction and is liable for tax imposed by section 4965(a)(1) shall be filed on or before the due date (not including extensions) for filing the tax-exempt entity's annual information return under section 6033(a)(1). If the tax-exempt entity is not required to file an annual information return under section 6033(a)(1), the Form 4720 shall be filed on or before the 15th day of the fifth month after the end of the tax-exempt entity's taxable year or, if the entity has not established a taxable year for Federal income tax purposes, the entity's annual accounting period.

(2) Returns by entity managers of tax-exempt entities described in section 4965(c)(1), (c)(2) or (c)(3). A Form 4720, required by §53.6011-1(b) for an entity manager of a tax-exempt entity described in section 4965(c)(1), (c)(2) or (c)(3) who is liable for tax imposed by section 4965(a)(2) shall be filed on or before the 15th day of the fifth month following the close of the entity manager's taxable year during which the entity entered into the prohibited tax shelter transaction.

(3) Transition rule. A Form 4720, for a section 4965 tax that is or was due on or before October 4, 2007 will be deemed to have been filed on the due date if it is filed by October 4, 2007 and if all section 4965 taxes required to be reported on that Form 4720 are paid by October 4, 2007.

(h) Effective/applicability date --(1) In general. Paragraph (g) of this section is applicable on July 6, 2007.

(2) Expiration date. Paragraph (g) of this section will cease to apply on July 6, 2010.



PART 54 --PENSION EXCISE TAXES

Par. 5. The authority citation for part 54 continues to read in part as follows:

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

Par. 6. Section 54.6011-1 is amended by adding and reserving paragraph (c) and adding paragraph (d) to read as follows:



§54.6011-1 General requirement of return, statement, or list.

* * * * *

(c) [Reserved]. For further guidance, see §54.6011-1T(c).

(d) Effective/applicability date. For the applicability date of paragraph (c) of this section, see §54.6011-1T(d).

Par. 7. Section 54.6011-1T is amended as follows:

1. The undesignated text is designated as paragraph (a) and a paragraph heading is added.

2. Paragraph (b) is added and reserved.

3. Paragraphs (c) and (d) are added.



§54.6011-1T General requirement of return, statement or list (temporary).

(a) Tax on reversions of qualified plan assets to employer. * * *

(b) [Reserved].

(c) Entity manager tax on prohibited tax shelter transactions --(1) In general. Any entity manager of a tax-exempt entity described in section 4965(c)(4), (c)(5), (c)(6), or (c)(7) who is liable for tax under section 4965(a)(2) shall file a return on Form 5330, "Return of Excise Taxes Related to Employee Benefit Plans," on or before the 15th day of the fifth month following the close of such entity manager's taxable year during which the entity entered into the prohibited tax shelter transaction, and shall include therein the information required by such form and the instructions issued with respect thereto.

(2) Transition rule. A Form 5330, "Return of Excise Taxes Related to Employee Benefit Plans," for an excise tax under section 4965 that is or was due on or before October 4, 2007 will be deemed to have been filed on the due date if it is filed by October 4, 2007 and if the section 4965 tax that was required to be reported on that Form 5330 is paid by October 4, 2007.

(d) Effective/applicability date --(1) In general. Paragraph (c) of this section is applicable on July 6, 2007.

(2) Expiration date. Paragraph (c) of this section will expire on July 5, 2010.

Kevin M. Brown,

Deputy Commissioner for Services and Enforcement.

Approved: June 21, 2007.

Eric Solomon,

Assistant Secretary of the Treasury (Tax Policy)



T.D. 9335 , filed with the Federal Register on July 5, 2007.

Returns: Information returns: Exempt organizations: Prohibited tax shelter transaction. --
Reg. §§1.6033-5T and 301.6033-5T, providing rules regarding the form, manner and timing of disclosure obligations with respect to prohibited tax shelter transactions to which tax-exempt entities are parties, are adopted.



AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Temporary regulations.

SUMMARY: This document contains temporary regulations under section 6033(a)(2) of the Internal Revenue Code (Code) that provide rules regarding the form, manner and timing of disclosure obligations with respect to prohibited tax shelter transactions to which tax-exempt entities are parties. These temporary regulations affect a broad array of tax-exempt entities, including charities, state and local government entities, Indian Tribal governments and employee benefit plans, as well as entity managers of these entities. This action is necessary to implement section 516 of the Tax Increase Prevention and Reconciliation Act of 2005. The text of the temporary regulations also serves as the text of the proposed regulations set forth in the Proposed Rules section in this issue of the Federal Register.

DATES: Effective Date: These regulations are effective on July 6, 2007.

Applicability Date: For dates of applicability, see §1.6033-5T(g).

FOR FURTHER INFORMATION CONTACT: Galina Kolomietz, (202) 622-6070, or Michael Blumenfeld, (202) 622-1124 (not toll-free numbers). For questions specifically relating to qualified pension plans, individual retirement accounts, and similar tax-favored savings arrangements, contact Dana Barry, (202) 622-6060 (not a toll-free number).

SUPPLEMENTARY INFORMATION:



Background

The Tax Increase Prevention and Reconciliation Act of 2005, Public Law 109-222 (120 Stat. 345) (TIPRA), enacted on May 17, 2006, defines certain transactions as prohibited tax shelter transactions and imposes excise taxes and disclosure requirements with respect to prohibited tax shelter transactions to which a tax-exempt entity is a party. TIPRA creates new section 4965 and amends sections 6033(a)(2) and 6011(g) of the Code. The amended section 6033(a)(2) requires every tax-exempt entity to which section 4965 applies that is a party to a prohibited tax shelter transaction to disclose to the IRS (in such form and manner and at such time as determined by the Secretary) the following information: (a) That such entity is a party to the prohibited tax shelter transaction; and (b) the identity of any other party to the transaction which is known to the tax-exempt entity. The amended section 6011(g) requires any taxable party to a prohibited tax shelter transaction to disclose by statement to any tax-exempt entity to which section 4965 applies that is a party to such transaction that such transaction is a prohibited tax shelter transaction.

On July 11, 2006, the IRS released Notice 2006-65 (2006-31 IRB 102), which alerted taxpayers to the new provisions. On February 7, 2007, the IRS released Notice 2007-18 (2007-9 IRB 608), which provided interim guidance regarding the circumstances under which a tax-exempt entity will be treated as a party to a prohibited tax shelter transaction for purposes of sections 4965, 6033(a)(2) and 6011(g) and regarding the allocation to various periods of net income and proceeds attributable to a prohibited tax shelter transaction, including amounts received prior to the effective date of the section 4965 tax. See §601.601(d)(2)(ii)(b).

These temporary regulations are being issued concurrently with proposed regulations under sections 4965, 6033(a)(2) and 6011(g) published elsewhere in the Federal Register.



Explanation of Provisions

These temporary regulations contain rules concerning disclosure requirements imposed by section 6033(a)(2) on tax-exempt entities that are parties to prohibited tax shelter transactions. Proposed regulations providing rules concerning disclosure requirements under section 6033(a)(2) are being issued concurrently with these temporary regulations.



Effective Date

These temporary regulations are applicable with respect to transactions entered into by a tax-exempt entity after May 17, 2006.



Special Analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order 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) does not apply to these regulations. For the applicability of the Regulatory Flexibility Act (5 U.S.C. chapter 6), refer to the Special Analyses section of the preamble to the cross-referencing notice of proposed rulemaking published in the Proposed Rules section in this issue of the Federal Register. Pursuant to section 7805(f) of the Code, these regulations have been submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on their impact on small business.



Drafting Information

The principal authors of these regulations are Galina Kolomietz and Dana Barry, Office of Division Counsel/Associate Chief Counsel (Tax Exempt and Government Entities). However, other personnel from the IRS and the Treasury Department participated in their development.



List of Subjects

26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 301

Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income taxes, Penalties, Reporting and recordkeeping requirements.



Adoption of Amendments to the Regulations

Accordingly, 26 CFR parts 1 and 301 are 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 1.6033-5T is added to read as follows:

§1.6033-5T Disclosure by tax-exempt entities that are parties to certain reportable transactions (temporary).

(a) In general. Every tax-exempt entity (as defined in section 4965(c)) shall file with the IRS on Form 8886-T, "Disclosure by Tax-Exempt Entity Regarding Prohibited Tax Shelter Transaction" (or a successor form), in accordance with this section and the instructions to the form, a disclosure of --

(1) Such entity's being a party (as defined in paragraph (b) of this section) to a prohibited tax shelter transaction (as defined in section 4965(e)); and

(2) The identity of any other party (whether taxable or tax-exempt) to such transaction that is known to the tax-exempt entity.

(b) Definition of tax-exempt party to a prohibited tax shelter transaction --(1) In general. For purposes of section 6033(a)(2), a tax-exempt entity is a party to a prohibited tax shelter transaction if the entity --

(i) Facilitates a prohibited tax shelter transaction by reason of its tax-exempt, tax indifferent or tax-favored status;

(ii) Enters into a listed transaction and the tax-exempt entity's tax return (whether an original or an amended return) reflects a reduction or elimination of its liability for applicable Federal employment, excise or unrelated business income taxes that is derived directly or indirectly from tax consequences or tax strategy described in the published guidance that lists the transaction; or

(iii) Is identified in published guidance, by type, class or role, as a party to a prohibited tax shelter transaction.

(2) Published guidance may identify which tax-exempt entities, by type, class or role, will not be treated as a party to a prohibited tax shelter transaction for purposes of section 6033(a)(2).

(c) Frequency of disclosure. A single disclosure is required for each prohibited tax shelter transaction.

(d) By whom disclosure is made --(1) Tax-exempt entities referred to in section 4965(c)(1), (2) or (3). In the case of tax-exempt entities referred to in section 4965(c)(1), (2) or (3), the disclosure required by this section must be made by the entity.

(2) Tax-exempt entities referred to in section 4965(c)(4), (5), (6) or (7). In the case of tax-exempt entities referred to in section 4965(c)(4), (5), (6) or (7), including a fully self-directed qualified plan, IRA, or other savings arrangement, the disclosure required by this section must be made by the entity manager (as defined in section 4965(d)(2)) of the entity.

(e) Time and place for filing --(1) Tax-exempt entities described in paragraph (b)(1)(i) of this section --(i) In general. The disclosure required by this section shall be filed on or before May 15 of the calendar year following the close of the calendar year during which the tax-exempt entered into the prohibited tax shelter transaction.

(ii) Subsequently listed transactions. In the case of subsequently listed transactions (as defined in section 4965(e)(2)), the disclosure required by this section shall be filed on or before May 15 of the calendar year following the close of the calendar year during which the transaction was identified by the Secretary as a listed transaction.

(2) Tax-exempt entities described in paragraph (b)(1)(ii) of this section. The disclosure required by this section shall be filed on or before the date on which the first tax return (whether an original or an amended return) is filed which reflects a reduction or elimination of the tax-exempt entity's liability for applicable Federal employment, excise or unrelated business income taxes that is derived directly or indirectly from tax consequences or tax strategy described in the published guidance that lists the transaction.

(3) Transition rule. If a tax-exempt entity entered into a prohibited tax shelter transaction after May 17, 2006 and before January 1, 2007, the disclosure required by this section shall be filed --

(i) In the case of tax-exempt entities described in paragraph (b)(1)(i) of this section, on or before November 5, 2007;

(ii) In the case of tax-exempt entities described in paragraph (b)(1)(ii) of this section, on or before the later of --

(A) November 5, 2007; or

(B) The date on which the first tax return (whether an original or an amended return) is filed which reflects a reduction or elimination of the tax-exempt entity's liability for applicable Federal employment, excise or unrelated business income taxes that is derived directly or indirectly from tax consequences or tax strategy described in the published guidance that lists the transaction.

(4) Disclosure is not required with respect to any prohibited tax shelter transaction entered into by a tax-exempt entity on or before May 17, 2006.

(f) Penalty for failure to provide disclosure statement. See section 6652(c)(3) for penalties applicable to failure to disclose a prohibited tax shelter transaction in accordance with this section.

(g) Effective date --(1) Applicability date. This section applies with respect to transactions entered into by a tax-exempt entity after May 17, 2006.

(2) Expiration date. This section will expire on July 6, 2010.



PART 301 --PROCEDURE AND ADMINISTRATION

Par. 3. The authority citation for part 301 continues to read in part as follows:

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

Par. 4. Section 301.6033-5T is added to read as follows:

§301.6033-5T Disclosure by tax-exempt entities that are parties to certain reportable transactions (temporary).

(a) In general. For provisions relating to the requirement of the disclosure by a tax-exempt entity that it is a party to certain reportable transactions, see §1.6033-5T of this chapter (Income Tax Regulations).

(b) Effective date --(1) Applicability date. This section applies with respect to transactions entered into by a tax-exempt entity after May 17, 2006.

(2) Expiration date. This section will expire on July 5, 2010.

Kevin M. Brown,

Deputy Commissioner for Services and Enforcement.

Approved: June 21, 2007.

Eric Solomon,

Assistant Secretary of the Treasury (Tax Policy).

Proposed Regulations (REG-142039-06, REG-139268-06) , published in the Federal Register on July 6, 2007.


Excise taxes: Tax-exempt entities: Tax shelter transactions: Returns: Filing requirements. --
Reg. §§53.4965-1 --53.4965-9, 301.6011(g)-1, 1.6033-5 and 301.6033-5 and amendments of Reg. §§53.6071-1 and 54.6011-1, providing guidance under Code Sec. 4965 relating to entity-level and manager-level excise taxes with respect to prohibited tax shelter transactions to which tax-exempt entities are parties, are proposed.



AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking by reference to temporary regulations and notice of proposed rulemaking.

SUMMARY: This document contains proposed regulations that provide guidance under section 4965 of the Internal Revenue Code (Code), relating to entity-level and manager-level excise taxes with respect to prohibited tax shelter transactions to which tax-exempt entities are parties; sections 6033(a)(2) and 6011(g), relating to certain disclosure obligations with respect to such transactions; and sections 6011 and 6071, relating to the requirement of a return and time for filing with respect to section 4965 taxes. In the Rules and Regulations section of this issue of the Federal Register, the IRS is issuing cross-referencing temporary regulations that provide guidance under section 6033(a)(2), relating to certain disclosure obligations with respect to prohibited tax shelter transactions; and sections 6011 and 6071, relating to the requirement of a return and time for filing with respect to section 4965 taxes. This action is necessary to implement section 516 of the Tax Increase Prevention Reconciliation Act of 2005. These proposed regulations affect a broad array of tax-exempt entities, including charities, state and local government entities, Indian tribal governments and employee benefit plans, as well as entity managers of these entities.

DATES: Written or electronic comments and requests for a public hearing must be received by October 4, 2007.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-142039-06; REG-139268-06), room 5203, Internal Revenue Service, PO Box 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand delivered Monday through Friday between the hours of 8 a.m. and 4 p.m. to: CC:PA:LPD:PR (REG-142039-06, REG-139268-06), Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue, NW., Washington, DC. Alternatively, taxpayers may submit comments electronically via the Federal eRulemaking Portal at http://www.regulations.gov (IRS-REG-142039-06; REG-139268-06).

