4.32.1. Process Guide for Combating Abusive Tax Avoidance Transactions

(1) Purpose: The IRS continues to identify new types of tax transactions or promotions that are either abusive or potentially abusive requiring different levels of coordination and varying strategies. This IRM outlines operating standards for both the highly complex and technical abusive transactions and those abusive transactions that are considered scams or promotions based on the erroneous application of tax law or clearly frivolous arguments.

(2) Audience: These procedures apply to examiners of abusive transactions in SB/SE, LB&I, TEGE, and TS.

(3) Policy Owner: The Director, Office of Promoter Investigations, which is under the Division Commissioner, SB/SE.

(4) Program Owner: The Policy and Technical Support Teams within the Office of Promoter Investigations.

(5) Primary Stakeholders: The following areas can be affected by these procedures: SB/SE Field Exam, SB/SE Exam Case Selection, SB/SE Specialty Tax, Collection Division, SB/SE Counsel, SB/SE Office of Fraud Enforcement, LB&I, TS, and TE/GE.

(6) Program Goals: The goal of the program is to combat abusive tax avoidance transactions.

(1) Before a recommendation for addressing abusive or potentially abusive tax transactions or promotions can be developed that is consistent with sound tax administration objectives, it is critical that the scope of the issue, transaction variations, potential case inventory, and the appropriate legal arguments are identified and explored. Because of their possible complexity and monetary significance, proper coordination of tax transactions or promotions that are either abusive or potentially abusive is vital to effective tax administration. Compliance personnel in one or more business operating divisions (BODs), Counsel, and other functions as appropriate, should be involved in coordinating efforts around each issue identified.

(2) There are a variety of abusive transactions and promotions ranging from the highly complex transactions to the basic scams or promotions, both of which can affect either a large number of taxpayers or only a few taxpayers. To fully understand a specific transaction or promotion and to develop an effective response, it is essential that service-wide communication and coordination be clear and consistent.

(1) The guiding principles that should be followed throughout the process of identifying and developing issues related to coordinated abusive transactions and promotions are as follows:

• Understand the transaction.

• Get the right people involved at the right time.

• Respect each function’s role in the administrative process.

• Develop a service-wide strategy to address the abusive transaction or promotion.

(2) Understanding the transaction or promotion is critical to the development of a successful strategy for addressing all tax transactions or promotions that are either abusive or potentially abusive. Service-wide, the IRS should completely understand the transaction or promotion and its variations. It is vital that individual transactions be reviewed so that the legal positions can be properly assessed based on the facts of an actual case rather than relying solely on the facts provided as part of a legal opinion or a promoter offering. Each transaction or promotion must meet a minimum standard of factual development to ensure proper application of legal theories and to ensure design of appropriate case strategies.

(3) It is critical to get the participation of all relevant parties for both gathering information about an identified transaction or promotion and developing strategies for addressing the abusive transactions or promotion. Depending on the specific issue, these efforts may need to include representatives from various operating divisions, Criminal Investigation, and multiple components of Counsel and Treasury.

(4) In the case of a transaction or promotion affecting only one operating division, the operating division may determine that a strategic division-wide compliance approach is required. In the case of a transaction or promotion affecting more than one operating division, a service-wide strategy should be pursued. A wide range of available options for combating the abusive transaction or promotion should be considered and include:

• Published Guidance

• Audit Techniques Guides

• Audit Resource Guides

• Litigation Designation

• Fast Track Process

• Specific Resolution Strategy including Collection Strategy

• Legislative Resolution

• Public or Private Settlement Offers

• Education and Marketing

(1) This section details information relating to potentially abusive transactions.

(1) This exhibit is intended for developing broad resolution strategies. Not for use in resolving individual taxpayer cases.

The purpose of any strategy should be to:

• Foster effective tax administration through overall impact on compliant and non-compliant taxpayers.

• Ensure fairness and consistency in administration of tax law.

• Maintain ethics and integrity in decision making.

• Consider the impact on future compliance risks of penalty settlement.

• Focus on changing taxpayer behavior to foster voluntary compliance.

• Address the specific transaction or promotion.

• Tailor the strategy to address the egregiousness of the taxpayer actions/non-action.

• Facilitate resolution early in the process.

• Reduce associated burden on both the IRS and the taxpayer.

(1) (including but not limited to)

(2) Consider the following when developing a strategy for integrating the applicable penalty provisions into the issue resolution strategy:

1. Periods of limitations on assessment of tax and penalties.

2. Differences in behavior, such as whether the taxpayer disclosed or concealed participation in the transaction, may justify different treatment of otherwise similarly situated taxpayers. See the list of behaviors and how each is treated below.

