Taxpayer Held to Have Entered a Listed Transaction Despite Slight Differences from Notice 2004-8

In a Chief Counsel Advice (CCA 200917030) the IRS held that the following transaction was similar to the transaction described as a listed transaction in Notice 2004-8 and the taxpayer’s failure to include a Form 8886 on their personal returns (despite including one on the related corporation’s return) subjected them to the extended statute of limitation period on their personal returns.

Both taxpayers performed services for an entity described in the ruling as Company X.  After making contributions of cash to each of their respective Roth IRAs, the taxpayers had the IRAs each purchase 50% of the stock of a newly forrmed corporation.  That corporation performed services for Company X and other entities, with the taxpayers being the ones who were actually performing the services for the new entity.  The new entity (referred to as the Roth Corporation in the ruling) then paid dividends in cash out to the taxpayers’ Roth IRAs.

The Roth Corporation filed a Form 8886 with its corporate return reporting the transaction.  However, the individual 1040s did not contain a Form 8886, but rather had only a Form 5329 that showed an excess contribution followed by a distribution of that contribution to the taxpayers.  The issue the Chief Counsel’s office was asked to opine on regarded whether this transaction was similar enough to the one described in IRS Notice 2004-8 to also be considered a listed transaction and, if it was, were the disclosures made on the two returns were sufficient to prevent the statute of limitation from being extended under §6501(c)(10).

The memorandum noted that the Taxpayers would point out the differences between the specific transaction described in the Notice and their transaction by attempting to equate the “existing company” described in the Notice with Company X, as well as noting they never had an ownership interest in the Roth Corporation.  The Chief Council Advice concluded that, as a practical matter, there was no real difference in the economic structure described in the Notice and the one the taxpayers entered into—they were still effectively in control of the Roth Corporation.

As well, by performing services that had income left in the Roth Corporation, the taxpayers were making an indirect contribution to the Roth IRA through their services, a contribution in excess of the limitations allowed under the law.  In substance, the ruling held, the transaction was clearing similar in nature and effect to the structure described in the Notice where taxpayers attempted to direct excess income into the Roth structure.  Thus, for both the corporation and the couple, the item was a listed transaction subject to disclosure.

With that decided, the Advice turned to whether the disclosures made with the returns were adequate.  The Chief Counsel’s office decided that the Roth Corporation had complied with the disclosure requirements and, as such, the statute of limitations for the assessment of tax did not remain open under §6501(c)(10).  However, the ruling held that the disclosure on the personal return was not adequate, as Reg. §1.6011-4 specifically requires the taxpayer to file a Form 8886—the filing of the Form 5329 with the personal return did not qualify.  Nor, it should be noted, did the office decide that the disclosure with the Roth Corporation return was sufficient to close down the statute.

One issue not discussed in the ruling, but of very real practical concern, would be the exposure to the automatic penalty under §6707A, which would amount to $100,000 per year for each year the taxpayers failed to include the disclosure on their personal returns.  The statute provides that the penalty shall be applied in the case of a failure, and for a listed transaction does not grant the IRS the right to waive the penalty.

As well, the ruling notes in a footnote that they did not consider the question of whether any of the activities constituted a prohibited transaction under §4975.  A finding of a prohibited transaction in an IRA disqualifies the entire IRA, creating a deemed distribution of the entire account.

What the ruling does indicate is that the IRS is showing a low tolerance for being “understanding” with taxpayers that entered into various shelter transactions and did not give credit for the fact that the transaction was disclosed on the tax   return of one of the involved entities.  As well, it also emphasizes why we and our staffs need to be aware of the listed transaction items—they aren’t just things that affect only large corporate taxpayers.

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