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Galina Kolomietz, (202) 622-6070 or Michael Blumenfeld, (202) 622-1124; concerning submission of comments and requests for a public hearing, Richard Hurst, Richard.A.Hurst@irscounsel.treas.gov (not toll-free numbers). For questions specifically relating to qualified pension plans, individual retirement accounts, and similar tax-favored savings arrangements, contact Dana Barry, (202) 622-6060 (not a toll-free number).



SUPPLEMENTARY INFORMATION:



Paperwork Reduction Act

An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a valid control number assigned by the Office of Management and Budget.

The collection of information in this proposed regulation is in §301.6011(g)-1. The collection of information in §301.6011(g)-1 flows from section 6011(g) which requires a taxable party to a prohibited tax shelter transaction to disclose to any tax-exempt entity that is a party to the transaction that the transaction is a prohibited tax shelter transaction. The likely recordkeepers are taxable entities or individuals that participate in prohibited tax shelter transactions. Estimated number of recordkeepers: 1250 to 6500. The information that is required to be collected for purposes of §301.6011(g)-1 is a subset of information that is required to be collected in order to complete and file Form 8886, "Reportable Transaction Disclosure Statement." The estimated paperwork burden for taxpayers filling out Form 8886 is approved under OMB number 1545-1800 and is as follows:


Recordkeeping ...................................................6 hr., 13 min.

Learning about the law
or the form ......................................................4 hr. 28 min.

Preparing, copying, assembling,
and sending the form to the IRS
..................................................................4 hr. 46 min.



Based on the numbers in the preceding paragraph, the total estimated burden per recordkeeper complying with the disclosure requirement in §301.6011(g)-1 will not exceed 15 hr., 27 min. This burden has been submitted to the Office of Management and Budget for review.

Books and records relating to the collection of information must be retained as long as their contents may become material in the administration of any internal revenue law.



Background

The Tax Increase Prevention and Reconciliation Act of 2005, Public Law 109-222 (120 Stat. 345) (TIPRA), enacted on May 17, 2006, defines certain transactions as prohibited tax shelter transactions and imposes excise taxes and disclosure requirements with respect to prohibited tax shelter transactions to which a tax-exempt entity is a party. Section 516 of TIPRA creates new section 4965 and amends sections 6033(a)(2) and 6011(g) of the Code.

On July 11, 2006, the IRS released Notice 2006-65 (2006-31 IRB 102), which alerted taxpayers to the new provisions and solicited comments regarding these provisions. One hundred written comments and numerous phone calls were received in response to the request for comments contained in Notice 2006-65. On February 7, 2007, the IRS released Notice 2007-18 (2007-9 IRB 608), which provided interim guidance regarding the circumstances under which a tax-exempt entity will be treated as a party to a prohibited tax shelter transaction and regarding the allocation to various periods of net income and proceeds attributable to a prohibited tax shelter transaction, including amounts received prior to the effective date of the section 4965 tax. Notice 2007-18 also solicited comments from the public regarding these and other issues raised by section 4965. Eight written comments and numerous phone calls were received in response to the request for comments contained in Notice 2007-18. See §601.601(d)(2)(ii)(b).

The comments received in response to Notice 2006-65 and Notice 2007-18 addressed all aspects of the new excise taxes and disclosure requirements. While some comments discussed the implications of a broad application of the new excise taxes and disclosure requirements, commentators generally responded favorably to Congress' effort to restrict tax-exempt entities from being involved in Federal tax avoidance schemes. Commentators noted the lack of meaningful penalties prior to TIPRA for tax-exempt entities involved in tax shelter transactions and the need for disclosure in the case where a tax-exempt entity is improperly using its tax-exempt status to facilitate a tax shelter transaction. After consideration of all comments received, the IRS and the Treasury Department are issuing the following proposed regulations and soliciting comments thereon. The major areas of comments and the IRS and Treasury Department's responses thereto are discussed in the following sections.



Explanation of Provisions



Covered Tax-Exempt Entities

Section 4965(c) defines the term "tax-exempt entity" for section 4965 purposes by reference to sections 501(c), 501(d), 170(c), 7701(a)(40), 4979(e) (paragraphs (1), (2) and (3)), 529, 457(b), and 4973(a). The proposed regulations describe the types of entities captured by the statutory cross-references in section 4965(c).



Definition of Prohibited Tax Shelter Transactions

Section 4965(e) defines the term "prohibited tax shelter transaction" by reference to section 6707A(c)(1) and (c)(2). In accordance with the statutory definition, the proposed regulations define the term "prohibited tax shelter transaction" by reference to the definition of the term "reportable transaction" in section 6707A(c)(1) and (c)(2) and the regulations under section 6011. The proposed regulations define a subsequently listed transaction as a transaction (other than a reportable transaction within the meaning of section 6707A(c)(1)) to which a tax-exempt entity becomes a party before the transaction becomes a listed transaction within the meaning of section 6707A(c)(2).

Several commentators expressed concern over the severe penalties imposed on tax-exempt entities and entity managers for participating in many common and legitimate transactions which have no tax avoidance purpose, yet may fall within the definition of prohibited tax shelter transaction. The commentators suggested that the IRS and the Treasury Department carve out certain types of transactions from the definition of "prohibited tax shelter transaction" or revise current listing procedures to give taxpayers an opportunity to object to the identification of a specific transaction as a tax avoidance transaction. Some commentators recommended that any future published guidance which designates a transaction as a listed or reportable transaction be issued with a prospective effective date and state that it will not apply retroactively. Several commentators requested that the proposed regulations identify listed, subsequently listed, confidential and contractual protection transactions that would not be treated as prohibited tax shelter transactions for purposes of section 4965. The above recommendations are not adopted in these proposed regulations because section 4965 defines the term "prohibited tax shelter transaction" by reference to the existing reportable transaction regime. Any additions to, or exclusions from, the definition of reportable transactions, or any changes to the current listing procedures, must be made within the framework of section 6011 rather than section 4965.

One commentator suggested that the term "reportable transaction" should be narrowly interpreted for purposes of section 4965. However, this term already has been defined under section 6011, and consequently, these proposed regulations interpret it consistently for section 4965 and section 6011 purposes.



Definition of Tax-Exempt Party to a Prohibited Tax Shelter Transaction

Excise taxes under section 4965 apply only if a tax-exempt entity is a party to a prohibited tax shelter transaction. A number of commentators requested guidance in determining when a tax-exempt entity is a party to a prohibited tax shelter transaction. Notice 2007-18 defined the term party as a tax-exempt entity that facilitates a prohibited tax shelter transaction by reason of its tax-exempt, tax indifferent or tax-favored status. The proposed regulations incorporate this definition of the term party. Notice 2007-18 also notified the public that the IRS and the Treasury Department would provide a broader definition of the term party in future guidance in accordance with section 4965. Consistent with Notice 2007-18, the proposed regulations define the term "party" for purposes of sections 4965 and 6033(a)(2) to include a tax-exempt entity that enters into a listed transaction and reflects on its tax return a reduction or elimination of its liability for applicable Federal employment, excise or unrelated business income taxes that is derived directly or indirectly from tax consequences or tax strategy described in the published guidance that lists the transaction.

Several commentators specifically requested that the proposed regulations address under what circumstances, if any, a tax-exempt entity may be treated as a party to a prohibited tax shelter transaction if the tax-exempt entity is an investor in a partnership, hedge fund or other conduit. Invoking the language in the legislative history to section 4965, commentators recommended that the IRS and Treasury Department establish a rule or a safe harbor that would treat an investor in an indirect investment activity as being a party for section 4965 purposes only in limited circumstances.

As illustrated by an example in the proposed regulations, a tax-exempt entity does not become a party to a prohibited tax shelter transaction solely because it invests in an entity that in turn becomes involved in a prohibited tax shelter transaction. To be considered a "party" under the proposed regulations, the tax-exempt entity must either facilitate the prohibited tax shelter transaction by reason of its tax-exempt, tax indifferent or tax-favored status, or must treat the prohibited tax shelter transaction on its tax return as reducing or eliminating its own Federal tax liability. The IRS and the Treasury Department request comments on any further clarifications that may be helpful in reflecting the intended application of the statute as expressed in the legislative history.



Entity Managers and Related Definitions

The proposed regulations clarify the definition of the term "entity manager" in section 4965(d) and provide guidance on persons who could be entity managers pursuant to a delegation of authority from other entity managers.

The proposed regulations also define the term "approve or otherwise cause." Under section 4965(a)(2), an entity manager may be liable for the manager-level excise tax only if the manager "approves such entity as (or otherwise causes such entity to be) a party" to a prohibited tax shelter transaction and knows or has reason to know the transaction is a prohibited tax shelter transaction. The proposed regulations generally limit the definition of "approving or otherwise causing" to affirmative actions of persons who, individually or as members of a collective body, have the authority to commit the entity to the transaction.

One commentator requested guidance on whether entity managers may be liable for section 4965 taxes in successor-in-interest situations. Several commentators requested guidance on the consequences under section 4965 of the exercise or nonexercise of certain options pursuant to the terms of the transaction. In response to these comments, the proposed regulations provide rules for successor-in-interest situations and the consequences of the exercise or nonexercise of certain options.



Meaning of "Knows or Has Reason to Know"

The level of tax imposed on the tax-exempt entity under section 4965(b)(1) depends upon whether the entity knows or has reason to know, at the time it enters into the transaction, that it is becoming a party to a prohibited tax shelter transaction. The liability of the entity manager for the tax under section 4965(b)(2) depends on whether the entity manager knows or has reason to know that the transaction is a prohibited tax shelter transaction at the time of approving or otherwise causing the entity to be a party to the transaction. The proposed regulations treat the entity as knowing or having reason to know if its manager(s) knew or had to reason to know and provide rules for determining whether entity managers knew or had reason to know. The "reason-to-know" rules in these proposed regulations are consistent with the "reason-to-know" and "should have known" standards under other provisions of the Code.

Commentators recommended that the IRS and the Treasury Department not treat receipt of a disclosure statement regarding a transaction by the tax-exempt entity as conclusive evidence that the tax-exempt entity knew or had reason to know that the transaction was a prohibited tax shelter transaction. The proposed regulations adopt this recommendation and provide that receipt by an entity manager of a disclosure statement in advance of a transaction is a relevant factor but, by itself, does not necessarily demonstrate that the tax-exempt entity or any of its managers knew or had reason to know that the transaction was a prohibited tax shelter transaction.



Taxes on Prohibited Tax Shelter Transactions

Section 4965(b)(1) provides the rules for computing the entity-level excise tax with respect to prohibited tax shelter transactions. Section 4965(b)(2) imposes a flat $20,000 excise tax on any entity manager that approved or otherwise caused the entity to become a party to a prohibited tax shelter transaction. The proposed regulations follow the computational rules in the statute, define the term "taxable year" for purposes of determining the entity-level tax under section 4965, and clarify the timing of the entity manager taxes under section 4965. The proposed regulations provide that entity manager liability for section 4965 taxes is not joint and several.



Definition of Net Income and Proceeds and Their Allocation to Various Periods

The proposed regulations define the terms "net income" and "proceeds" for section 4965 purposes and provide rules regarding the allocation of net income or proceeds attributable to a prohibited tax shelter transaction to various periods, including the appropriate treatment of net income or proceeds received prior to the effective date of the section 4965(a) tax.

Commentators recommended that net income for purposes of section 4965 be determined in a manner consistent with the determination of net income for other purposes of the Code. The proposed regulations adopt this recommendation.

Numerous commentators requested guidance in determining what amounts constitute proceeds for section 4965 purposes and urged the IRS and the Treasury Department to limit the definition of proceeds to the tax-exempt entity's economic return from the transaction. One commentator recommended that return of basis and return of capital be excluded from the definition of proceeds as these amounts are arguably not "attributable to" a prohibited tax shelter transaction. Several commentators recommended that the IRS and the Treasury Department adopt a rule that would exclude from proceeds earnings on certain set-aside amounts that are used to defease the tax-exempt entity's obligations under so-called sale-in, lease-out (SILO) and lease-in, lease-out (LILO) transactions. See Notice 2000-15 (2000-1 CB 826), and Notice 2005-13 (2005-9 IRB 630). Several commentators suggested that nonexercise of options to repurchase in the SILO / LILO context should not be treated as giving rise to net income or proceeds. See §601.601(d)(2)(ii)(b).

The proposed regulations define the term proceeds separately for tax-exempt entities that are involved in prohibited tax shelter transactions to facilitate the tax avoidance of others and tax-exempt entities that are involved in listed transactions for their own tax benefit. In the case of tax-exempt entities that are involved in prohibited tax shelter transactions to facilitate the tax avoidance of others, the proposed regulations define proceeds as the gross amount of the tax-exempt entity's consideration for facilitating the transaction, not reduced by any costs or expenses attributable to the transaction. This definition subjects the tax-exempt party's economic return from the transaction to the entity-level excise tax. In the case of tax-exempt entities that are involved in listed transactions to reduce or eliminate their own tax liability, the proposed regulations define the term proceeds as tax savings purportedly generated by the transaction and claimed by the tax-exempt entity in the tax year.

In Notice 2007-18, the IRS and Treasury Department provided that the allocation of net income and proceeds is determined according to normal tax accounting rules. The proposed regulations incorporate this rule both for purposes of allocating amounts to pre- and post-effective date periods, and allocating amounts to pre- and post-listing periods where a subsequently listed transaction is involved. Under the proposed regulations, tax-exempt entities that have not adopted a method of accounting are required to use the cash method. Several commentators recommended that the IRS adopt a position that net income or proceeds from pre-enactment transactions would not be properly allocable to any periods after the effective date of the section 4965(a) tax. The IRS and the Treasury Department decline to adopt this blanket rule because such rule would be inconsistent with established principles of tax accounting and would conflict with the plain language of the effective date provisions in section 516 of TIPRA.



Effective Dates of the Taxes

In accordance with section 516(d) of TIPRA, the proposed regulations provide that the taxes under section 4965 are effective for taxable years ending after May 17, 2006, with respect to transactions entered into before, on or after such date, except that no tax under section 4965(a) applies with respect to income or proceeds that are properly allocable to any period ending on or before August 15, 2006. The proposed regulations also provide that the 100 percent entity-level tax under section 4965(b)(1)(B) with respect to knowing transactions does not apply to prohibited tax shelter transactions entered into by a tax-exempt entity on or before May 17, 2006 and that the IRS will not assert an entity manager tax under section 4965(b)(2) with respect to any prohibited tax shelter transaction entered into by a tax-exempt entity on or before May 17, 2006. In addition, the proposed regulations provide that the 100 percent entity-level tax under section 4965(b)(1)(B) and the entity manager tax under section 4965(b)(2) do not apply with respect to any subsequently listed transaction.

Numerous commentators questioned whether it would be appropriate to apply the new excise taxes to pre-enactment transactions that already have closed and advocated a narrow application of the new excise taxes to pre-enactment transactions. The commentators argued that it would be unfair to apply the new excise taxes to pre-enactment transactions that have already closed and subject tax-exempt entities to unforeseen, harsh penalties. The commentators recommended that all transactions closed prior to May 17, 2006, be "delisted" for purposes of section 4965. The proposed regulations do not adopt these recommendations as they are inconsistent with the statutory effective date of section 4965 and the statutory definition of prohibited tax shelter transaction.

