Revised Corporate Tax Shelter Discussion Draft
February 14, 2001

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II. Section 6662: Substantial Understatements of Participants in Tax Shelters other than Abusive Tax Shelter Devices

The Draft replaces the "reasonable cause" exception to the existing 20% substantial understatement penalty in Code section 6662 with a new "reasonable belief" exception that effectively adds a disclosure requirement to the reasonable cause exception. Specifically, the new "reasonable belief" exception allows taxpayers to reduce or avoid the 20% penalty if (1) there was substantial authority for the item, (2) the taxpayer discloses relevant facts about the item on his return, and (3) the taxpayer reasonably believed that the tax treatment claimed by the taxpayer was more likely than not to prevail. Reasonable belief may be based on the opinion of an independent tax advisor, but may not be based on the opinion of a tax advisor who has a financial interest in the transaction or otherwise has a conflict of interest or lack of independence or on a tax opinion that is based on unreasonable facts, assumptions, or representations. We agree with the replacement of the reasonable cause exception with the reasonable belief exception and with the restrictions on reliance on certain tax advisors and opinions, as long as a statutory change is made to clarify that a taxpayer can rely on the opinion of a tax advisor engaged in tax planning for a non-contingent hourly fee where the tax advisor has no entrepreneurial stake in the transaction.

Proposed section 6662(d)(2)(C)(ii) eliminates the threshold of a required minimum amount of an understatement relating to a tax shelter item before the 20% penalty applies. We believe that the elimination of a required minimum amount will force taxpayers to obtain tax opinions on insignificant tax return items. To avoid that result, we suggest that the Draft be amended to add back the requirement of a required minimum amount for an understatement to be treated as a substantial understatement to which the 20% penalty applies.

Proposed section 6662(d)(2)(C)(iii) defines a "tax shelter" as a transaction or other arrangement a significant purpose of which is tax avoidance or evasion. Substantively, we believe that the appropriate test is "the principal purpose," rather than "a significant purpose," because we believe that a significant purpose of many legitimate business transactions is tax avoidance. See Treas. Reg. § 1.6662-4(g)(2)(i). However, we understand that, politically, Congress may be hesitant to go back to that standard because it could appear that Congress is being "soft" on tax shelters.

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