Tax professionals are intimately familiar with certain reporting requirements under the Internal Revenue Code.  Indeed, a failure to properly and timely report a position on a return where it is otherwise required may result in significant penalties to a taxpayer.

One common failure-to-report penalty relates to so-called “listed transactions.”  Generally, these transactions must be reported on an IRS Form 8886, Reportable Transaction Disclosure Statement.  Any failure to report the transaction on a timely and properly filed Form 8886 can result in significant penalties—up to $200,000 per year.  See I.R.C. § 6707A.

Regrettably, the taxpayers in a recent decision from the Eleventh Circuit Court of Appeals learned this lesson the hard way.  See Turnham v. Comm’r, 2020 WL 6536896 (11^th Cir. Nov. 6, 2020).  In that case, a physician who practiced in Alabama set up, through his S corporation, a “10 or more employer plan” under I.R.C. § 419A(f)(6).  Because these plans offer significant tax benefits and are subject to abuse, the IRS has made these types of transactions a “listed transaction,” requiring disclosure.  When the taxpayers in Turnham failed to disclose the welfare plan each year, the IRS assessed penalties of $30,000.  The taxpayers filed an administrative claim for refund with the IRS, which was never acted upon.  Thereafter, the taxpayers filed a lawsuit in the Middle District of Alabama against the government.  This Insight discusses listed transactions and the Eleventh Circuit’s decision in Turnham.

Listed Transactions Generally. 

The regulations provide that every taxpayer who has participated in a “reportable transaction” must generally file a disclosure statement (e.g., Form 8886).  Treas. Reg. § 1.6011-4.  For these purposes, a “reportable transaction” includes, among other things, a “listed transaction.”  In turn, a listed transaction is defined as “a transaction that is the same as or substantially similar to one of the types of transactions that the Internal Revenue Service (IRS) has determined to be a tax avoidance transaction and identified by notice, regulation, or other form of published guidance as a listed transaction.”  Treas. Reg. § 1.6011-4(b)(2).  A transaction is substantially similar to one identified by the IRS if it “is expected to obtain the same or similar types of tax consequences and . . . is either factually similar or based upon the same or similar

.”  Treas. Reg. § 1.6011-4(c)(4).

The Turnham Decision.

For several years, the physician’s S corporation took significant deductions for contributions it made to a multi-employer welfare benefit plan.  The plan, at least according to the taxpayers, was designed to provide pre-retirement and post-retirement life insurance benefits to covered employees.  Generally, there are limitations under the Code on the amount of deductions allowed for these types of plans—however, those limitations do not apply if the plan has 10 or more participating employers and meets various other conditions.  The taxpayers took the position that the welfare benefit plan they participated in met such requirements.

Because taxpayers routinely abuse these types of plans to take advantage of deductions and no corresponding inclusion of income, the IRS issued Notice 95-34 to caution taxpayers that not all of these plans qualified for the deduction permitted under I.R.C. § 419A(f)(6).  Under Notice 95-34, if the welfare plan was equivalent to the plans listed in the notice, or substantially similar, a taxpayer was required to disclose the reporting position on a timely and properly filed Form 8886.

The taxpayers in Turnham failed to do so for the 2009-2011 tax years.  Nevertheless, and likely due to the large deductions, the IRS discovered the welfare plan and issued penalty notices for the taxpayers’ failure to disclose.  After the taxpayers filed suit against the government, the government moved for summary judgment on the penalties issue.  The summary judgment motion was granted in the government’s favor, and the taxpayers appealed.

On these facts, the Eleventh Circuit had “no difficulty determining that the district court correctly granted summary judgment to the IRS.”  Specifically, the Eleventh Circuit concluded that the plan at issue was “at least substantially similar to the types of plans that the IRS has indicated do not qualify for the exemption and the corresponding full deduction.”  Facts the Eleventh Circuit found relevant included:  (1) the welfare plan was marketed by promoters; (2) the promoters of the plan advised that participants could make certain transactions to move the insurance out of the participants’ estate or alternatively sell the death benefit to a willing beneficiary or, in some cases, covert the certificate in whole or in part to a health reimbursement plan; (3) the plan kept track of contributions on an employer-by-employer basis; and (4) the size of the contributions to the plan ($837,000 over 3 years) with only a fraction (roughly 3%) used to pay the premiums on the group life insurance policy for the S corporation’s employees.

Because the ability to claim the deductions was still at issue in the Tax Court, the Eleventh Circuit did not opine on whether the taxpayers could take advantage of the $837,000 deductions claimed over 3 years.

Conclusion. 

As the Turnham decision shows, sometimes it pays to ensure that certain reporting positions are properly and timely disclosed to the IRS.  Taxpayers who fail to properly report the transaction—when they otherwise must—run the risk of significant penalties for non-disclosure.

Have a question? Contact Matthew Roberts, Freeman Law, Texas.