When finalized, the regulations under section 4965 are proposed to be applicable for taxable years ending after July 6, 2007. Taxpayers may rely on these proposed regulations for periods ending on or before such date.



Disclosure by Tax-exempt Entities that Are Parties to Certain Reportable Transactions

Section 6033(a)(2), as amended by TIPRA, requires every tax-exempt entity that is a party to a prohibited tax shelter transaction to disclose to the IRS, in such form and manner and at such time as determined by the Secretary, such entity's being a party to such transaction and the identity of any other party to the transaction which is known to the tax-exempt entity. The statute gives the IRS discretion with respect to the form, manner and timing of this disclosure. The proposed regulations provide rules regarding the form, manner and timing of this disclosure. With respect to the due date for the disclosure, the proposed regulations provide that, in the case of tax-exempt entities that are involved in prohibited tax shelter transactions to facilitate the tax avoidance of others, the disclosure must be filed by May 15 of the calendar year following the close of the calendar year during which the tax-exempt entity entered into the prohibited tax shelter transaction (or, in the case of subsequently listed transactions, by May 15 of the calendar year following the close of the calendar year during which the transaction was identified by the Secretary as a listed transaction). In the case of tax-exempt entities that are involved in listed transactions to reduce or eliminate their own tax liability, the proposed regulations provide that the disclosure must be filed on or before the date on which the first tax return (whether an original or an amended return) is filed on which the tax-exempt entity reflects a reduction or elimination of its liability for applicable Federal employment, excise or unrelated business income taxes that is derived directly or indirectly from tax consequences or tax strategy described in the published guidance that lists the transaction.

Temporary regulations providing the same rules are being issued concurrently with these proposed regulations.

The temporary regulations under section 6033(a)(2) apply to disclosures with respect to transactions entered into by a tax-exempt entity after May 17, 2006. Transition relief is provided with respect to transactions entered into during a transition period beginning on May 18, 2006 and ending on December 31, 2006. The due date for the disclosure with respect to the transactions entered into during the transition period is November 5, 2007 or, in the case of tax-exempt entities that are involved in listed transactions to reduce or eliminate their own tax liability, the later of: the date on which the first tax return (whether an original or an amended return) is filed on which the tax-exempt entity reflects a reduction or elimination of its liability for applicable Federal employment, excise or unrelated business income taxes that is derived directly or indirectly from tax consequences or tax strategy described in the published guidance that lists the transaction; or November 5, 2007.



Disclosure by Taxable Party to the Tax-exempt Entity

Section 6011(g), as amended by TIPRA, requires any taxable party to a prohibited tax shelter transaction to notify any tax-exempt entity which is a party to such transaction that the transaction is a prohibited tax shelter transaction. The statute is silent as to how and when the section 6011(g) disclosure needs to be made. The proposed regulations provide rules regarding the form, timing and frequency of the section 6011(g) disclosure. The proposed regulations also explain to whom the section 6011(g) disclosure must be made. With respect to the due date for the disclosure, the proposed regulations provide that the disclosure to each tax-exempt entity that is a party to the transaction must be made within 60 days after the last to occur of: (1) The date the taxable person becomes a taxable party to the transaction; or (2) the date the taxable party knows or has reason to know that the tax-exempt entity is a party to the transaction. No disclosure is required if the taxable party does not know or have reason to know that the tax-exempt entity is a party to the transaction on or before the first date on which the transaction is required to be disclosed by the taxable party under §§1.6011-4, 20.6011-4, 25.6011-4, 31.6011-4, 53.6011-4, 54.6011-4, or 56.6011-4.

One commentator recommended that the IRS provide an exception to the disclosure requirements for any transactions for which there would be no income or proceeds subject to the taxes imposed by section 4965. The proposed regulations do not adopt this recommendation because one of the purposes of section 6011(g) disclosure is to notify the tax-exempt entity that it may have a disclosure obligation under section 6033(a)(2) with respect to the transaction.

When finalized, the proposed regulations under section 6011(g) will apply to disclosures with respect to transactions entered into by a tax-exempt entity after May 17, 2006.



Payment of Section 4965 Taxes

The proposed regulations amend the existing regulations under sections 6011 and 6071 to specify the forms that must be used to pay section 4965 taxes and to provide the due dates for filing these forms. With respect to the due dates, the proposed regulations provide that a return of the entity-level excise tax under section 4965 must be made on or before the due date (not including extensions) for filing the tax-exempt entity's annual information return under section 6033(a)(1). If the tax-exempt entity is not required to file an annual information return, the return of section 4965 taxes must be made on or before the 15th day of the fifth month after the end of the tax-exempt entity's annual accounting period. A return of manager-level excise tax under section 4965 must be made on or before the 15th day of the fifth month following the close of the entity manager's taxable year during which the entity entered into the prohibited tax shelter transaction.

Temporary regulations providing the same rules are being issued concurrently with these proposed regulations.

A commentator recommended that the IRS and the Treasury Department not make the section 4965 excise taxes effective prior to the issuance of final regulations in cases where application of the new law or provisions of the new law is unclear. The proposed regulations do not adopt this recommendation because the effective date for the section 4965 taxes is statutory.

One commentator recommended that the IRS waive the excise taxes under section 4965 in appropriate circumstances. The proposed regulations do not adopt this recommendation as the obligation to pay section 4965 taxes flows directly from the statute, which does not authorize the IRS to waive the entity-level or manager-level taxes.

The amendments and additions to the regulations under sections 6011 and 6071 will be effective on July 6, 2007. Transition relief is provided with respect to returns of section 4965 taxes due on or before October 4, 2007. These returns will be deemed timely if the return is filed and the tax paid before October 4, 2007.



Special Analyses

It has been determined that this notice of proposed rulemaking is not a significant regulatory action as defined in Executive Order 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) does not apply to this notice of proposed rulemaking. It is hereby certified that the collection of information in §301.6011(g)-1 will not have a significant economic impact on a substantial number of small entities. Accordingly, a regulatory flexibility analysis under the Regulatory Flexibility Act (5 U.S.C. 601) (RFA) is not required.

The effect of these proposed regulations on small entities flows directly from the statutes these regulations implement. Section 6011(g), as amended by TIPRA, requires any taxable party to a prohibited tax shelter transaction to notify any tax-exempt entity which is a party to such transaction that the transaction is a prohibited tax shelter transaction. In implementing this statute, §301.6011(g)-1 of the proposed regulations requires every taxable party to a prohibited tax shelter transaction (or a single taxable party acting by designation on behalf of other taxable parties) to provide to every tax-exempt entity that the taxable party knows or has reason to know is a party to the transaction a single statement disclosing that the transaction is a prohibited tax shelter transaction within 60 days after the last to occur: (1) The date the taxable person becomes a taxable party to the transaction; or (2) the date the taxable party knows or has reason to know that the tax-exempt entity is a party to the transaction. Moreover, it is unlikely that a significant number of small businesses will engage in transactions that are subject to disclosure under 301.6011(g). The IRS and the Treasury Department request comments concerning the likelihood that small businesses are engaging in transactions subject to disclosure under this provision.

Pursuant to section 7805(f) of the Code, this regulation as been submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.



Comments and Requests for a Public Hearing

Before these proposed regulations are adopted as final regulations, consideration will be given to any comments (a signed original and eight (8) copies) that are submitted timely to the IRS at the address listed in the Addresses section of this document. The IRS and the Treasury Department specifically request comments on the clarity of the proposed rule and how it may be made easier to understand. All comments will be available for public inspection and copying.

A public hearing may be scheduled if requested in writing by a person who timely submits written comments. If a public hearing is scheduled, notice of the date, time, and place will be published in the Federal Register.



Drafting Information

The principal authors of these regulations are Galina Kolomietz and Dana Barry, Office of Division Counsel/Associate Chief Counsel (Tax Exempt and Government Entities). However, other personnel from the IRS and the Treasury Department participated in their development.



List of Subjects

26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 53

Excise taxes, Foundations, Investments, Lobbying, Reporting and recordkeeping requirements.

26 CFR Part 54

Excise Taxes, Pensions, Reporting and recordkeeping requirements.

26 CFR Part 301

Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income taxes, Penalties, Reporting and recordkeeping requirements.



Proposed Amendments to the Regulations

Accordingly, 26 CFR parts 1, 53, 54, and 301 are 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 1.6033-5 is added to read as follows:



§1.6033-5 Disclosure by tax-exempt entities that are parties to certain reportable transactions.

[The text of this section is the same as the text of §1.6033-5T published elsewhere in this issue of the Federal Register].



PART 53 --FOUNDATION AND SIMILAR EXCISE TAXES

Par. 3. The authority citation for part 53 continues to read in part as follows:

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

Par. 4. Sections 53.4965-1 through 53.4965-9 are added to read as follows:



§53.4965-1 Overview.

(a) Entity-level excise tax. Section 4965 imposes two excise taxes with respect to certain tax shelter transactions to which tax-exempt entities are parties. Section 4965(a)(1) imposes an entity-level excise tax on certain tax-exempt entities that are parties to "prohibited tax shelter transactions," as defined in section 4965(e). See §53.4965-2 for the discussion of covered tax-exempt entities. See §53.4965-3 for the definition of prohibited tax shelter transactions. See §53.4965-4 for the definition of tax-exempt party to a prohibited tax shelter transaction. The entity-level excise tax under section 4965(a)(1) is imposed on a specified percentage of the entity's net income or proceeds that are attributable to the transaction for the relevant tax year (or a period within that tax year). The rate of tax depends on whether the entity knew or had reason to know that the transaction was a prohibited tax shelter transaction at the time the entity became a party to the transaction. See §53.4965-7(a) for the discussion of the entity-level excise tax under section 4965(a)(1). See §53.4965-6 for the discussion of "knowing or having reason to know." See §53.4965-8 for the definition of net income and proceeds and the standard for allocating net income and proceeds that are attributable to a prohibited tax shelter transaction to various periods.

(b) Manager-level excise tax. Section 4965(a)(2) imposes a manager-level excise tax on "entity managers," as defined in section 4965(d), of tax-exempt entities who approve the entity as a party (or otherwise cause the entity to be a party) to a prohibited tax shelter transaction and know or have reason to know, at the time the tax-exempt entity enters into the transaction, that the transaction is a prohibited tax shelter transaction. See §53.4965-5 for the definition of entity manager and the meaning of "approving or otherwise causing," and §53.4965-6 for the discussion of "knowing or having reason to know." See §53.4965-7(b) for the discussion of the manager-level excise tax under section 4965(a)(2).

(c) Effective/applicability dates. See §53.4965-9 for the discussion of the relevant effective dates.



§53.4965-2 Covered tax-exempt entities

(a) In general. Under section 4965(c), the term "tax-exempt entity" refers to entities that are described in sections 501(c), 501(d), or 170(c) (other than the United States), Indian tribal governments (within the meaning of section 7701(a)(40)), and tax-qualified pension plans, individual retirement arrangements and similar tax-favored savings arrangements that are described in sections 4979(e)(1), (2) or (3), 529, 457(b), or 4973(a). The tax-exempt entities referred to in section 4965(c) are divided into two broad categories, non-plan entities and plan entities.

(b) Non-plan entities. Non-plan entities are --

(1) Entities described in section 501(c);

(2) Religious or apostolic associations or corporations described in section 501(d);

(3) Entities described in section 170(c), including states, possessions of the United States, the District of Columbia, political subdivisions of states and political subdivisions of possessions of the United States (but not including the United States); and

(4) Indian tribal governments within the meaning of section 7701(a)(40).

(c) Plan entities. Plan entities are --

(1) Entities described in section 4979(e)(1) (qualified plans under section 401(a), including qualified cash or deferred arrangements under section 401(k) (including a section 401(k) plan that allows designated Roth contributions));

(2) Entities described in section 4979(e)(2) (annuity plans described in section 403(a));

(3) Entities described in section 4979(e)(3) (annuity contracts described in section 403(b), including a section 403(b) arrangement that allows Roth contributions);

(4) Qualified tuition programs described in section 529;

(5) Eligible deferred compensation plans under section 457(b) that are maintained by a governmental employer as defined in section 457(e)(1)(A);

(6) Arrangements described in section 4973(a) which include --

(i) Individual retirement plans defined in sections 408(a) and (b), including --

(A) Simplified employee pensions (SEPs) under section 408(k);

(B) Simple individual retirement accounts (SIMPLEs) under section 408(p);

(C) Deemed individual retirement accounts or annuities (IRAs) qualified under a qualified plan (deemed IRAs) under section 408(q)); and

(D) Roth IRAs under section 408A.

(ii) Arrangements described in section 220(d) (Archer Medical Savings Accounts (MSAs));

(iii) Arrangements described in section 403(b)(7) (custodial accounts treated as annuity contracts);

(iv) Arrangements described in section 530 (Coverdell education savings accounts); and

(v) Arrangements described in section 223(d) (health savings accounts (HSAs)).



§53.4965-3 Prohibited tax shelter transactions.

(a) In general. Under section 4965(e), the term prohibited tax shelter transaction means --

(1) Listed transactions within the meaning of section 6707A(c)(2), including subsequently listed transactions described in paragraph (b) of this section; and

(2) Prohibited reportable transactions, which consist of the following reportable transactions within the meaning of section 6707A(c)(1) --

(i) Confidential transactions, as described in §1.6011-4(b)(3) of this chapter; or

(ii) Transactions with contractual protection, as described in §1.6011-4(b)(4) of this chapter.

(b) Subsequently listed transactions. A subsequently listed transaction for purposes of section 4965 is a transaction that is identified by the Secretary as a listed transaction after the tax-exempt entity has entered into the transaction and that was not a prohibited reportable transaction (within the meaning of section 4965(e)(1)(C) and paragraph (a)(2) of this section) at the time the entity entered into the transaction.

(c) Cross-reference. The determination of whether a transaction is a listed transaction or a prohibited reportable transaction for section 4965 purposes shall be made under the law applicable to section 6707A(c)(1) and (c)(2).



§53.4965-4 Definition of tax-exempt party to a prohibited tax shelter transaction.

(a) In general. For purposes of sections 4965 and 6033(a)(2), a tax-exempt entity is a party to a prohibited tax shelter transaction if the entity --

(1) Facilitates a prohibited tax shelter transaction by reason of its tax-exempt, tax indifferent or tax-favored status;

(2) Enters into a listed transaction and the tax-exempt entity's tax return (whether an original or an amended return) reflects a reduction or elimination of its liability for applicable Federal employment, excise or unrelated business income taxes that is derived directly or indirectly from tax consequences or tax strategy described in the published guidance that lists the transaction; or

(3) Is identified in published guidance, by type, class or role, as a party to a prohibited tax shelter transaction.

(b) Published guidance may identify which tax-exempt entities, by type, class or role, will not be treated as a party to a prohibited tax shelter transaction for purposes of sections 4965 and 6033(a)(2).

