Disclosing listed transaction to avoid automatic penalties

Jul 23, 2019
Jul 23, 2019
0 min. read

Aggressive tax avoidance transactions are required to be disclosed to the IRS. The failure to disclose such transaction can result in automatic penalties being assessed.  A recent court case, Interior Glass Systems, Inc., v. United States, No 17-15713, (9th Cir. 2019), reaffirmed the IRS’s power to assess penalties for failure to disclose a transaction identified by the IRS as a tax avoidance transaction.


Interior Glass Systems entered into a Group Life Insurance Term Plan (GLTP) to fund a cash-value life insurance policy owned by its sole shareholder and only employee. For the years at issue (2009 through 2011), the company failed to disclose its participation in the GLTP on its federal income tax returns. Upon examination, the IRS determined that the GLTP was substantially similar to the transaction identified as a “listed transaction” in Notice 2007-83. A listed transaction is a transaction that is the same as or substantially similar to one of the types of transactions that the IRS has determined to be a tax avoidance transaction, identified by notice, regulation, or other form of published guidance as a listed transaction. The IRS assessed penalties in the amount of $10,000 per year for failure to disclose a listed transaction. A United States District Court upheld the IRS’s penalty assessment under section 6707A, and the taxpayer appealed to the United States Court of Appeals for the Ninth Circuit.

Penalty imposed

In order to combat sophisticated tax avoidance transactions, Congress established a penalty for failure to disclose certain transactions under section 6707A of the Code, as well as an enhanced accuracy penalty under section 6662A. The disclosure penalty under section 6707A, allows the IRS to immediately assess a penalty for failure to disclose a listed transaction or a reportable transaction. Regulations under section 1.6011-4 provide the requirements for supplying a statement disclosing participation in a listed transaction or a reportable transaction. Generally, for each year a taxpayer participated in one of these transactions, the taxpayer must file Form 8886 with its tax return for each year the transaction provides a tax benefit. In addition, the taxpayer must file Form 8886 with the Office of Tax Shelter Administration (OTSA) for the first year of the transaction.

Interior Glass failed to disclose its participation in the GLTP transaction for tax years 2009 through 2011. On appeal, the taxpayer made two arguments; first that the GLTP transaction was not substantially similar to the listed transaction Notice 2007-83, and second that the taxpayer’s procedural due process rights were violated. The taxpayer argued that under the due process clause of the Constitution, there should have been judicial review of the penalty before it was assessed.

The Court of Appeals found that the GLTP transaction was substantially similar to the listed transaction described in Notice 2007-83. Although the taxpayer used a tax exempt business league as an intermediary differing slightly from the Notice, the Court concluded that the transaction was substantially similar in both its facts and its tax consequences. The GLTP transaction promised the same favorable tax consequences as the listed transaction. Factually, the GLTP transaction was identical to 3 of the 4 elements of the listed transaction, with only a slight change in the intermediary entity.

The section 6707A penalty was assessed by the IRS upon determining that a transaction was not properly disclosed. Interior Glass argued that assessing and collecting the penalty before judicial review violated its due process rights. The court disagreed stating: “Congress added the section 6707A penalty provision in 2004 to encourage voluntary disclosure of listed transactions. This important objective “could be jeopardized if full scale pre-deprivation hearings and court cases are required whenever the government attempts to collect” the authorized penalties.” Citing Jolly v. United States, 764 F.2d 642 (9th Cir. 1985).    

Practical disclosure

An important point to take away from this case is the IRS ability to impose penalties for failing to disclose a transaction, separate and apart from the merits of the transaction. The section 6707A penalty can be assessed by the IRS when it is determined that a taxpayer has entered into a listed transaction (or an otherwise reportable transaction under regulation 1.6011-4) without further examination. In addition, the IRS has broad judgment to determine whether a transaction is substantially similar to a listed transaction requiring disclosure.

It is also important to note that the penalties in Interior Glass were the minimum penalties applicable for the years at issue. However, the penalty can be imposed based on 75% of the decrease in tax shown on the return as a result of the transaction. The maximum penalty that can be imposed for failure to disclose a listed transaction is $200,000 for an entity and $100,000 in the case of an individual.  For reportable transactions detailed in Regulation 1.6011-4(b), the maximum penalty is $50,000 for an entity or $10,000 for an individual.

For taxpayers engaged in transactions that may be similar to a listed transaction or fall under the requirements of a reportable transaction, disclosure with the tax return (and with OTSA) is required.  

Disclosing a transaction on Form 8886, or making a protective disclosure in accordance with section 1.6011-4(f)(2) can insure that a taxpayer does not have penalties automatically imposed under section 6707A. 

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