SERVICE AMENDS 'ADEQUATE DISCLOSURE' PROCEDURES FOR PURPOSES OF SUBSTANTIAL UNDERSTATEMENT PENALTY.

Rev. Proc. 88-37

SECTION 1. PURPOSE

01 This revenue procedure updates Rev. Proc. 87-48, 1987-2 C.B. 645, and identifies circumstances under which the disclosure on a taxpayer's return of an item or a position taken is adequate disclosure for the purpose of reducing the understatement under section 6166 of the Internal Revenue Code.

02 This procedure applies to 1987 tax forms filed for all taxable years beginning in 1987. It also applies to 1987 forms filed in 1988 for short taxable years beginning in 1988.

SEC. 2. CHANGES FROM PREVIOUS YEAR

01 Section 4 of Rev. Proc. 87-48 is revised to clarify that items must not be combined but must be separately stated on the appropriate lines. The taxpayer must also be able to show that the taxpayer acted in good faith in demonstrating the origin of the money amounts.

02 Changes were made to reflect amendments to the law made by the Tax Reform Act of 1986 (the Act), 1986-3 (Vol. 1) C.B. 1. For example, section 4(b)(4) of Rev. Proc. 87-48, Reserve for Bad Debts, is deleted due to repeal of the bad debt provisions by section 805 of the Act.

03 Section 4(d)(7) of Rev. Proc. 87-48, Cost of Goods Sold and/or Operations, has been deleted.

04 Editorial changes have been made throughout the revenue procedure.

SEC. 3. BACKGROUND

01 Section 6661(a) of the Code imposes a penalty in situations in which there is a substantial understatement of income tax. The rate is 25 percent for penalties assessed after October 21, 1986. Section 6661(b)(1) provides that there is a substantial understatement of income tax if the amount of the understatement exceeds the greater of 10 percent of the amount required to be shown on the return or $5,000 ($10,000 in the case of a corporation other than an S corporation or a personal holding company). Section 6661(b)(2) defines an understatement as the difference between the amount of tax required to be shown on the return for the taxable year and the amount of the tax that is actually shown on the return (reduced by any rebate within the meaning of section 6211(b)(2)).

02 In the case of an item not attributable to a tax shelter, section 6661(b)(2)(B) of the Code provides that the amount of the understatement is reduced by the amount of the understatement attributable to any item if the taxpayer discloses in the return, or in an attachment, the identity and amount of the item as well as the specific facts or the position taken relevant to the tax treatment of the item. Disclosure on a return of items attributable to a tax shelter does not reduce an understatement.

03 Section 6661(c) of the Code allows the Secretary to waive all or part of the penalty provided by section 6661(a) if the taxpayer shows that there was reasonable cause for all or part of the understatement and that the taxpayer acted in good faith.

04 In general, rules providing guidance on the adequacy of disclosure for purposes of reducing an understatement under section 6661 of the Code are set forth in the regulations under section 6661. Section 1.6661-4(c) of the Income Tax Regulations gives the Commissioner authority to prescribe by revenue procedure the circumstances under which information provided on the return, in accordance with the applicable forms and instructions, is adequate disclosure for purposes of section 6661. The taxpayer must furnish all required information in accordance with the applicable forms and instructions, and the money amounts entered on these forms must be verifiable. This revenue procedure provides guidance in determining when such disclosure is adequate. Guidance for returns filed in 1983, 1984, 1985, 1986 and 1987 is provided in Rev. Proc. 83-21, 1983-1 C.B. 680, Rev. Proc. 84-19, 1984-1 C.B. 433,Rev. Proc. 85-19, 1985-1 C.B. 520, Rev. Proc. 86-22, 1986-1 C.B. 562, and Rev. Proc. 87-48, respectively.

SEC. 4. PROCEDURE

Additional disclosure of facts relevant to, or positions taken with respect to, issues involving any of the items set forth below is unnecessary for purposes of reducing any understatement of tax under section 6661 of the Code, provided, however, that the forms and attachments are completed in a clear manner and in accordance with the instructions. Pursuant to the forms and instructions, items must not be combined but must be separately stated on the appropriate line. The money amounts entered on the forms must be verifiable, and the information on the return must be disclosed in the manner described below. For purposes of this revenue procedure, a number is verifiable if, on audit, the taxpayer can demonstrate the origin of the number (even if that number is not ultimately accepted by the Internal Revenue Service) and the taxpayer can show good faith in entering that number on the applicable form.

(a) Form 1040, Schedule A, Itemized Deductions:

(1) Medical and Dental Expenses: Complete lines 1-4 supplying all required information. Line 1c must list each item and the amount paid.