(c) Examples. The following examples illustrate the principles of this section:

Example 1. A tax-exempt entity enters into a transaction (Transaction A) with an S corporation. Transaction A is the same as or substantially similar to the transaction identified by the Secretary as a listed transaction in Notice 2004-30 (2004-1 CB 828). The tax-exempt entity's role in Transaction A is similar to the role of the tax-exempt party, as described in Notice 2004-30. Under the terms of the transaction, as described in Notice 2004-30, the tax-exempt entity receives the S corporation stock and, due to the tax-exempt entity's tax-exempt status, aids the S corporation and its shareholders in avoiding taxable income. The tax-exempt entity facilitates Transaction A by reason of its tax-exempt, tax indifferent or tax-favored status. Accordingly, the tax-exempt entity is a party to Transaction A for purposes of sections 4965 and 6033(a)(2). See §601.601(d)(2)(ii)(b) of this chapter.

Example 2. A tax-exempt entity is a partner in a partnership. The partnership has a number of other taxable and tax-exempt partners. The tax-exempt entity does not control the partnership. The partnership enters into a number of transactions, including a transaction (Transaction B) which is the same as or substantially similar to the transaction identified by the Secretary as a listed transaction in Notice 2002-35 (2002-1 CB 992) (as clarified and modified by Notice 2006-16 (2006-9 IRB 538). The partnership's role in Transaction B is similar to the role of T, as described in Notice 2002-35, that is, the role of the taxpayer claiming the tax benefits from the transaction. The tax-exempt entity's tax returns do not reflect a reduction or elimination of its liability for applicable Federal taxes as a result of Transaction B. The tax and economic consequences from Transaction B to the other partners are not dependent on the tax-exempt entity's tax-exempt, tax indifferent or tax-favored status. Accordingly, the tax-exempt entity does not facilitate Transaction B by reason of its tax-exempt, tax indifferent or tax-favored status. Because the tax-exempt entity's tax returns do not reflect a reduction or elimination of its liability for applicable Federal taxes that is derived directly or indirectly from tax consequences or tax strategy described in the published guidance that lists the transaction, the tax-exempt entity is not a party to Transaction B by reason of paragraph (a)(2) of this section. The tax-exempt entity also has not been identified, by type, class or role, as a party to a prohibited tax shelter transaction in published guidance. Therefore, the tax-exempt entity is not a party to Transaction B for purposes of sections 4965 and 6033(a)(2). See §601.601(d)(2)(ii)(b) of this chapter.

(d) Effective/applicability dates. See §53.4965-9 for the discussion of the relevant applicability dates.



§53.4965-5 Entity managers and related definitions.

(a) Entity manager of a non-plan entity --(1) In general. Under section 4965(d)(1), an entity manager of a non-plan entity is --

(i) A person with the authority or responsibility similar to that exercised by an officer, director, or trustee of an organization (that is, the non-plan entity); and

(ii) With respect to any act, the person who has final authority or responsibility (either individually or as a member of a collective body) with respect to such act.

(2) Definition of officer. For purposes of paragraph (a)(1)(i) of this section, a person is considered to be an officer of the non-plan entity (or to have similar authority or responsibility) if the person --

(i) Is specifically designated as such under the certificate of incorporation, by-laws, or other constitutive documents of the non-plan entity; or

(ii) Regularly exercises general authority to make administrative or policy decisions on behalf of the non-plan entity.

(3) Exception for acts requiring approval by a superior. With respect to any act, any person is not described in paragraph (a)(2)(ii) of this section if the person has authority merely to recommend particular administrative or policy decisions, but not to implement them without approval of a superior.

(4) Delegation of authority. A person is an entity manager of a non-plan entity within the meaning of paragraph (a)(1)(ii) of this section if, with respect to any prohibited tax shelter transaction, such person has been delegated final authority or responsibility with respect to such transaction (including by transaction type or dollar amount) by a person described in paragraph (a)(1)(i) of this section or the governing board of the entity. For example, an investment manager is an entity manager with respect to a prohibited tax shelter transaction if the non-plan entity's governing body delegated to the investment manager the final authority to make certain investment decisions and, in the exercise of that authority, the manager committed the entity to the transaction. To be considered an entity manager of a non-plan entity within the meaning of paragraph (a)(1)(ii) of this section, a person need not be an employee of the entity. A person is not described in paragraph (a)(1)(ii) of this section if the person is merely implementing a decision made by a superior.

(b) Entity manager of a plan entity --(1) In general. Under section 4965(d)(2), an entity manager of a plan entity is the person who approves or otherwise causes the entity to be a party to the prohibited tax shelter transaction.

(2) Special rule for plan participants and beneficiaries who have investment elections --(i) Fully self-directed plans or arrangements. In the case of a fully self-directed qualified plan, IRA, or other savings arrangement (including the case where a plan participant or beneficiary is given a list of prohibited investments, such as collectibles), if the plan participant or beneficiary selected a certain investment and, therefore, approved the plan entity to become a party to a prohibited tax shelter transaction, the plan participant or the beneficiary is an entity manager.

(ii) Plans or arrangements with limited investment options. In the case of a qualified plan, IRA, or other savings arrangement where a plan participant or beneficiary is offered a limited number of investment options from which to choose, the person responsible for determining the pre-selected investment options is an entity manager and the plan participant or the beneficiary generally is not an entity manager.

(c) Meaning of "approves or otherwise causes" --(1) In general. A person is treated as approving or otherwise causing a tax-exempt entity to become a party to a prohibited tax shelter transaction if the person has the authority to commit the entity to the transaction, either individually or as a member of a collective body, and the person exercises that authority.

(2) Collective bodies. If a person shares the authority described in paragraph (c)(1) of this section as a member of a collective body (for example, board of trustees or committee), the person will be considered to have exercised such authority if the person voted in favor of the entity becoming a party to the transaction. However, a member of the collective body will not be treated as having exercised the authority described in paragraph (c)(1) of this section if he or she voted against a resolution that constituted approval or an act that caused the tax-exempt entity to be a party to a prohibited tax shelter transaction, abstained from voting for such approval, or otherwise failed to vote in favor of such approval.

(3) Exceptions --(i) Successor in interest. If a tax-exempt entity that is a party to a prohibited tax shelter transaction is dissolved, liquidated, or merged into a successor entity, an entity manager of the successor entity will not, solely by reason of the reorganization, be treated as approving or otherwise causing the successor entity to become a party to a prohibited tax shelter transaction, provided that the reorganization of the tax-exempt entity does not result in a material change to the terms of the transaction. For purposes of this paragraph a material change includes an extension or renewal of the agreement (other than an extension or renewal that results from another party to the transaction unilaterally exercising an option granted by the agreement) or a more than incidental change to any payment under the agreement. A change for the sole purpose of substituting the successor entity for the original tax-exempt party is not a material change.

(ii) Exercise or nonexercise of options. Nonexercise of an option pursuant to a transaction involving the tax-exempt entity generally will not constitute an act of approving or causing the entity to be a party to the transaction. If, pursuant to a transaction involving the tax-exempt entity, the entity manager exercises an option (such as a repurchase option), the entity manager will not be subject to the entity manager-level tax if the exercise of the option does not result in the tax-exempt entity becoming a party to a second transaction that is a prohibited tax shelter transaction.

(4) Example. The following example illustrates the principles of paragraph (c)(3)(ii) of this section:

Example. In a sale-in, lease-out (SILO) transaction described in Notice 2005-13 (2005-9 IRB 630), X, which is a non-plan entity, has purported to sell property to Y, a taxable entity and lease it back for a term of years. At the end of the basic lease term, X has the option of "repurchasing" the property from Y for a predetermined purchase price, with funds that have been set aside at the inception of the transaction for that purpose. The entity manager, by deciding to exercise or not exercise the "repurchase" option is not approving or otherwise causing the non-plan entity to become a party to a second prohibited tax shelter transaction. See §601.601(d)(2)(ii)(b) of this chapter.

(5) Coordination with the reason-to-know standard. The determination that an entity manager approved or caused a tax-exempt entity to be a party to a prohibited tax shelter transaction, by itself, does not establish liability for the section 4965(a)(2) tax. For rules on determining whether an entity manager knew or had reason to know that the transaction was a prohibited tax shelter transaction, see §53.4965-6(b).

(d) Effective/applicability dates. See §53.4965-9 for the discussion of the relevant applicability dates.



§53.4965-6 Meaning of "knows or has reason to know".

(a) Attribution to the entity. An entity will be treated as knowing or having reason to know for section 4965 purposes if one or more of its entity managers knew or had reason to know that the transaction was a prohibited tax shelter transaction at the time the entity manager(s) approved the entity as (or otherwise caused the entity to be) a party to the transaction. The entity shall be attributed the knowledge or reason to know of any entity manager described in §53.4965-5(a)(1)(i) even if that entity manager does not approve the entity as (or otherwise cause the entity to be) a party to the transaction.

(b) Determining whether an entity manager knew or had reason to know --(1) In general. Whether an entity manager knew or had reason to know that a transaction is a prohibited tax shelter transaction is based on all facts and circumstances. In order for an entity manager to know or have reason to know that a transaction is a prohibited tax shelter transaction, the entity manager must have knowledge of sufficient facts that would lead a reasonable person to conclude that the transaction is a prohibited tax shelter transaction. An entity manager will be considered to have "reason to know" if a reasonable person in the entity manager's circumstances would conclude that the transaction was a prohibited tax shelter transaction based on all the facts reasonably available to the manager at the time of approving the entity as (or otherwise causing the entity to be) a party to the transaction. Factors that will be considered in determining whether a reasonable person in the entity manager's circumstances would conclude that the transaction was a prohibited tax shelter transaction include, but are not limited to --

(i) The presence of tax shelter indicia (see paragraph (b)(2) of this section);

(ii) Whether the entity manager received a disclosure statement prior to the consummation of the transaction indicating that the transaction may be a prohibited tax shelter transaction (see paragraph (b)(3) of this section); and

(iii) Whether the entity manager made appropriate inquiries into the transaction (see paragraph (b)(4) of this section).

(2) Tax-shelter indicia. The presence of indicia that a transaction is a tax shelter will be treated as an indication that the entity manager knew or had reason to know that the transaction was a prohibited tax shelter transaction. Tax shelter indicia include but are not limited to --

(i) The transaction is extraordinary for the entity considering prior investment activity;

(ii) The transaction promises an economic return for the organization that is exceptional considering the amount invested by, the participation of, or the absence of risk to the organization; or

(iii) The transaction is of significant size relative to the receipts of the entity.

(3) Effect of disclosure statements. Receipt by an entity manager of a statement, including a statement described in section 6011(g), in advance of a transaction that the transaction may be a prohibited tax shelter transaction (or a statement that a partnership, hedge fund or other investment conduit may engage in a prohibited tax shelter transaction in the future) is a factor relevant in the determination of whether the entity manager knew or had reason to know that the transaction is a prohibited transaction. However, an entity manager will not be treated as knowing or having reason to know that the transaction was a prohibited tax shelter transaction solely because the entity manager receives such a disclosure.

(4) Appropriate inquiries. What inquiries are appropriate will be determined from the facts and circumstances of each case. For example, if one or more tax shelter indicia are present or if an entity manager receives a disclosure statement described in paragraph (b)(3) of this section, an entity manager has a responsibility to inquire further whether the transaction is a prohibited tax shelter transaction.

(c) Reliance on professional advice --(1) In general. An entity manager is not required to obtain the advice of a professional tax advisor to establish that the entity manager made appropriate inquiries. Moreover, not seeking professional advice, by itself, shall not give rise to an inference that the entity manager had reason to know that a transaction is a prohibited tax shelter transaction.

(2) Reliance on written opinion of professional tax advisor. An entity manager may establish that he or she did not have a reason to know that a transaction was a prohibited tax shelter transaction at the time the tax-exempt entity entered into the transaction if the entity manager reasonably, and in good faith, relied on the written opinion of a professional tax advisor. Reliance on the written opinion of a professional tax advisor establishes that the entity manager did not have reason to know if, taking into account all the facts and circumstances, the reliance was reasonable and the entity manager acted in good faith. For example, the entity manager's education, sophistication, and business experience will be relevant in determining whether the reliance was reasonable and made in good faith. In no event will an entity manager be considered to have reasonably relied in good faith on an opinion unless the requirements of this paragraph (c)(2) are satisfied. The fact that these requirements are satisfied, however, will not necessarily establish that the entity manager reasonably relied on the opinion in good faith. For example, reliance may not be reasonable or in good faith if the entity manager knew, or reasonably 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 pertinent facts and circumstances and the law as it relates to those facts and circumstances. The requirements of this paragraph (c)(2) are not satisfied if the entity manager fails to disclose a fact that it knows, or reasonably should know, is relevant to determining whether the transaction is a prohibited tax shelter transaction.

(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 entity manager or any other person (including another party to the transaction or a material advisor within the meaning of sections 6111 and 6112).

(iii) "More likely than not" opinion. The written opinion of the professional tax advisor must apply the appropriate law to the facts and, based on this analysis, must conclude that the transaction was not a prohibited tax shelter transaction at a "more likely than not" level of certainty at the time the entity manager approved the entity (or otherwise caused the entity) to be a party to the transaction.

(3) Special rule. An entity manager's reliance on a written opinion of a professional tax advisor will not be considered reasonable if the advisor is, or is related to a person who is, a material advisor with respect to the transaction within the meaning of sections 6111 and 6112.

(d) Subsequently listed transactions. An entity manager will not be treated as knowing or having reason to know that a transaction (other than a prohibited reportable transaction as defined in section 4965(e)(1)(C) and §53.4965-3(a)(2)) is a prohibited tax shelter transaction if the entity enters into the transaction before the date on which the transaction is identified by the Secretary as a listed transaction.

(e) Effective/applicability dates. See §53.4965-9 for the discussion of the relevant applicability dates.



§53.4965-7 Taxes on prohibited tax shelter transactions.

(a) Entity-level taxes --(1) In general. Entity-level excise taxes apply to non-plan entities (as defined in §53.4965-2(b)) that are parties to prohibited tax shelter transactions.

(i) Prohibited tax shelter transactions other than subsequently listed transactions --(A) Amount of tax if the entity did not know and did not have reason to know. If the tax-exempt entity did not know and did not have reason to know that the transaction was a prohibited tax shelter transaction at the time the entity entered into the transaction, the tax is the highest rate of tax under section 11 multiplied by the greater of --

(1) The entity's net income with respect to the prohibited tax shelter transaction (after taking into account any tax imposed by Subtitle D, other than by this section, with respect to such transaction) for the taxable year; or

(2) 75 percent of the proceeds received by the entity for the taxable year that are attributable to such transaction.

(B) Amount of tax if the entity knew or had reason to know. If the tax-exempt entity knew or had reason to know that the transaction was a prohibited tax shelter transaction at the time the entity entered into the transaction, the tax is the greater of --

(1) 100 percent of the entity's net income with respect to the transaction (after taking into account any tax imposed by Subtitle D, other than by this section, with respect to such transaction) for the taxable year; or

(2) 75 percent of the proceeds received by the entity for the taxable year that are attributable to such transaction.