3. Degree of technical difficulty of the transaction or promotion.

4. Whether the transaction or promotion was marketed/promoted?

5. Sophistication of the taxpayer and their involvement in the investment decision.

(3) TREATMENT OF INVESTORS' POSSIBLE BEHAVIORS

(4) 1) As part of an issue resolution strategy, it is reasonable to treat investors who complied with disclosure requirements differently than those who failed to comply. Different treatment may be appropriate for those taxpayers who:

• Disclosed under Announcement 2002-2, 2002-1 C.B. 304., which provides that a penalty can be waived if the investor complied with the Announcement.

• Disclosed in accordance with 26 CFR 1.6011-4 in a timely manner on a return (including an amended return). As a general matter, a taxpayer must disclose their participation in a reportable transaction (such as a listed transaction or a transaction of interest) by attaching a Form 8886, Reportable Transaction Disclosure Statement, with its tax return for each year in which the taxpayer participated in the transaction and by sending a copy of that form to the Office of Tax Shelter Analysis (OTSA) at the same time that any disclosure statement is first filed by the taxpayer pertaining to a particular reportable transaction.

• Later listed transactions or Transactions of Interest: or a transaction of interest: If a transaction identified as a listed transaction or a transaction of interest is after a taxpayer filed a tax return reflecting participation in a reportable transaction and before the end of the period of limitations on assessment of tax, for any taxable year in which the taxpayer participated in the listed transaction or transaction of interest the taxpayer must disclose by filing a Form 8886 with OTSA within 90 calendar days after the date on which the transaction became a listed transaction or a transaction of interest unless the published guidance identifying the transaction as a listed transaction or transaction of interest provides otherwise.

• Voluntarily disclosed non-listed transaction to Criminal Investigation under voluntary disclosure or by filing a corrected taxable amended return.

(5) 2) For investors who were required to disclose and did not comply: No waiver of the penalty would be generally proposed as part of a resolution strategy. The penalty issue would need to be developed in each case and reasonable cause addressed for penalties to which reasonable cause is a defense.

(6) 3) For investors who received fees from other investors (promoters/advisers) for activities related to the shelter: They would be excluded from any other general categories of penalty relief as part of a resolution strategy. The penalty issue would need to be developed in each case and reasonable cause addressed for penalties to which reasonable cause is a defense.

(7) 4) For investors who were not required to disclose: It may be appropriate to provide a no waiver of penalty as part of a resolution strategy. The penalty issue would need to be developed in each case and potential reasonable cause should be addressed.

(8) 5) When developing a resolution strategy, consider investor attempts to fully disclose the transaction or to conceal the transaction. Different actions on the part of the investor may warrant different penalty considerations.

(1) Circumstances for Considering Designation Include, but are not limited to:

(2) Certain legal issues are susceptible to recurring compliance challenges that are not effectively addressed administratively or through published guidance. In limited circumstances, examination personnel may consider requesting designation of an issue in a case where sound tax administration is best served by establishing a legal precedent on the issue. Examples illustrative of situations in which sound tax administration is best served by establishing judicial precedent are where designation would:

• stem the proliferation of abusive tax transactions or other significant non-compliance (through early issue resolution),

• reduce future compliance and litigation costs of other taxpayers and the government (through early issue resolution, broad-based settlement initiatives, or other means), or

• resolve issues with respect to which published guidance has not resulted in compliance or where there is a wide divergence between IRS and taxpayer viewpoints on the law.

(3) While addressing whether selected issues in cases should be considered for designation for litigation as part of an overall tax shelter strategy, the following criteria should be considered:

1. If the shelter transaction includes a significant legal issue that affects a large number of taxpayers or has significant tax impact, consideration should be given to designation.

2. If the shelter transaction is still generally being used or promoted, consideration should be given to designation. However, the fact that the shelter is no longer promoted or has been closed down by legislation or regulation does not mean that designation should not be considered. There may be a significant number of cases for prior years that need resolution if the legislation or regulation is prospective only. Consider, for example, the use of a resolution in the contingent liability transactions. See Rev. Proc. 2002-67, Settlement of Section 351 Contingent Liability Tax Shelter Cases.

3. If there is a need to establish judicial precedent due to a wide divergence between IRS and taxpayer viewpoints on the law, consideration should be given to designation. Designation and a court decision would promote ultimate resolution of the issue and conserve resources for both the government and taxpayers. An example of this is lease-in, lease-out transactions ("LILOs") described in Rev. Rul. 2002-69.

4. If one or more aspects of the shelter transaction continue to be significant to other tax shelter transactions and have broader impact than the immediate shelter, e.g., issues surrounding application of IRC 351, Transfer to Corporation Controlled by Transferor, defeasance, or partnership basis, consideration should be given to designation. For example, the shelter may no longer be promoted or tax benefits from the shelter transaction may no longer be claimed by the taxpayer; however, transactions with similar structures or features may continue to be promoted or subsequent shelter transactions may utilize overstated tax basis from the prior shelter.

