SERVICE ISSUES PROCEDURES FOR 'ADEQUATE DISCLOSURE' FOR PURPOSES OF REDUCING UNDERSTATEMENTS SUBJECT TO PENALTIES UNDER SECTION 6661.

Rev. Proc. 87-48

SECTION 1. PURPOSE

01 The purpose of this revenue procedure is to identify circumstances under which the disclosure on a taxpayer's return of an item or a position taken, with no specific reference to section 6661 of the Internal Revenue Code, is adequate disclosure for the purpose of reducing the understatement under section 6661.

02 This revenue procedure applies to 1986 tax forms filed for all taxable years beginning in 1986. It also applies to 1986 forms filed in 1987 for short taxable years beginning in 1987.

03 This revenue procedure also extends the application of Rev. Proc. 86-22, 1986-1 C.B. 562, to cover certain fiscal year filers with tax years beginning in 1985 (and, thus, required to file on 1985 tax forms) and ending in 1986 but with due dates for filing (without regard to extensions) in 1987. Such filers are not currently covered under Rev. Proc. 86-22, which provides guidance for returns filed in 1986 the due date (regardless of extensions) for filing of which is after December 31, 1985.

SEC. 2. CHANGES FROM PREVIOUS YEAR

01 Section 1 is revised to apply to returns filed for all taxable years beginning in 1986.

02 Section 3.01 is revised to show the 25 percent rate effective for penalties assessed after October 21, 1986.

03 Section 4(b)(4), Reserve for Bad Debts, is revised to include Form 1065, U.S. Partnership Return of Income.

04 Section 4(d), Other, adds (6) Form 3468, Computation of Investment Credit, and (7) Cost of Goods Sold and/or Operations for Forms 1040, 1065, 1120, and 1120S.

05 Editorial changes were made throughout the revenue procedure.

06 Section 5, Effective Date, is changed to apply to returns filed for all taxable years beginning in 1986.

SEC. 3. BACKGROUND

01 Section 6661(a) of the Code imposes an addition to tax in situations where there is a substantial understatement. The rate is 25 percent for penalties assessed after October 21, 1986. A substantial understatement is defined as an understatement of liability for income tax which 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). Under section 6661(b)(2), an understatement is defined as the excess of the amount of tax required to be shown on the return for the taxable year over the amount of the tax imposed which is shown on the return (reduced by any rebate within the meaning of section 6211(b)(21).

02 In the case of an item not attributable to a tax shelter, the amount of the understatement is reduced if the taxpayer discloses in the return or an attachment thereto 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 Under section 6661(c) of the Code, the Secretary may waive all or part of the addition to tax provided by section 6661(a) if the taxpayer shows that there was reasonable cause for 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 regulations. Under section 1.6661- 4(c) of the Income Tax Regulations, the Commissioner may by revenue procedure prescribe the circumstances in which information provided on the return in accordance with the applicable forms and instructions is adequate disclosure for purposes of section 6661 of the Code. 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 guidelines as to when such disclosure is adequate. Guidance for returns filed in 1983, 1984, 1985, and 1986 was provided by 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, and Rev. Proc. 86-22.

SEC. 4. PROCEDURE

Additional disclosure of facts relevant to, or positions 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 thereto, the money amounts entered on the forms are verifiable, and the information on the return is 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).

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

(1) Medical Expenses: Complete lines 1-5 supplying all required information. Line 2c must be itemized listing each item and its cost.

(2) Taxes: Complete lines 6-10 supplying all required information. Line 9 must list each type of tax and amount paid.

(3) Interest Expense: Complete lines 11-14 supplying all required information. Line 13 must list the type of expense and the amount paid. This section 4(a)(3) does not apply to amounts disallowed under section 163(d) of the Code unless Form 4952, Investment Interest Expense Deduction, is completed, or to any amounts disallowed under section 265.

(4) Contributions: Complete lines 15-18 supplying all required information. If a contribution of property other than cash is made and the claimed 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.

(b) Trade or Business Expenses:

(1) Casualty and Theft Losses: The procedure outlined in section 4(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) Reserve for Bad Debts: Form 1120A, Question K; Form 1120, Schedule F; Form 1120S, required attached schedule; or Form 1065, required attached schedule, must be completed supplying all required information.

(5) 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 section 4(b)(5) does not apply to "golden parachute" compensation prohibited by section 280G of the Code.

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

(7) 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 several 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) Moving Expenses: Complete Form 3903, Moving Expenses, and attach to the return.

(4) Jobs Credits and WIN Credit Carryovers: Amounts shown on Line 8, Form 3800, General Business Credit.

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

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

(7) Cost of Goods Sold and/or Operations: Form 1065, Schedule A; Forms 1120 and 1120S, Schedule A; and Form 1040, Schedule C, Part 111, must be completed, and any required statement or schedule must be attached.

(e) Foreign Tax Items:

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

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

(3) Intercompany Transactions: Transactions and amounts shown on Form 5471, Schedule 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 1, 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).

SEC. 5. EFFECTIVE DATE

This revenue procedure is effective for returns filed on 1986 tax forms for all taxable years beginning in 1986, and 1986 forms filed in 1987 for short taxable years beginning in 1987.

SEC. 6 EFFECT ON OTHER REVENUE PROCEDURES

Rev. Proc. 86-22 is amplified to cover certain fiscal year filers with tax years beginning in 1985 (and, thus, required to file on 1985 tax forms) and ending in 1986, but with due dates for filing (without regard to extensions) in 1987.