(ii) Subsequently listed transactions --(A) In general. In the case of a subsequently listed transaction (as defined in section 4965(e)(2) and §53.4965-3(b)), the tax-exempt entity's income and proceeds attributable to the transaction are allocated between the period before the transaction became listed and the period beginning on the date the transaction became listed. See §53.4965-8 for the standard for allocating net income or proceeds to various periods. The tax for each taxable year is the highest rate of tax under section 11 multiplied by the greater of --

(1) The entity's net income with respect to the subsequently listed transaction (after taking into account any tax imposed by Subtitle D, other than by this section, with respect to such transaction) for the taxable year that is allocable to the period beginning on the later of the date such transaction is identified by the Secretary as a listed transaction or the first day of the taxable year; or

(2) 75 percent of the proceeds received by the entity for the taxable year that are attributable to such transaction and allocable to the period beginning on the later of the date such transaction is identified by the Secretary as a listed transaction or the first day of the taxable year.

(B) No increase in tax. The 100 percent tax under section 4965(b)(1)(B) and §53.4965-7(a)(1)(i)(B) does not apply to any subsequently listed transaction (as defined in section 4965(e)(2) and §53.4965-3(b)) entered into by a tax-exempt entity before the date on which the transaction is identified by the Secretary as a listed transaction.

(2) Taxable year. The excise tax imposed under section 4965(a)(1) applies for the taxable year in which the entity becomes a party to the prohibited tax shelter transaction and any subsequent taxable year for which the entity has net income or proceeds attributable to the transaction. A taxable year for tax-exempt entities is the calendar year or fiscal year, as applicable, depending on the basis on which the tax-exempt entity keeps its books for Federal income tax purposes. If a tax-exempt entity has not established a taxable year for Federal income tax purposes, the entity's taxable year for the purpose of determining the amount and timing of net income and proceeds attributable to a prohibited tax shelter transaction will be deemed to be the annual period the entity uses in keeping its books and records.

(b) Manager-level taxes --(1) Amount of tax. If any entity manager approved or otherwise caused the tax-exempt entity to become a party to a prohibited tax shelter transaction and knew or had reason to know that the transaction was a prohibited tax shelter transaction, such entity manager is liable for the $20,000 tax. See §53.4965-5(d) for the meaning of approved or otherwise caused. See §53.4965-6 for the meaning of knew or had reason to know.

(2) Timing of the entity manager tax. If a tax-exempt entity enters into a prohibited tax shelter transaction during a taxable year of an entity manager, then the entity manager that approved or otherwise caused the tax-exempt entity to become a party to the transaction is liable for the entity manager tax for that taxable year if the entity manager knew or had reason to know that the transaction was a prohibited tax shelter transaction.

(3) Example. The application of paragraph (b)(2) of this section is illustrated by the following example:

Example. The entity manager's taxable year is the calendar year. On December 1, 2006, the entity manager approved or otherwise caused the tax-exempt entity to become a party to a transaction that the entity manager knew or had reason to know was a prohibited tax shelter transaction. The tax-exempt entity entered into the transaction on January 31, 2007. The entity manager is liable for the entity manager level tax for the entity manager's 2007 taxable year, during which the tax-exempt entity entered into the prohibited tax shelter transaction.

(4) Separate liability. If more than one entity manager approved or caused a tax-exempt entity to become a party to a prohibited tax shelter transaction while knowing (or having reason to know) that the transaction was a prohibited tax shelter transaction, then each such entity manager is separately (that is, not jointly and severally) liable for the entity manager-level tax with respect to the transaction.

(c) Effective dates. See §53.4965-9 for the discussion of the relevant effective dates.



§53.4965-8 Definition of net income and proceeds and standard for allocating net income or proceeds to various periods.

(a) In general. For purposes of section 4965(a), the amount and the timing of the net income and proceeds attributable to the prohibited tax shelter transaction will be computed in a manner consistent with the substance of the transaction. In determining the substance of listed transactions, the IRS will look to, among other items, the listing guidance and any subsequent guidance published in the Internal Revenue Bulletin relating to the transaction.

(b) Definition of net income and proceeds --(1) Net income. A tax-exempt entity's net income attributable to a prohibited tax shelter transaction is its gross income derived from the transaction reduced by those deductions that are attributable to the transaction and that would be allowed by chapter 1 of the Internal Revenue Code if the tax-exempt entity were treated as a taxable entity for this purpose, and further reduced by taxes imposed by Subtitle D, other than by this section, with respect to the transaction.

(2) Proceeds --(i) Tax-exempt entities that facilitate the transaction by reason of their tax-exempt, tax indifferent or tax-favored status. Solely for purposes of section 4965, in the case of a tax-exempt entity that is a party to the transaction by reason of §53.4965-4(a)(1) of this chapter, the term proceeds means the gross amount of the tax-exempt entity's consideration for facilitating the transaction, not reduced for any costs or expenses attributable to the transaction. Published guidance with respect to a particular prohibited tax shelter transaction may designate additional amounts as proceeds from the transaction for section 4965 purposes.

(ii) Tax-exempt entities that enter into transactions to reduce or eliminate their liability for applicable Federal taxes. For purposes of section 4965, in the case of a tax-exempt entity that is a party to the transaction by reason of §53.4965-4(a)(2) of this chapter, the term proceeds means tax savings purportedly generated by the transaction and claimed by the tax-exempt entity on its tax return with respect to the tax year. Published guidance with respect to a particular prohibited tax shelter transaction may designate additional amounts as proceeds from the transaction for section 4965 purposes.

(iii) Treatment of gifts and contributions. To the extent not otherwise included in the definition of proceeds in paragraphs (b)(2)(i) and (ii) of this section, any amount that is a gift or a contribution to a tax-exempt entity and is attributable to a prohibited tax shelter transaction will be treated as proceeds for section 4965 purposes, unreduced by any associated expenses.

(c) Allocation of net income and proceeds --(1) In general. For purposes of section 4965(a), the net income and proceeds attributable to a prohibited tax shelter transaction must be allocated in a manner consistent with the tax-exempt entity's established method of accounting for Federal income tax purposes. If the tax-exempt entity has not established a method of accounting for Federal income tax purposes, solely for purposes of section 4965(a) the tax-exempt entity must use the cash receipts and disbursements method of accounting (cash method) provided for in section 446 of the Internal Revenue Code to determine the amount and timing of net income and proceeds attributable to a prohibited tax shelter transaction.

(2) Special rule. If a tax-exempt entity has established a method of accounting other than the cash method, the tax-exempt entity may nevertheless use the cash method of accounting to determine the amount of the net income and proceeds --

(i) Attributable to a prohibited tax shelter transaction entered into prior to the effective date of section 4965(a) tax and allocable to pre- and post-effective date periods; or

(ii) Attributable to a subsequently listed transaction and allocable to pre- and post-listing periods.

(d) Transition year rules. In the case of the taxable year that includes August 16, 2006 (the transition year), the IRS will treat the period beginning on the first day of the transition year and ending on August 15, 2006, and the period beginning on August 16, 2006, and ending on the last day of the transition year as short taxable years. This treatment is solely for purposes of allocating net income or proceeds under section 4965. The tax-exempt entity continues to file tax returns for the full taxable year, does not file tax returns with respect to these deemed short taxable years and does not otherwise take the short taxable years into account for Federal tax purposes. Accordingly, the net income or proceeds that are properly allocated to the transition year in accordance with this section will be treated as allocable to the period --

(1) Ending on or before August 15, 2006 (and accordingly not subject to tax under section 4965(a)) to the extent such net income or proceeds would have been properly taken into account in accordance with this section by the tax-exempt entity in the deemed short year ending on August 15, 2006; and

(2) Beginning after August 15, 2006 (and accordingly subject to tax under section 4965(a)) to the extent such income or proceeds would have been properly taken into account in accordance with this section by the tax-exempt entity in the short year beginning August 16, 2006.

(e) Allocation to pre- and post-listing periods. If a transaction (other than a prohibited reportable transaction (as defined in section 4965(e)(1)(C) and §53.4965-3(a)(2)) to which the tax-exempt entity is a party is subsequently identified in published guidance as a listed transaction during a taxable year of the entity (the listing year) in which it has net income or proceeds attributable to the transaction, the net income or proceeds are allocated between the pre- and post-listing periods. The IRS will treat the period beginning on the first day of the listing year and ending on the day immediately preceding the date of the listing, and the period beginning on the date of the listing and ending on the last day of the listing year as short taxable years. This treatment is solely for purposes of allocating net income or proceeds under section 4965. The tax-exempt entity continues to file tax returns for the full taxable year, does not file tax returns with respect to these deemed short taxable years and does not otherwise take the short taxable years into account for Federal tax purposes. Accordingly, the net income or proceeds that are properly allocated to the listing year in accordance with this section will be treated as allocable to the period --

(1) Ending before the date of the listing (and accordingly not subject to tax under section 4965(a)) to the extent such net income or proceeds would have been properly taken into account in accordance with this section by the tax-exempt entity in the deemed short year ending on the day immediately preceding the date of the listing; and

(2) Beginning on the date of the listing (and accordingly subject to tax under section 4965(a)) to the extent such income or proceeds would have been properly taken into account in accordance with this section by the tax-exempt entity in the short year beginning on the date of the listing.

(f) Examples. The following examples illustrate the allocation rules of this section:

Example 1. (i) In 1999, X, a calendar year non-plan entity using the cash method of accounting, entered into a lease-in/lease-out transaction (LILO) substantially similar to the transaction described in Notice 2000-15 (2000-1 CB 826) (describing Rev. Rul. 99-14 (1999-1 CB 835), superseded by Rev. Rul. 2002-69 (2002-2 CB 760)). In 1999, X purported to lease property to Y pursuant to a "head lease," and Y purported to lease the property back to X pursuant to a "sublease" of a shorter term. In form, X received $268M as an advance payment of head lease rent. Of this amount, $200M had been, in form, financed by a nonrecourse loan obtained by Y. X deposited the $200M with a "debt payment undertaker." This served to defease both a portion of X's rent obligation under its sublease and Y's repayment obligation under the nonrecourse loan. Of the remainder of the $268M advance head lease rent payment, X deposited $54M with an "equity payment undertaker." This served to defease the remainder of X's rent obligation under the sublease as well as the exercise price of X's end-of-sublease term purchase option. This amount inures to the benefit of Y and enables Y to recover its investment in the transaction and a return on that investment. In substance, the $54M is a loan from Y to X. X retained the remaining $14M of the advance head lease rent payment. In substance, this represents a fee for X's participation in the transaction. See §601.601(d)(2)(ii)(b) of this chapter.

(ii) According to the substance of the transaction, the head lease, sublease and nonrecourse debt will be ignored for Federal income tax purposes. Therefore, any net income or proceeds resulting from these elements of the transaction will not be considered net income or proceeds attributable to the LILO transaction for purposes of section 4965(a). The $54M deemed loan from Y to X and the $14M fee are not ignored for Federal income tax purposes.

(iii) Under X's established cash basis method of accounting, any net income received in 1999 and attributable to the LILO transaction is allocated to X's December 31, 1999, tax year for purposes of section 4965. The $14M fee received in 1999, and which constitutes proceeds of the transaction, is likewise allocated to that tax year. Because the 1999 tax year is before the effective date of the section 4965 tax, X will not be subject to any excise tax under section 4965 for the amounts received in 1999.

(iv) Any earnings on the amount deposited with the equity payment undertaker that constitute gross income to X will be reduced by X's original issue discount deductions with respect to the deemed loan from Y, in determining X's net income from the transaction.

Example 2. B, a non-plan entity using the cash method of accounting, has an annual accounting period that ends on December 31, 2006. B entered into a prohibited tax shelter transaction on March 15, 2006. On that date, B received a payment of $600,000 as a fee for its involvement in the transaction. B received no other proceeds or income attributable to this transaction in 2006. Under B's method of accounting, the payment received by B on March 15, 2006, is taken into account in the deemed short year ending on August 15, 2006. Accordingly, solely for purposes of section 4965, the payment is treated as allocable solely to the period ending on or before August 15, 2006, and is not subject to the excise tax imposed by section 4965(a).

Example 3. The facts are the same as in Example 2, except that B received an additional payment of $400,000 on September 30, 2006. Under B's method of accounting, the payment received by B on September 30, 2006, is taken into account in the deemed short year beginning on August 16, 2006. Accordingly, solely for purposes of section 4965, the $400,000 payment is treated as allocable to the period beginning after August 15, 2006, and is subject to the excise tax imposed by section 4965(a).

Example 4. C, a non-plan entity using the cash method of accounting, has an annual accounting period that ends on December 31. C entered into a prohibited tax shelter transaction on May 1, 2005. On March 15, 2007, C received a payment of $580,000 attributable to the transaction. On June 1, 2007, the transaction is identified by the IRS in published guidance as a listed transaction. On June 15, 2007, C received an additional payment of $400,000 attributable to the transaction. Under C's method of accounting, the payments received on March 15, 2007, and June 15, 2007, are taken into account in 2007. The IRS will treat the period beginning on January 1, 2007, and ending on May 31, 2007, and the period beginning on June 1, 2007, and ending on December 31, 2007, as short taxable years. The payment received by C on March 15, 2007, is taken into account in the deemed short year ending on May 31, 2007. Accordingly, solely for purposes of section 4965, the payment is treated as allocable solely to the pre-listing period, and is not subject to the excise tax imposed by section 4965(a). The payment received by C on June 15, 2007, is taken into account in the deemed short year beginning on June 1, 2007. Accordingly, solely for purposes of section 4965, the payment is treated as allocable to the post-listing period, and is subject to the excise tax imposed by section 4965(a).

(g) Effective/applicability dates. See §53.4965-9 for the discussion of the relevant applicability dates.



§53.4965-9 Effective/applicability dates.

(a) In general. The taxes under section 4965(a) and §53.4965-7 are effective for taxable years ending after May 17, 2006, with respect to transactions entered into before, on or after that date, except that no tax under section 4965(a) applies with respect to income or proceeds that are properly allocable to any period ending on or before August 15, 2006.

(b) Applicability of the regulations. Except as provided in paragraph (c) of this section, upon publication of final regulations, §§53.4965-1 through 53.4965-8 of this chapter will apply to taxable years ending after July 6, 2007. A tax-exempt entity may rely on the provisions of §§53.4965-1 through 53.4965-8 for taxable years ending on or before July 6, 2007.

(c) Effective date with respect to certain knowing transactions --(1) Entity-level tax. The 100 percent tax under section 4965(b)(1)(B) and §53.4965-7(a)(1)(i)(B) does not apply to prohibited tax shelter transactions entered into by a tax-exempt entity on or before May 17, 2006.

(2) Manager-level tax. The IRS will not assert that an entity manager who approved or caused a tax-exempt entity to become a party to a prohibited tax shelter transaction is liable for the entity manager tax under section 4965(b)(2) and §53.4965-7(b)(1) with respect to the transaction if the tax-exempt entity entered into such transaction prior to May 17, 2006.

Par. 5. In §53.6071-1, paragraphs (g) and (h) are added to read as follows:



§53.6071-1 Time for filing returns.

