Promoting abusive tax shelters. Taxpayers and tax return preparers should be aware of the various penalties that exist and can be assessed for certain actions (or nonactions). One such action includes promoting an abusive tax shelter. In a previous blog, Freeman Law provided an expansive overview of tax shelter penalties: Tax Shelter Penalties: Listed Transactions and Reportable Transactions. However, in a recent memorandum, the Office of Chief Counsel of the Internal Revenue Service commented on what constitutes a “false or fraudulent” statement under Section 6700.

Section 6700, Generally

Under Subchapters A and B of 26 U.S. Code Chapter 68, taxpayers may be subject to certain additions to tax and assessable penalties. Taxpayers who promote abusive tax shelters can be subject to Section 6700 of the Internal Revenue Code. Section 6700 generally provides as follows:

(a) Imposition of Penalty

Any person who—

(1)

(A) organizes (or assists in the organization of)—

(i) a partnership or other entity,

(ii) any investment plan or arrangement, or

(iii) any other plan or arrangement, or

(B) participates (directly or indirectly) in the sale of any interest in an entity or plan or arrangement referred to in subparagraph (A), and 

(2) makes or furnishes or causes another person to make or furnish (in connection with such organization or sale)—

(A) a statement with respect to the allowability of any deduction or credit, the excludability of any income, or the securing of any other tax benefit by reason of holding an interest in the entity or participating in the plan or arrangement which the person knows or has reason to know is false or fraudulent as to any material matter, or

(B) a gross valuation overstatement as to any material matter,

shall pay, with respect to each activity described in paragraph (1), a penalty equal to $1,000 or, if the person establishes that it is lesser, 100 percent of the gross income derived (or to be derived) by such person from such activity. For purposes of the preceding sentence, activities described in paragraph (1)(A) with respect to each entity or arrangement shall be treated as a separate activity and participation in each sale described in paragraph (1)(B) shall be so treated. Notwithstanding the first sentence, if an activity with respect to which a penalty imposed under this subsection involves a statement described in paragraph (2)(A), the amount of the penalty shall be equal to 50 percent of the gross income derived (or to be derived) from such activity by the person on which the penalty is imposed.[1]

Chief Counsel Advice 202134016

On August 27, 2021, the Office of Chief Counsel of the Internal Revenue Service issued a memorandum (Chief Counsel Advise), in accordance with Section 6110(k)(3). The Chief Counsel Advice responded to an inquiry of what constitutes a false or fraudulent statement for purposes of assessing a Section 6700 penalty against a promoter. The general facts of the taxpayer’s situation are reproduced below:

X is an LLC that engaged in the promotion of micro-captive insurance transactions. In a typical micro-captive insurance transaction, a taxpayer attempts to reduce the aggregate taxable income of the taxpayer, related persons, or both, using contracts that the parties treat as insurance contracts and a related company that the parties treat as a captive insurance company. Each entity that the parties treat as an insured entity under the contracts claims deductions for premiums for insurance coverage. The related company that the parties treat as a captive insurance company elects pursuant to section 831(b) to be taxed only on investment income and therefore excludes the payments directly or indirectly received under the contracts from its taxable income.

Many of the documents X distributed to investors and potential investors in the micro-captive insurance transaction contain statements with respect to the allowability of deductions for purported “insurance premiums” under section 162, the excludability of such premium income under section 831(b), or other federal tax benefits such as eligibility of the captives to elect treatment under section 953(d).[2]

In its analysis, the Office of Chief Counsel noted the following:

There are two types of statements that fall within the statutory bar of section 6700(a)(2)(A): statements directly addressing the availability of tax benefits and those concerning factual matters that are relevant to the availability of the tax benefits. Advice and recommendations are considered statements for purposes of section 6700. False statements under section 6700 include representations that a plan qualifies for special tax treatment when the plan does not comply with the law.

Further, statements are false when assertions are not qualified and customers are not notified that following the advice could subject them to IRS scrutiny. Where a promoter has knowledge of the risks incident to a tax shelter, the promoter must clearly and unambiguously inform its agents, prospective clients, and current clients of that risk.

Statements in the context of micro-captive insurance transactions include opinions, promotional materials, reports, tax savings projections, or other statements (or materials relied upon in making such statements) that are false or fraudulent as to any matter material to exclusion of income under section 831(b) or tax deductions under section 162 for premiums paid by the insured.[3]

Conclusion

The penalty under Section 6700 may seem relatively small in comparison to other penalty provisions under the Internal Revenue Code. However, the activities described above are rarely performed in isolation. For those taxpayers involved in multiple organizing activities or sales activities (see Section 6700(a)(1)(A)-(B)), a $1,000 penalty may be assessed per activity. Moreover, with respect to “statements,” such statements may be oral or written. Written statements are certainly easier to point to, but taxpayers should be wary of all oral representations that he or she knows (or has reason to know) are false or fraudulent. Chief Counsel Advice 202134016 essentially prescribes a clear “warning label” when a promoter makes certain statements or representations.

Have a question? Contact Zachary Montgomery, Freeman Law.