(2) Taxes: Complete lines 5-8 supplying all required information. Line 7 must list each type of tax and the amount paid.

(3) Interest Expense: If applicable, the box above line 9a must be checked and Form 8598, Home Mortgage Interest, must be attached to the return. Complete lines 9-13 supplying all required information. This section of the procedure does not apply to (i) amounts disallowed under section 163(d) of the Code unless Form 4952, Investment Interest Expense Deduction, is completed, or (ii) any amounts disallowed under section 265 of the Code.

(4) Contributions: Complete lines 14-17 supplying all required information. Merely entering the name of an organization to which the taxpayer makes a donation and the amount of the donation on Schedule A, however, will not constitute adequate disclosure for purposes of section 6661 of the Code if the taxpayer receives a substantial benefit from the donation shown. If a contribution of property other than cash is made and the value of the contribution exceeds $500, a properly completed Form 8283, Noncash Charitable Contributions, must be attached to the return.

(5) Casualty and Theft Losses: Form 4684, Casualties and Thefts, must be completed and attached to the return. Each item or article for which a casualty or theft loss is claimed must be listed on Form 4684.

(6) Moving Expenses: Complete Form 3903, Moving Expenses, or Form 3903F, Foreign Moving Expenses, and attach to the return.

(b) Trade or Business Expenses:

(1) Casualty and Theft Losses: The procedure outlined in (a)(5) above must be followed.

(2) Legal Fees: The amount paid must be stated.

(3) Specific Bad Debt Charge-off: The amount written off must be stated.

(4) Reasonableness of Officers' Compensation: Form 1120, Schedule E, must be completed when required by instructions. The time devoted to business must be expressed as a percentage as opposed to "part" or "as needed." This does not apply to "golden parachute" compensation prohibited by section 280G of the Code.

(5) Repair as Opposed to Capital Expenditure: The amount of repairs must be stated.

(6) Taxes (other than foreign taxes): The amount of taxes must be stated.

(c) Form 1120, Schedule M-1, Reconciliation of Income Per Books With Income Per Return:

An item clearly identified on Form 1120, Schedule M-1, but only if --

(1) The amount of the deviation from the financial books and records is not the result of a computation that includes the netting of items; and

(2) The information provided reasonably may be expected to apprise the Service of the nature of the potential controversy concerning the tax treatment of the item.

(d) Other:

(1) Sale or Exchange of Principal Residence: Complete Form 2119, Sale or Exchange of Principal Residence, and attach to the return.

(2) Employee Business Expenses: Complete Form 2106, Employee Business Expenses, and attach to the return.

(3) General Business Credit Carryforwards: Amounts shown on Line 7, Form 3800, General Business Credit.

(4) Gasoline and Special Fuels Credit: Amounts shown on Form 4136, Computation of Credit for Federal Tax on Gasoline and Special Fuels.

(5) Investment Credit: Complete Form 3468, Computation of Investment Credit, and attach to the return.

(e) Foreign Tax Items:

(1) International Boycott Transactions: Transactions disclosed on Form 5713, International Boycott Report.

(2) Subpart F Income: Amounts shown on Schedule J, Form 5471, Information Return with Respect to a Foreign Corporation.

(3) Intercompany Transactions: Transactions and amounts shown on Form 5471, Schedules G and M.

(4) With respect to foreign taxes paid or accrued, additional disclosure is unnecessary if Form 1116, Computation of Foreign Tax Credit, Part II, in the case of individuals, and Form 1118, Computation of Foreign Tax Credit -- Corporations, Schedule B, Part I, Item 4, and Schedule C, Item 6, Schedules D, and E, Item 5, as appropriate, are completed, supplying all information called for and attaching the evidence required by section 1.905-2 of the regulations (receipts for the payment of the foreign tax or a copy of the foreign tax return). Taxpayers claiming a credit for taxes paid to the Virgin Islands under section 932(b) of the Code who are not required to complete Part II of Form 1116 must attach Form 8689 instead, showing the amount of U.S. tax to be allocated to the Virgin Islands.

SEC. 5. EFFECTIVE DATE

This revenue procedure is effective for returns filed on 1984 tax forms for all taxable years beginning in 1987, and 1987 forms filed in 1988 for short taxable years beginning in 1988.

SEC. 6. DRAFTING INFORMATION

The principal author of this revenue procedure is Mary Jane Kossar of the Individual Tax Division. For further information regarding this revenue procedure contact Ms. Kossar on (202) 566-4751 (not a toll-free call).