* * * * *

(g) [The text of the proposed amendment to §53.6071-1(g) is the same as the text of §53.6071-1T(g) published elsewhere in this issue of the Federal Register].

(h) [The text of the proposed amendment to §53.6071-1(h) is the same as the text of §53.6071-1T(h) published elsewhere in this issue of the Federal Register].



PART 54 --EXCISE TAXES, PENSIONS, REPORTING AND RECORDKEEPING REQUIREMENTS

Par. 6. The authority citation for part 54 continues to read, in part, as follows:

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

Par. 7. In §54.6011-1, paragraphs (c) and (d) are added to read as follows:



§54.6011-1 General requirement of return, statement or list.

* * * * *

(c) [The text of the proposed amendment to §54.6011-1(c) is the same as the text of §54.6011-1T(c) published elsewhere in this issue of the Federal Register].

(d) [The text of the proposed amendment to §54.6011-1(d) is the same as the text of §54.6011-1T(d) published elsewhere in this issue of the Federal Register].



PART 301 --PROCEDURE AND ADMINISTRATION

Par. 8. The authority citation for part 301 continues to read, part, as follows:

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

Par. 9. Section 301.6011(g)-1 is added to read as follows:



§301.6011(g)-1 Disclosure by taxable party to the tax-exempt entity.

(a) Requirement of disclosure --(1) In general. Except as provided in paragraph (d)(2) of this section, any taxable party (as defined in paragraph (c) of this section) to a prohibited tax shelter transaction (as defined in section 4965(e) and §53.4965-3 of this chapter) must disclose by statement to each tax-exempt entity (as defined in section 4965(c) and §53.4965-2 of this chapter) that the taxable party knows or has reason to know is a party to such transaction (as defined in paragraph (b) of this section) that the transaction is a prohibited tax shelter transaction.

(2) Determining whether a taxable party knows or has reason to know. Whether a taxable party knows or has reason to know that a tax-exempt entity is a party to a prohibited tax shelter transaction is based on all the facts and circumstances. If the taxable party knows or has reason to know that a prohibited tax shelter transaction involves a tax-exempt, tax indifferent or tax-favored entity, relevant factors for determining whether the taxable party knows or has reason to know that a specific tax-exempt entity is a party to the transaction include --

(i) The extent of the efforts made to determine whether a tax-exempt entity is facilitating the transaction by reason of its tax-exempt, tax-indifferent or tax-favored status (or is identified in published guidance, by type, class or role, as a party to the transaction); and

(ii) If a tax-exempt entity is facilitating the transaction by reason of its tax-exempt, tax-indifferent or tax-favored status (or is identified in published guidance, by type, class or role, as a party to the transaction), the extent of the efforts made to determine the identity of the tax-exempt entity.

(b) Definition of tax-exempt party to a prohibited tax shelter transaction --(1) In general. For purposes of section 6011(g), a tax-exempt entity is a party to a prohibited tax shelter transaction if the entity --

(i) Facilitates a prohibited tax shelter transaction by reason of its tax-exempt, tax indifferent or tax-favored status; or

(ii) Is identified in published guidance, by type, class or role, as a party to a prohibited tax shelter transaction.

(2) Published guidance may identify which tax-exempt entities, by type, class or role, will not be treated as a party to a prohibited tax shelter transaction for purposes of section 6011(g).

(c) Definition of taxable party --(1) In general. For purposes of this section, the term taxable party means --

(i) A person who has entered into and participates or expects to participate in the transaction under §§1.6011-4(c)(3)(i)(A), (B), or (C), 20.6011-4, 25.6011-4, 31.6011-4, 53.6011-4, 54.6011-4, or 56.6011-4 of this chapter; or

(ii) A person who is designated as a taxable party by the Secretary in published guidance.

(2) Special rules --(i) Certain listed transactions. If a transaction that was otherwise not a prohibited tax shelter transaction becomes a listed transaction after the filing of a person's tax return (including an amended return) reflecting either tax consequences or a tax strategy described in the published guidance listing the transaction (or a tax benefit derived from tax consequences or a tax strategy described in the published guidance listing the transaction), the person is a taxable party beginning on the date the transaction is described as a listed transaction in published guidance.

(ii) Persons designated as non-parties. Published guidance may identify which persons, by type, class or role, will not be treated as a party to a prohibited tax shelter transaction for purposes of section 6011(g).

(d) Time for providing disclosure statement --(1) In general. A taxable party to a prohibited tax shelter transaction must make the disclosure required by this section to each tax-exempt entity that the taxable party knows or has reason to know is a party to the transaction within 60 days after the last to occur of --

(i) The date the person becomes a taxable party to the transaction within the meaning of paragraph (c) of this section; or

(ii) The date the taxable party knows or has reason to know that the tax-exempt entity is a party to the transaction within the meaning of paragraph (b) of this section.

(2) Termination of a disclosure obligation. A person shall not be required to provide the disclosure otherwise required by this section if the person does not know or have reason to know that the tax-exempt entity is a party to the transaction within the meaning of paragraph (b) of this section on or before the first date on which the transaction is required to be disclosed by the person under §§1.6011-4, 20.6011-4, 25.6011-4, 31.6011-4, 53.6011-4, 54.6011-4, or 56.6011-4 of this chapter.

(3) Disclosure is not required with respect to any prohibited tax shelter transaction entered into by a tax-exempt entity on or before May 17, 2006.

(e) Frequency of disclosure. One disclosure statement is required per tax-exempt entity per transaction. See paragraph (h) of this section for rules relating to designation agreements.

(f) Form and content of disclosure statement. The statement disclosing to the tax-exempt entity that the transaction is a prohibited tax shelter transaction must be a written statement that --

(1) Identifies the type of prohibited tax shelter transaction (including the published guidance citation for a listed transaction); and

(2) States that the tax-exempt entity's involvement in the transaction may subject either it or its entity manager(s) or both to excise taxes under section 4965 and to disclosure obligations under section 6033(a) of the Internal Revenue Code.

(g) To whom disclosure is made. The disclosure statement must be provided --

(1) In the case of a non-plan entity as defined in §53.4965-2(b) of this chapter, to --

(i) Any entity manager of the tax-exempt entity with authority or responsibility similar to that exercised by an officer, director or trustee of an organization; or

(ii) If a person described in paragraph (g)(1)(i) of this section is not known, to the primary contact on the transaction.

(2) In the case of a plan entity as defined in §53.4965-2(c) of this chapter, including a fully self-directed qualified plan, IRA, or other savings arrangement, to any entity manager of the plan entity who approved or otherwise caused the entity to become a party to the prohibited tax shelter transaction.

(h) Designation agreements. If more than one taxable party is required to disclose a prohibited tax shelter transaction under this section, the taxable parties may designate by written agreement a single taxable party to disclose the transaction. The transaction must then be disclosed in accordance with this section. The designation of one taxable party to disclose the transaction does not relieve the other taxable parties of their obligation to disclose the transaction to a tax-exempt entity that is a party to the transaction in accordance with this section, if the designated taxable party fails to disclose the transaction to the tax-exempt entity in a timely manner.

(i) Penalty for failure to provide disclosure statement. See section 6707A for penalties applicable to failure to disclose a prohibited tax shelter transaction in accordance with this section.

(j) Effective/applicability date. This section will apply with respect to transactions entered into by a tax-exempt entity after May 17, 2006.

Par. 11. Section 301.6033-5 is added to read as follows:



§301.6033-5 Disclosure by tax-exempt entities that are parties to certain reportable transactions.

[The text of this section is the same as the text of §301.6033-5T published elsewhere in this issue of the Federal Register].

Kevin M. Brown,

Deputy Commissioner for Services and Enforcement.

Tax Help: Innocent Spouse New Form 8857 - IRSNews Release IR 2007-125 , July 6, 2007.

The IRS has released a revised Form 8857, Request for Innocent Spouse Relief. The new form will ask for more information early in the process, eliminating the need for follow-up letters requesting further information. The revisions will result in faster determinations and lower government costs. The new form will also be easier to understand and will educate taxpayers about the innocent spouse relief process. The revisions were based on suggestions from a team lead by the Office of Taxpayer Burden Reduction.

WASHINGTON --The Internal Revenue Service today announced a redesigned Form 8857, Request for Innocent Spouse Relief, that will help reduce follow up questions and reduce the burden on taxpayers.

The form will ask more questions initially, but collecting critical information early in the process will mean faster processing of the request. The new design will eliminate an estimated 30,000 follow-up letters annually. The result will be a reduced burden and quicker answer for taxpayers and less cost for the government.

The form was revised based on suggestions from an IRS process improvement team led by the Office of Taxpayer Burden Reduction. The new Form 8857 is available on the IRS.gov Web site.

When a taxpayer files a joint return, both spouses are jointly and individually responsible for the tax. Innocent Spouse relief provides an opportunity for a spouse to be relieved from the joint debt under certain circumstances. If one taxpayer believes that only his or her spouse or former spouse who should be responsible for the tax, the taxpayer can request relief from the tax liability.

The redesigned form also will be easier to understand and to complete and will help educate taxpayers about the process. Previously, the questionnaire was separate from the form. A line-by-line analysis also resulted in a reduction in the number of questions asked of taxpayers.
For married taxpayers, joint and several liability is the obligation that accompanies the privilege of filing a joint return. Thus, one spouse may be subject to joint liability for the omissions from income or erroneous deductions of the other spouse. In some cases, one spouse intentionally has not reported income or has claimed false deductions and concealed the return errors from the other spouse. The question then becomes whether the innocent spouse, who merely signed a joint return, should be held liable for errors on the return attributable to the actions of the other spouse. The answer is especially critical if the couple has divorced and the innocent spouse is the only source of collection for the unpaid tax. However, once a joint liability has been reduced to a closing agreement with the IRS, executed by both spouses, innocent spouse relief is unavailable (Reg. §1.6015-1(c)).

Code Sec. 6015 offers conditional relief to an innocent spouse. Enacted by the IRS Restructuring and Reform Act of 1998 (P.L. 105-206), it replaced Code Sec. 6013(e), which was enacted in 1971 (P.L. 91-679) in response to judicial pleas for statutory language enabling relief from liability in situations where the result of joint and several liability was particularly harsh and inequitable. The rules for granting relief were amended by the Tax Reform Act of 1984 (P.L. 98-369), but the crucial elements necessary to obtain relief under current law are similar in many respects to those contained in the original rule. For that reason, pre-1998 case law cannot be disregarded in attempting to interpret the scope of the present language of Code Sec. 6015.

A spouse may qualify for relief from joint and several liability under Code Sec. 6015 if:
(1) a joint return has been made for the tax year;

(2) on the return there is an understatement of tax attributable to erroneous items of one of the individuals filing the joint return;

(3) the innocent spouse establishes that in signing the return he or she did not know or have reason to know of the understatement;

(4) under all the facts and circumstances, it would be inequitable to hold the innocent spouse liable for the deficiency in tax resulting from the substantial understatement; and

(5) the other individual properly elects this relief within two years after the date the IRS has begun collection activities with respect to the individual making the election (see Code Sec. 6015(b) and Reg. §1.6015-2(a)).

Failing to establish any one of these requirements generally prevents a spouse from qualifying for relief. If a spouse qualifies, relief extends to the tax (including interest, penalties and other amounts) attributable to the understatement.

However, even if these requirements cannot be satisfied, a spouse has two other avenues of relief:
Elect separation of liability (Code Sec. 6015(c) or

Request equitable relief (Code Sec. 6015(f).

While a requesting spouse may qualify for relief under Code Sec. 6015(b) (innocent spouse relief), Code Sec. 6015(c) (separation of liability), or Code Sec. 6015(f) (equitable relief), relief under (b) and (c) must be specifically elected by the requesting spouse. If the requesting spouse only seeks equitable relief under Code Sec. 6015(f), the IRS cannot grant relief under either (b) or (c). However, if it is determined that the requesting spouse would be eligible for innocent spouse relief or separation of liability, then the IRS will contact the requesting spouse to see if he or she wishes to amend the claim for relief to affirmatively seek relief under Code Sec. 6015(b) or Code Sec. 6015(c). For purposes of determining timeliness of the claim, the amended claim will relate back to the time of the filing of the original claim (Reg. §1.6015-1(a)(2)).

Although Code Sec. 6015 continues many rules contained in former Code Sec. 6013(e), it also contains significant provisions designed to protect married taxpayers from the tax misdeeds of their spouses.

Innocent spouse relief is available on an apportioned basis.

The IRS has initiated a series of steps to protect victims of domestic violence who apply for innocent spouse relief. Taxpayers who are victims of domestic violence and fear that filing a claim for innocent spouse relief would result in retaliation should write the term "Potential Domestic Abuse Case" on the top of their Form 8857, Request for Innocent Spouse Relief. Taxpayers should also explain their concerns in a statement attached to the form, in addition to explaining why they should qualify for innocent spouse relief. These steps will alert the IRS as to the sensitivity of the taxpayer's situation and the information provided. IRS employees working innocent spouse cases will receive special training on how to properly handle abuse cases (Internal Revenue News Release IR-2001-23, February 20, 2001).

The IRS is authorized to provide equitable innocent spouse relief to spouses in community property states who do not file joint returns.

Divorced or widowed taxpayers, and married taxpayers who are legally separated or who have been living apart for at least one year are permitted to elect separate tax liability despite having filed a joint return.

The Tax Court is given jurisdiction to review denials of innocent spouse relief and separate liability elections and restrains IRS collection efforts while a Tax Court procedure is pending (see ¶35,192.028).

In order to make married taxpayers more aware of the legal consequences of filing a joint return, the IRS is required to notify joint filers of their joint and several liability and send any notice relating to a joint return separately to each individual on the return.

Effective date. The provisions in Code Sec. 6015 apply to any tax liability arising after July 22, 1998 and any tax liability arising on or before July 22, 1998 remaining unpaid as of that date (Act Sec. 3201(g)(1) of the IRS Restructuring and Reform Act of 1998 (P.L. 105-206)).

Election of innocent spouse treatment under the 1998 Act is available for any tax liabilities remaining unpaid as of July 22, 1998, even liabilities arising from a court decision. The Second Circuit vacated a Tax Court decision that had denied innocent spouse relief for a capital loss carryover deduction because the deduction was not grossly erroneous as required by former Code Sec. 6013(e)(2) (P. Friedman, CA-2, 98-2 USTC ¶50,717, at ¶35,192.67). The IRS conceded that the wife could elect "innocent spouse" treatment under Code Sec. 6015, because the liabilities remained unpaid.

The two-year period for electing innocent spouse relief or separate liability will not expire before the date which is two years after the date of the first collection activity after the date of enactment (Act Sec. 3201(g)(2) of P.L. 105-206).

A Taxpayer Advocate Directive addresses the abatement of any penalty accrued or assessed to taxpayers who had made claims for relief from liability under Code Secs. 6015 or Code Sec. 6013(e) prior to December 7, 1998, and whose cases were placed on suspension until procedures were provided for relief. The penalties that should be abated (1) are attributable to unpaid tax liability for which the taxpayers made a claim for relief and (2) apply to the period beginning the later of the date such claim for relief was made or July 22, 1998, and ending on March 31, 1999 (Taxpayer Advocate Directive 1998-1, March 19, 1999).