5. Designation may not be necessary if cases with the same or similar issue are already docketed or scheduled for trial.

6. Designation may not be necessary if the issue under examination is being conceded by many taxpayers during examination.

(4) If a decision is made to select issues to designate for litigation, the following factors should be considered:

(5) Several cases should be considered and developed for potential designation. Often taxpayers may concede the issue or threaten to pay the tax and file a refund suit. If the taxpayer concedes the issue, the case should not be designated. A threat to pay the tax and file a refund suit should not alter the decision to designate. If a taxpayer pays the tax and files a refund suit after the case is designated, the Department of Justice will be apprised of the designation and take it into consideration when handling the case.

(6) The issue in the case recommended for litigation should result in a decision that will impact the other cases with similar transactions. Thus, cases should be selected with fact patterns that are fairly representative of the cases involved in the shelter strategy.

(7) Designated issues in cases must be developed and resources must be committed for their complete development. When an issue in a case is identified as a potential for designation and the development of the issue is underway, a commitment must be made to follow through on the process unless the recommendation for designation is determined to be no longer appropriate. Compliance must commit its resources to the complete development of the issues, including but not limited to:

• Hiring of outside experts including appraisers, economists, etc.

• Transcribed interviews for key parties.

• Summonses of necessary taxpayer and third party documents and enforcement if necessary.

(8) The process of designating an issue in a case is generally lengthy. The procedures for designating a case for litigation are set forth in the Chief Counsel's Directive Manual. See CCDM 33.3.6, Other Legal Advice; Designating a Case for Litigation. In addition, once a case is before the court, the time frame for an ultimate decision is uncertain and may be lengthy.

(9) Full development of the penalty should be completed and the penalty analysis and decision made part of the case designation process. Designation of non-penalty issues in a case does not necessarily mean the penalty should be designated. The penalty must separately meet the criteria for designation.

(10) The effect of the statute of limitations on case development and designation process must be considered. For example, there must be sufficient time to fully develop the case including making the recommendation and securing approval for designation.

(11) The overall impact on the particular taxpayer must be considered. For example, if the taxpayer has carry backs, carry-overs, or credits that eliminate or significantly reduce the tax deficiency, the case may not be a good one to designate for litigation.

(12) The positions that may have been taken on the same or a similar issue for the particular taxpayer that may affect an overall view of the case must be considered, for example, whether the issue was examined and no adjustment made on a prior examination.

(13) Effect of Designating a Case for Litigation

(14) When an issue under the jurisdiction of a BOD is designated for litigation, a partial agreement may be secured for the non-designated and agreed issues. The taxpayer will not receive a 30-day (or similar) letter with respect to the remaining unresolved issues in the case. Rather, the taxpayer will be issued a SNOD for the unagreed issues. Chief Counsel should be contacted to discuss the appropriate procedures to follow if the issue in question is an employment tax issue. In general, the designation of an issue in a case will not preclude the settlement of the remaining issues either before or after the case is docketed. Nor, in general, will designation preclude Appeals from considering and settling the same issue in other cases within its jurisdiction.

(1) Transaction costs may include fees to promoters and to accommodating parties, fees for document preparation, actual losses incurred that are associated with the transaction (true economic losses), fees for legal advice and for valuations or appraisals, interest expense and similar types of expenses. These transaction costs are sometimes referred to as the "out-of-pocket costs". As a legal matter, rarely would taxpayers be entitled to out-of-pocket costs where a transaction is a sham in fact or lacks economic substance because such transactions generally do not give rise to valid deductions or losses.

(2) Factors that tend to support allowing transactions cost include, but not limited to:

1. The legal theory is based on a technical argument.

2. A specific transaction cost that is attributable to a separate economically substantive element that was not the centerpiece of the underlying sham transaction.

   Note: It is important to considered how the transaction costs would be allowed. For example, should the costs be part of a basis determination.

(3) Factors that tend to support disallowing transactions cost include, but not limited to:

1. Transaction costs that are an integral part of the purported benefits of the transaction. For example, if the taxpayer generates interest deductions by entering into an abusive repurchase agreement that results in payment of more interest than interest received, the payments made by the taxpayer should not be permitted as an allowable deduction because the payments constitute the principal tax benefits of the transaction. See, e.g. United States v. Wexler, 31 F. 3d 117 (3rd Cir. 1994).

2. Transaction costs that cannot be readily determined and, therefore, allowance will result in disparate treatment among taxpayers.

3. Transaction costs that were paid to an external party for the majority of the investors.

4. Transaction costs incurred by the taxpayer to develop the transaction costs and that were not paid to external parties, taking into account equitable treatment of taxpayers and the resources required to develop the amount of the transaction costs.

(4) In some cases it may be appropriate to allow only partial transaction cost or only specific transaction costs.