In Program Manager Technical Advice 2015-11 the IRS National Office discussed the application of the §6662A penalty when a taxpayer fails to disclose a listed transaction.

Generally under §6662A, if the taxpayer has an understatement related to a reportable transaction, a 20% penalty will apply to that understatement. However, under §6662A(c), if the taxpayer did not disclose the reportable transaction as required by IRC §6664(d)(2)(A) the penalty increases to 30%.

In this situation the PMTA describes the facts as follows:

From 2003 through 2011, taxpayers participated in, but did not disclose, a listed transaction described in Notice 2007-83, 2007-2 C.B. 960, which describes. abusive arrangements using cash-value life insurance policies purportedly to provide welfare benefits. On October 17, 2007, when the Service issued Notice 2007-83, tax years 2004 and later were open for assessment. The Service is making a single adjustment for the accumulated value of the insurance policies, in a year for which the assessment period remains open (the adjustment year).

As we understand it, one or more provisions applicable to the taxation of the benefits provided through the arrangement requires the taxpayer to include in income each year the fair market value of the insurance policy(ies) on the life of the taxpayer, but reduced by amounts previously included in income. Thus, in cases where a taxpayer had not yet included any amount in income prior to the adjustment year, the entire amount would be includible in the adjustment year. Generally this amount would be the Accumulation Value (the policy's cash value without regard to surrender charges) of the policy.

Given this treatment, the question was posted regarding how this penalty would be applied.

The first question to be answered was “If part of the accumulated value derives from a year before the Service issued Notice 2007-83, but the Service is making the accumulated value adjustment in an open year after the listing notice and for which the taxpayer failed to disclose the transaction, is the entire section 6662A reportable transaction understatement penalty imposed at the thirty-percent rate?”

The memorandum concluded the answer to this question was yes, then 30% penalty applied to the entire understatement even if a portion arose from amounts that should have been reported in prior years.

The advice notes:

On the facts you presented, the taxpayers participated in the listed transaction during each year from 2003 through 2011, the Service is making the accumulated-value adjustment in a year with an open assessment period, and the taxpayers did not disclose their participation on the return for that year. The reportable transaction understatement resulting from that transaction, therefore, is subject to the 30-percent penalty for nondisclosed listed transactions. Sec. 6662A(c). The fact that some of the accumulated value could have been reported in a closed year is not relevant. Of course, if the taxpayers had included any of the cash value in income in any year before the adjustment year, that amount would not be part of the accumulated-value adjustment in the adjustment year.

Because the Service is making the adjustment in the adjustment year, the “increase (if any) in taxable income which results from a difference between the proper tax treatment of an item to which this section applies and the taxpayer's treatment of such item (as shown on the taxpayer's return of tax)”, sec. 6662A(b)(1)(A), occurs in that year.

The second question to be posed was “When computing the section 6662A penalty, must the Service apportion the penalty between the closed year the transaction was not listed and the open years when it was listed and for which the taxpayers failed to disclose?” Again, based on the above analysis, the memorandum concludes. “[t]he reportable transaction understatement also occurs in the adjustment year, and apportionment is neither necessary nor appropriate.”

Under IRC §6662A(b)(1)(A) the understatement applicable to the listed transaction for purposes of this penalty is the difference between the proper tax treatment and the one the taxpayer reported multiplied by the highest tax rate imposed on individuals. The next question was whether, since the maximum tax rate varied over the years in question, if a blended rate had to be calculated based on the various years involved.

Again the memorandum concluded that only the year of the actual IRS adjustment was relevant. As well, the penalty does not need to be apportioned over the various years involved in order to compute the penalty.