Tax Attorney: Unrelated business income for a Business League
ULTR 200717029, April 27, 2007.

ISSUES



Whether funds derived by T, a state-chartered credit union described in section 501(c)(14) of the Internal Revenue Code, from the following activities should be treated as unrelated business taxable income under section 511 of the Internal Revenue Code:



A. Sale of accidental death and dismemberment (AD&D) insurance



B. Sale of credit life and credit disability insurance



FACTS



Established in 1973, T is a state-chartered credit union, which is recognized as exempt from federal income tax under section 501(a) of the Internal Revenue Code ("Code") as an organization described in section 501(c)(14)(A).



T's board of directors, supervisory committee and loan committee are comprised entirely of elected members of the credit union who serve on a voluntary basis without compensation.



T's purposes as stated in its articles of incorporation are to promote thrift and provide low cost credit for its members.



T's activities include accepting deposits from and maintaining the accounts and savings of its members. These deposit accounts include savings or share accounts on which members earn periodic dividends credited to the accounts and share draft accounts, which are transaction accounts similar to bank checking accounts. T represents that its day-to-day business operations differ from conventional banking institutions in several ways. T states that it conducts its business to reflect its non-profit mutual structure. T makes loans to its members and states that many borrowers have low incomes and might not otherwise qualify for credit from conventional for-profit banks. T also represents that it regularly issues loans for very small amounts, such as loans for auto repairs, which are typically not made by for-profit banks. T indicates that it serves smaller communities than those served by for-profit banks. T also indicates that because of its mutual, non-profit operation, all members, not just those maintaining high minimum balances, are able to earn competitive rates on their deposits and pay low banking fees.



T represents that in order to maintain its financial viability and continue to satisfy its stated purposes of promoting thrift and providing a source of low cost credit, it has endeavored to become a full service financial institution. Consequently, T offers more than just demand deposits and loans. Currently, T makes AD&D insurance and credit life and credit disability insurance available to members. The different types of insurance are described in more detail below.



All of these insurance products are underwritten or otherwise provided by third-party insurance companies or other third-party vendors. In each case, T makes its members aware of the purpose and availability of these products, answers members' questions about the products or refers the member to the vendor for additional information, and with respect to some of the products, obtains and submits applications for coverage, premium payments and claims.



During the year at issue, T made the following types of loans: personal, mortgage, vehicle, and other secured and unsecured loans. The majority of the loans were personal, mortgage and vehicle. In 2000, a total of 100 loans were made and 26% of these loans were collateralized.



The default rate on these loans as a percentage of total loans for the year at issue was 1.21%.



T filed Form 990-T, Unrelated Business Income Tax Return for the year at issue. However, the amounts derived from the sale of the products discussed herein were not included as income derived from unrelated trade or business.



A. Sale of AD&D insurance



T offers AD&D insurance to its members. T states that providing this insurance is an activity that is beyond the scope of services directly associated with members' monetary deposits and loans made to members. Rather, the provision of AD&D insurance is a financial security activity that is offered to members. Under the terms of the AD&D policy, if the member has an accident that triggers a claim meeting the terms of the policy, then the member or the member's beneficiary receive specified insurance payments under the policy. In the case of accidental death, the member's beneficiary would receive payments; in the case of dismemberment, the member would receive payments.



T markets and sells AD&D insurance to its members under a policy issued by an independent insurance company. T makes its members aware of the purpose and availability of AD&D insurance, answers members' questions about the product, refers the member to the independent insurance company for additional information if it is needed, and obtains and submits applications for coverage, premium payment and claims. T receives an administrative allowance for AD&D insurance based on services provided by T. The reimbursement is 30% of gross premiums collected less the cost of basic insurance which was $0.18 per $2,000 of coverage per quarter.



No information was provided regarding number of policies sold during the year at issue, or the percentage of members that elected AD&D insurance coverage.



B. Sale of credit life and credit disability insurance



T offers its member/borrowers the opportunity to purchase credit life and credit disability insurance on certain loans. T is a party to, and beneficiary under, standard group credit life and credit disability policies with a third party insurance company. Under these policies, a member-borrower who obtains a loan (mortgages and other loans secured by real estate are often excluded) may, if he or she chooses, obtain credit life and credit disability insurance which pays the loan installments during the period of physical disability which impacts the borrower's employment. A loan officer informs each member-borrower of the availability of credit life and credit disability insurance coverage, and if the member-borrower elects to obtain the coverage, the premium charge is added to the borrower's loan balance. Obtaining the credit life and credit disability insurance coverage is never a condition of the member's receiving the loan.



As reflected in the group credit insurance policy and letter agreements, the credit disability coverage is standard coverage that provides that the insurer will repay the balance of a member's loan up to the policy limit. The maximum loan duration covered was not provided, however, only credit union members are eligible. T does not offer credit disability insurance in connection with overdraft protection, home equity loans, and real estate loans.



Under the terms of the policy, T is also reimbursed for its administrative expenses in connection with its performance of the prescribed duties as the policyholder. T's employees perform the following duties with respect to the credit disability insurance program:



--During the loan process, and as part of the loan transaction itself, explain the insurance program to member-borrowers;



--Process insurance applications;



--Collect and forward the premiums to the insurance company;



--Receive and forward claims (claims can be filed directly by the member-borrower) to the insurance company; and



--Answer member-borrowers' questions.



T's staff may recommend that the member opt to obtain coverage in situations where coverage appears beneficial based on the level of personal and family resources available for loan repayment in the event of disability.



The credit disability insurance coverage requires monthly premium payments. The charges are calculated by T and added to the member's loan balance. T remits the premiums it has collected, less its expenses as noted above, to the insurance company.



T receives a commission for its role in coverage issuance and policy administration that is based on a percentage of the premiums written for credit life and credit disability insurance. This percentage is based on an agreement between T and the insurance company at the time the insurance was purchased.



No information was provided regarding loans covered by credit life and credit disability insurance during the year at issue. Additionally, no information was provided regarding what percentage of these loans to total loans made by T during that year.



LAW



Section 501(a) of the Internal Revenue Code ("Code") provides, in part, that organizations described in section 501(c) are exempt from federal income tax.



Section 501(c)(14)(A) of the Code specifically exempts from federal income tax credit unions without capital stock organized and operated for mutual purposes and without profit.



Section 1.501(c)(14)-1 of the Income Tax Regulations ("regulations") provides, in part, that credit unions (other than Federal credit unions described in section 501(c)(1) of the Code) without capital stock, organized and operated for mutual purposes and without profit, are exempt from tax under section 501(a).



State-chartered credit unions were first acknowledged as exempt from federal income tax in a 1917 Opinion of the Attorney General. The Attorney General considered credit unions organized under the laws of the Commonwealth of ***** The Attorney General's opinion described the purposes of credit unions existing at that time:



[I]t is apparent that the purpose of these financial associations is to help people save and to assist those in need of financial help whose credit may not be established at the larger banks. In reality, they are fundamentally similar and supplemental to the existing agencies for promoting thrift, namely, the savings banks and cooperative banks, except on a much smaller scale.



The Attorney General's opinion also described some of the operations of credit unions --making loans in appropriate amounts to members, "on which a low rate of interest is charged," and that "[p]rompt payment of obligations is a fundamental requirement..." The opinion described in detail the procedures by which members' savings were held by the credit union, and how the members earned interest on their deposits. The opinion also pointed to the democratic character of the governance of these early credit unions by their members: "At the annual meeting of the association each member (shareholder and depositor) has but one vote..."



After review of the features and operations of these early credit unions, the Attorney General's opinion held that state-chartered credit unions would be exempt from federal income tax. See 31 U.S. Op. Atty. Gen. 176 (1917).



The legal analysis of the Attorney General's 1917 opinion was adopted in Treasury regulations issued in 1918, and this remained the official basis for the tax exempt status of state-chartered credit unions until the Revenue Act of 1951 granted express statutory tax-exempt status to state-chartered credit unions. However, the Revenue Act of 1951 removed tax exemption from savings and loan associations, cooperative banks, and mutual savings banks. The legislative history of the act suggests that the reason these entities lost their exemption was because of their increasing similarity to commercial banks and the resulting loss of their original characteristic of mutuality. Specifically referring to the early days of these institutions, the legislative history states:



"The fact that the members were both the borrowers and the lenders was the essence of the "mutuality" of these organizations." See generally S. Rep. No. 781 (Sept. 18, 1951), reprinted in U.S. CODE CONG. & AD. SVC. 1969, 1991-97.



Present-day section 501(c)(14)(A) - as enacted in 1951 - incorporates the requirements of mutuality and non-profit operation which formed the basis for the Attorney General's recognition of credit unions' tax-exempt status in 1917. Accordingly, the basic purposes of the credit union tax exemption remain essentially the same today as they were in 1917. Based on the Attorney General's opinion, the basis for exemption is the provision of savings accounts and loans to members who may not be served by banks in a non-profit and mutual manner.



Section 511 of the Code imposes a tax on the unrelated business taxable income of organizations otherwise exempt from federal income tax under section 501(c).



Section 512(a)(1) of the Code provides that the term "unrelated business taxable income" means, with certain modifications, the gross income derived by an organization from any unrelated trade or business regularly carried on by it, less allowable deductions.



Section 513(a) of the Code defines the term "unrelated trade or business" in the case of any organization subject to tax imposed by section 511, as any trade or business the conduct of which is not substantially related (aside from the need of such organization for the income or funds or the use it makes of the profits derived) to the exercise or performance by such organization of its exempt function.



Section 1.513-1(a) of the regulations provides that gross income of an exempt organization subject to the tax imposed by section 511 of the Code is, with certain exceptions, includable in the computation of unrelated business taxable income if (1) it is income from trade or business, (2) such trade or business is regularly carried on by the organization, and (3) the conduct of such trade or business is not substantially related (other than through the production of funds) to the organization's performance of its exempt functions.



Section 1.513-1(b) of the regulations provides that the term "trade or business" has the same meaning it has in section 162 of the Code, and generally includes any activity carried on for the production of income from the sale of goods or the performance of services.



Section 1.513-1(c)(1) of the regulations states that in determining whether a trade or business is "regularly carried on" within the meaning of section 512 of the Code, regard must be had to the frequency and continuity with which the activities are conducted and the manner in which they are pursued. Hence, for example, specific business activities will ordinarily be deemed "regularly carried on" if they manifest a frequency and continuity, and are pursued in a manner generally similar to comparable commercial activities of nonexempt organizations.



Section 1.513-1(d)(1) of the regulations provides that gross income is derived from "unrelated trade or business" within the meaning of section 513(a) of the Code, if the conduct of the trade or business which produces the income is not substantially related (other than through the production of funds) to the purposes for which exemption is granted. The presence of this requirement necessitates an examination of the relationship between the business activities that generate the particular income in question - the activities, that is, of producing or distributing the goods or performing the services involved - and the accomplishment of the organization's exempt purposes.



Section 1.513-1(d)(2) of the regulations provides that a trade or business is "related" to exempt purposes, in the relevant sense, only where the conduct of the business activities has a causal relationship to the achievement of exempt purposes (other than through the production of income), and it is "substantially related," for purposes of section 513, only if the causal relationship is a strong one. Thus, for the conduct of a trade or business from which a particular amount of gross income is derived to be substantially related to purposes for which exemption is granted, the production or distribution of the goods or the performance of the services from which the gross income is derived must contribute importantly to the accomplishment of those exempt purposes. Whether activities contribute importantly to an organization's exempt purposes depends in each case upon the facts and circumstances involved.



In Louisiana Credit Union League, 693 F.2d 525 (5th Cir. 1982), a business league described in section 501(c)(6) of the Code engaged in several activities including the endorsement of insurance to its members. The court analyzed whether these activities were substantially related to the business league's exempt purpose under section 501(c)(6) of advancing the credit union movement, in order to determine whether income generated from those activities resulted in unrelated business income to the business league. In its analysis, the court stated that the "'substantial relationship' determination is necessarily a fact-based inquiry." Id. at 535. The court also noted that the regulations under section 513 require a case-by-case identification of the exempt purpose, an analysis of how the activity contributes to that purpose and an examination of the scale on which the activity is conducted. The League promoted the purchase of insurance policies from a particular carrier, providing the carrier with convenient services in the marketing and administration of its programs. The court stated that the League's endorsement of group insurance plans was principally motivated by a desire to raise revenue. The court also discussed at length the distinction between group and individual benefit. The court said the distinction between inherently group benefits and individual benefits is analogous to the aggregate/entity concept familiar in partnership taxation.



Just as a member of a partnership may enjoy benefits in his separate capacities as partner and non-partner, so may a member of the ..[League may]... enjoy benefits both as a League member and as an individual credit union. Only those activities that benefit the credit unions in their capacities as League members can be considered substantially related to the League's exempt function. This group benefit standard also accords with the requirement that a business league seek to improve the conditions of an entire line of business rather than perform discrete services for individuals. See Treas. Reg. Section 1.501(c)(6)-1. When the activities of a business league are directed toward the achievement of the common business interest of its members, the benefits that accrue to its members are inherently group benefits.


Id. at 536. The court continued its analysis by stating that insurance endorsement and administration is not the sort of unique activity that satisfies the substantial relationship test, nor are its benefits group-related. Id. at 536. Rather than merely advising members of the availability and desirability of insurance coverage to credit unions generally, the league promoted the purchase of polices from a particular carrier. The court affirmed the district court's rationale that the league's insurance activities did little more than generate revenue. Because the league's endorsement was basically a fundraising activity, it was by definition unrelated business activity under section 513(a). Id. at 537. Therefore, the court concluded that the League's insurance activities were not substantially related to its tax-exempt purpose of advancing the credit union movement. Rather, the connection between the furtherance of the credit union movement and the selling of insurance was at best tangential.


In Professional Insurance Agents of Michigan v. Comm'r., 78 T.C. 246 (1982) [CCH Dec. 38,797], aff'd 726 F.2d 1097 (6th Cir. 1984), the court held that promotional and administrative fees and an experience rating reserve refund received by a business league described in section 501(c)(6) of the Code for promoting group insurance programs for its members constituted unrelated business taxable income under section 512(a)(1). In holding that the business league's activities were not substantially related, the court considered whether the league's insurance activities contributed importantly to the league's exempt purpose of advancing the common business interests of independent insurance agents. The court stated the burden is on the taxpayer to show that the challenged activities contribute directly and importantly to the improvement of conditions in a particular line of business. The court noted that the petitioner's insurance activities did little more than generate revenue for the association and provided members with a convenient and economical service in the operation of their agencies. As such, they stood in sharp contrast to petitioner's educational and legislative activities, which served the broader purpose of improving the general business environment in which insurance agents operated. Thus, the court found petitioner's activity of promoting insurance was not substantially related to its exempt purpose.



In La Caisse Populaire Ste. Marie (St. Mary's Bank) v. U.S., 563 F.2d 505 (1st Cir. 1977)[77-2 USTC ¶9698], the Government unsuccessfully challenged the exempt status under section 501(c)(14)(A) of the Code of an organization chartered as a credit union by the State of New Hampshire. The Government maintained that the organization was not exempt because it offered a wide variety of services typically offered by nonexempt full service banks, and was therefore not organized or operated as a credit union. Among these services were checking accounts, mortgage loans, banking by mail, safe deposit boxes and a night depository. This case focused solely on the taxpayer's exemption under section 501(c)(14) and did not address the provisions of sections 511 through 513.



In Alabama Central Credit Union v. U.S., 646 F. Supp. 1199 (N.D. Ala. 1986) [86-2 USTC ¶9658], a credit union described in section 501(c) (14) of the Code offered cancer and group life insurance to its individual members. The issue was whether commissions the credit union received from servicing these particular types of insurance policies constituted unrelated business income under section 512. The court did not reach the issue for jurisdictional reasons; however, it stated in a footnote that the petitioner would have lost on the merits of this issue because the policies benefited the insured without any reference to the member's loans or accounts with the credit union. That court stated in dicta that cancer and group life insurance offered by a credit union to its members would result in unrelated business table income for the following reasons:



1. Petitioner earned commissions for servicing cancer and group life insurance policies;



2. These policies were for the express benefit of the insured without any reference to the member's loans or accounts with the credit union;



3. Petitioner derived no benefit from the policies other than commission on the sale of said policies earned from the insurance companies which issued the policies;



4. The sale of the cancer and group life insurance policies referred to had no substantial, causal relationship to petitioner's exempt purposes; and



5. The sale of the policies bore no relationship to petitioner's function as a credit union.


Id. at 1208, n. 14.


Rev. Rul. 69-282, 1969-1 C.B. 155, provides that an organization must be formed and operated under the state law governing the formation of credit unions to qualify for exemption under section 501(c)(14) of the Code as a state-chartered credit union.



Rev. Rul. 72-37, 1972-1 C.B. 152, provides that to qualify as a credit union exempt from income tax under section 501(c) (14) (A) of the Code an organization must, in addition to being formed and operated under a state credit union law, operate without profit and for the mutual benefit of its members. The revenue ruling clarified Rev. Rul. 69-282, stating that a state charter is a threshold requirement for exemption but not the sole requirement.



Rev. Rul. 60-228, 1960-1 C.B. 200, interprets the substantially related requirement of section 513. An organization exempt from federal income tax as an agricultural organization described in section 501(c)(5) of the Code promoted wider insurance coverage among its members and other local farmers, including life, casualty, and fire insurance. The insurance programs are provided by several insurance companies, but the organization's administrative and secretarial staff is assigned to the work. The organization receives an overall fee from the insurance company for office and other services rendered them in connection with the insurance programs. The revenue ruling provides that a trade or business is substantially related to an organization's exempt activities if the principal purpose of the trade or business furthers these exempt purposes. However, in this case, such activities are not usually associated with the functions of an agricultural organization and normally would not be carried on by such an organization in furtherance of its exempt purposes. Therefore, these activities are not substantially related to the organization's exempt purposes. Thus, the income resulting from these activities is subject to tax under section 511.



ANALYSIS



In determining whether an income-producing activity is an unrelated trade or business, it is necessary to show that (1) there is a trade or business, (2) the trade or business is regularly carried on, and (3) the conduct of the trade or business is not substantially related to the organization's exempt purpose or function. See section 1.513-1 (a) of the regulations.



T has agreed that the activities at issue are trades or businesses that are regularly carried on. Therefore, the sole issue is whether each activity is substantially related to the organization's achievement of its exempt purposes.



Gross income is derived from an unrelated trade or business if the conduct of the trade or business is not substantially related (other than through production of funds) to the purposes for which exemption is granted. Section 1.513-1(d)(1) of the regulations. Determination of the substantial relationship issue requires an examination of the relationship between the business activities which generate the particular income in question, and the accomplishment of the organization's exempt purposes. Id. The regulations further state that for the conduct of trade or business from which a particular amount of gross income is derived to be substantially related to purposes for which exemption is granted, the production or distribution of the goods or the performance of services from which the gross income is derived must contribute importantly to the accomplishment of those purposes. Section 1.513-1(d)(2) of the regulations. See also Prof'l Ins. Agents of Michigan, supra, (insurance activity was not substantially related because activity did little more than generate revenue and provide members with a service and did not further taxpayer's exempt purpose of improving business conditions); and Louisiana Credit Union League, supra, (League's endorsement of group insurance plans was principally motivated by a desire to raise revenue, and at best was only tangentially related to the furtherance of the League's exempt purpose of improving business conditions of one or more lines of business. The court found the requisite substantial relationship lacking.)



For T's activities to escape taxation as unrelated business income, the activities must contribute directly and importantly to the accomplishment of one or more of T's exempt purposes --promotion of thrift and providing low cost credit for its members through mutual and nonprofit operation. Section 1.513-1(d)(2) of the regulations. See also Prof'l Ins. Agents of Michigan, supra. We address each of the activities below.



AD&D insurance



T argues that making AD&D insurance available to members is substantially related to the credit union's exempt purpose of promoting thrift by providing basic financial protection to members on a mutual basis. T also argues that AD&D insurance facilitates prompt repayment of loans on a mutual basis by protecting the individual member's financial security.



The facts do not show how T's sales of AD&D insurance contribute directly and importantly to T's exempt purposes. T has not demonstrated that sales of AD&D insurance encourage savings by members who purchase it. T has also not provided information showing that the sale of AD&D insurance aids a member in obtaining credit or reduces the cost of providing credit to members. The facts do not demonstrate that the sale of AD&D insurance to individual members advances T's mutual operation. AD&D insurance provides a financial protection to an individual. The individual's purchase of the AD&D insurance does not provide a benefit to the members as a whole. The legislative history of section 501(c)(14)(A) of the Code indicates that mutuality is tied to the same members being the borrowers and lenders in loan transactions rather than the general principles that T espouses. S. Rep. No. 781 (Sept. 18, 1951).



T has not stated how the sale of AD&D insurance to an individual provides a mutual benefit to T members. The facts also do not show how sale of AD&D insurance benefits the members of the credit union as a whole. A member may purchase AD&D insurance without obtaining credit or a loan from T. If a member of T receives accidental dismemberment insurance payments, the member may use the insurance payments as he or she wishes rather than saving them or paying off an obligation to T. In the case of accidental death, the member's beneficiary may or may not be a member of T and also may use the payments as he or she desires.



In Alabama Central Credit Union, supra, the court stated in dicta several factors cited above relevant to the "substantially related" inquiry. In this case, T (1) earns commissions for servicing AD&D insurance policies; (2) sells policies for the express benefit of the insured without any reference to the member's loans or accounts with the credit union; (3) derives no benefit from the policies other than commission on the sale of the policies earned from the insurance companies which issued the policies; (4) the sale of the insurance policies referred to has no substantial, causal relationship to T's exempt purposes; and (5) the sale of the policies bears no relationship to T's function as a credit union.



Based on all of the facts and circumstances, T's activities with respect to the sale of AD&D insurance do not contribute importantly to accomplishing T's exempt purposes. The AD&D insurance sold benefits an individual and T receives no benefit other than the production of income. Therefore, the sale of AD&D insurance is not substantially related to T's exempt purposes and amounts received therefrom are subject to unrelated business income tax (UBIT).



Credit life and credit disability



T argues that the sale of credit disability insurance is directly related to the credit union's specific exempt purposes of fostering thrift among the members (including both the extension of credit to members on reasonable terms, and encouraging savings among the members), and providing services to members on a mutual basis. T further maintains that credit insurance, which is an integral part of a member loan transaction, is a mechanism for assuring the prompt repayment of debts in situations where the financial resources of the borrower, and the borrower's family, become strained as a result of disability.



The facts do not show how sales of credit life and credit disability insurance contribute directly and importantly to accomplishing T's exempt purposes. Credit life and credit disability insurance is not required for the approval of a loan. In fact, credit life and credit disability insurance is not available to members on certain types of loans, such as mortgage and other real estate loans. The member decides whether to purchase credit life and credit disability insurance based on his or her own assessment of whether the insurance will provide a benefit to that individual member. The individual member benefits in that the member need not worry about paying a loan to T in the event of death or disability. While there is also a benefit to the credit union as the beneficiary, the facts do not show how the sale of credit life and credit disability insurance otherwise contributes importantly and directly to accomplishing T's exempt purposes, other than through the production of income. Availability of credit life and credit disability insurance does not encourage savings or assist T in offering low cost credit.



T does not take into consideration the need for this insurance by members. T performs no studies to determine which members may need credit life and credit disability insurance, and there is no required corresponding counseling to members who may have more need than others. Although T's staff may recommend insurance based on the level of personal and family resources, these recommendations are not mandatory in specific cases and coverage is not required in these cases.



Additionally, T receives a commission based on a percentage of premiums paid for credit life and credit disability. Because the insurance is voluntary and has no bearing on the approval of a loan, the individual benefit --to the selling employee --is the primary benefit of offering the insurance.



Applying the factors of Alabama Central Credit Union, supra, T (1) earns commissions for providing credit life and credit disability insurance; (2) sells policies for the express benefit of the insured albeit with reference to a member's loan with the credit union; (3) derives some benefit from the credit life and credit disability insurance but the primary benefit is production of income, through the commission on the sale of the insurance earned; (4) the insurance referred to has no substantial, causal relationship to T's exempt purposes; and (5) the insurance bears no relationship to T's function as a credit union.



Looking at the facts with respect to credit life and credit disability insurance, the sale of credit insurance is not substantially related to T's exempt purposes. The available information indicates that the sale of insurance is primarily: 1) for the purpose of generating income to T and some of its employees; and 2) for the benefit of the insured rather than for the benefit of T's membership. Based on all of the facts and circumstances, T's activities with respect to the sale of credit life and credit disability insurance do not contribute importantly to accomplishing T's exempt purposes. Therefore, the sale of credit life and credit disability insurance is not substantially related to T's exempt purposes and amounts received therefrom are subject to UBIT.



CONCLUSION



For reasons set forth above, we conclude that the income received by a section 501(c)(14) credit union from the activities listed below are not substantially related to the furtherance of T's exempt purposes and therefore are subject to UBIT.



A. Sale of AD&D insurance



B. Sale of credit life and credit disability insurance



A copy of this technical advice memorandum is to be given to the taxpayer. Section 6110(k)(3) of the Code provides that it may not be used or cited as precedent.

Back Taxes: What is alimony? Payments made by an ex-husband to his ex-wife pursuant to a settlement agreement were not alimony payments under Code Sec. 71(b) because the payments would not terminate on the death of the ex-wife; thus, the payments were not deductible under Code Sec. 215(a). The ex-husband's obligation was for a lump sum payable in monthly installments, which, under state (Georgia) law, was a lump-sum alimony that does not terminate upon the death of either the payee or the payor. Further, under state law, the obligation to pay lump-sum alimony does not terminate upon the death of either party because lump-sum alimony is in the nature of property settlement, regardless of whether it was designated as alimony. See Thomas Lettieri v. Commissioner<, T.C. Summary Opinion 2007-114, Docket No. 13055-06S . Filed July 3, 2007.


Section 215(a) provides a deduction to an individual equal to the alimony or separate maintenance payments paid during that individual's taxable year. Section 215(b) defines alimony as any payment that is includable in the gross income of the payee under section 71. Section 71(a) provides for the inclusion in income of any alimony or separate maintenance payments received during the taxable year. Section 71(b)(1) defines "alimony or separate maintenance payment" as any payment in cash if --

(A) such payment is received by (or on behalf of) a spouse under a divorce or separation instrument,

(B) the divorce or separation instrument does not designate such payment as a payment which is not includible in gross income under this section and not allowable as a deduction under section 215,

(C) in the case of an individual legally separated from his spouse under a decree of divorce or of separate maintenance, the payee spouse and the payor spouse are not members of the same household at the time such payment is made, and

(D) there is no liability to make any such payment for any period after the death of the payee spouse and there is no liability to make any payment (in cash or property) as a substitute for such payments after the death of the payee spouse.

Under section 71(b)(1)(D), if the payor is liable for any qualifying payment after the recipient's death, none of the related payments required will be deductible as alimony by the payor. See Kean v. Commissioner, 407 F.3d 186, 191 (3d Cir. 2005), affg. T.C. Memo. 2003-163. Whether a postdeath obligation exists may be determined by the terms of the divorce or separation instrument or, if the instrument is silent on the matter, by State law. Morgan v. Commissioner, 309 U.S. 78, 80-81 (1940); see also Kean v. Commissioner, supra. The parties dispute whether the payments at issue meet the requirement of section 71(b)(1)(D). The parties are in agreement that the divorce decree does not provide any conditions for the termination of these payments. Respondent maintains that the payments made by petitioner to Von Bergen are not deductible from petitioner's income as alimony under section 215(a) because the obligation to make the payments does not terminate at the death of either party under Georgia law. Petitioner contends that the payments are deductible because he intended the payments to be alimony and because the settlement agreement did not specifically state that the payments do not terminate at the death of petitioner or Von Bergen.

Although section 71(b)(1)(D), as it was enacted in 1984, originally required that a divorce or separation instrument affirmatively state that liability for payments terminate upon the death of the payee spouse in order to be considered alimony, the statute was retroactively amended in 1986 so that such payments now qualify as alimony as long as termination of such liability would occur upon the death of the payee spouse by operation of State law. Hoover v. Commissioner, 102 F.3d 842, 845-846 (6th Cir. 1996), affg. T.C. Memo. 1995-183.

Under Georgia law, the obligation to pay periodic alimony terminates at the death of either party, while the obligation to pay lump sum alimony in installments over a period of time does not. Winokur v. Winokur, 365 S.E.2d 94, 95 (Ga. 1988). The Georgia Supreme Court has held that the obligation to pay lump sum alimony does not terminate upon the death of either party because lump sum alimony is in the nature of a property settlement, regardless of whether it is designated as alimony. Id. The Georgia Supreme Court has also established the following test to be used in determining whether particular payments are lump sum alimony payable in installments, as opposed to periodic alimony: "If the words of the documents creating the obligation state the exact amount of each payment and the exact number of payments to be made without other limitations, conditions or statements of intent, the obligation is one for lump sum alimony payable in installments." Id. at 96.

The settlement agreement between petitioner and Von Bergen requires petitioner to pay "the sum of $66,000" to Von Bergen in monthly payments of at least $1,000. Although the exact number of payments would have varied if petitioner had paid more than the minimum $1,000 in any installment, petitioner was not legally obligated to pay to Von Bergen any more than "the sum of $66,000"; if petitioner did not have the option in the settlement agreement of paying more than the required $1,000 each month, he would have been required by the settlement agreement to pay Von Bergen exactly 66 payments of $1,000 each. Petitioner's obligation to Von Bergen is for an exact sum payable in monthly installments, which obligation is lump sum alimony under Georgia law and does not terminate upon the death of either the payee or the payor. Thus, we hold that the $12,000 paid to Von Bergen in 2004 pursuant to the settlement agreement between petitioner and Von Bergen does not qualify to be deducted as alimony paid by petitioner under section 215. Sec. 71(b)(1)(D); see Mukherjee v. Commissioner, T.C. Memo. 2004-98.