Temporary and Proposed Regs Reflect Changes to Penalty Rules Made by OBRA '93

 [4830-01-p]

 ACTION: Temporary regulations.

 SUMMARY: This document contains temporary regulations relating to the accuracy-related penalty under chapter 1 of the Internal Revenue Code. These regulations affect all persons that file returns of income tax and provide guidance necessary to comply with these changes. These regulations are necessary to effect changes to the accuracy-related penalty made by the Omnibus Budget Reconciliation Act of 1993.

 EFFECTIVE DATE: March 14, 1994.

 FOR FURTHER INFORMATION CONTACT: David L. Meyer, 202-622-6232 (not a toll-free number).

 SUPPLEMENTARY INFORMATION:

BACKGROUND

 These temporary regulations set forth certain changes made to the accuracy-related penalty in section 6662 of the Internal Revenue Code (Code) by section 13251 of the Omnibus Budget Reconciliation Act of 1993 (OBRA 1993). These changes eliminated the disclosure exception for the negligence penalty (section 6662(b)(1) of the Code) and raised the disclosure standard for purposes of the penalties for disregarding rules or regulations (section 6662(b)(1) of the Code) and a substantial understatement of income tax (section 6662(b)(2) of the Code) from "not frivolous" to "reasonable basis." See section 13251 of OBRA 1993 and H. Rep. No. 213, 103rd Cong., 1st Sess. 669 (1993) (the Conference Report).

 The legislative history to OBRA 1993 indicates that this "reasonable basis" standard is a relatively high standard of tax reporting that is significantly higher than the "not frivolous" disclosure standard previously applicable to taxpayers under section 6662 of the Code and currently applicable to preparers under section 6694 of the Code. See Conference Report, at p.669. A position is not frivolous if it is not "patently improper." See section 1.6694-2(c)(2) of the Income Tax Regulations and current section 1.6662-3(b)(3). The legislative history to OBRA 1993 also provides that the reasonable basis standard is not satisfied by a position that is merely arguable or merely a colorable claim. See Conference Report, at p.669.

 In addition to adopting the new reasonable basis standard as the standard that a disclosed return position must satisfy to avoid the disregard and substantial understatement penalties, Congress adopted the new reasonable basis standard as the standard that a return position must satisfy to avoid the negligence penalty. See Conference Report at p.669.

 Treasury requests comments on how the new reasonable basis standard should be defined for purposes of the negligence, disregard, and substantial understatement penalties.

EXPLANATION OF CHANGES

 Section 1.6662-3(a) of the regulations generally provides that if any portion of an underpayment, as defined in section 6664(a) of the Code and section 1.6664-2, of any income tax imposed under subtitle A of the Code that is required to be shown on a return is attributable to negligence or disregard of rules or regulations, there is added to the tax an amount equal to 20 percent of such portion. Section 1.6662-3(b)(1) defines "negligence" to include any failure to make a reasonable attempt to comply with the provisions of the internal revenue laws or to exercise ordinary and reasonable care in the preparation of a tax return. Currently, section 1.6662-3(c) generally provides that no penalty under section 6662(b)(1) may be imposed on any portion of any underpayment that is attributable to negligence or a position contrary to a rule or regulation if the position is adequately disclosed and is not frivolous, if the requirements of that section are met.

 Section 1.6662-4(a) of the regulations generally provides that if any portion of an underpayment of any income tax imposed under subtitle A of the Code that is required to be shown on a return is attributable to a substantial understatement of such income tax, there is added to the tax an amount equal to 20 percent of such portion. Section 1.6662-4(a) further provides that, except in the case of any item attributable to a tax shelter, an understatement is reduced by the portion of the understatement that is attributable to positions for which there was substantial authority or adequate disclosure. Currently, under section 1.6662-4(e)(2), this adequate disclosure exception will not apply if the position on the return is frivolous.

 As a result of OBRA 1993, the minimum standard that a disclosed return position must satisfy to avoid either the penalty for disregarding rules or regulations or for a substantial understatement of income tax has been raised from "not frivolous" to "reasonable basis." In addition, there is no longer a disclosure exception for the negligence penalty and, to avoid that penalty, the return position generally must satisfy the new reasonable basis standard.

 These rules generally apply to returns that are due (without regard to extensions for filing) after December 31, 1993. However, the rules relating to changes to the penalties for negligence or disregard of rules or regulations will not apply to returns, including qualified amended returns, filed on or before March 14, 1994.

SPECIAL ANALYSES

 It has been determined that this Treasury decision is not a significant regulatory action as defined in EO 12866. Therefore, a regulatory assessment is not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to these regulations, and therefore, a Regulatory Flexibility Analysis is not required. Pursuant to section 7805(f) of the Internal Revenue Code, these temporary regulations will be submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on their impact on small business.

DRAFTING INFORMATION

 The principal author of these regulations is David L. Meyer, Office of Assistant Chief Counsel, Income Tax and Accounting, Internal Revenue Service. However, other personnel from the IRS and Treasury Department participated in their development.

LIST OF SUBJECTS 26 CFR PART 1

 Income taxes, Reporting and recordkeeping requirements.

AMENDMENTS TO THE REGULATIONS

Accordingly, 26 CFR part 1 is amended as follows:

PART 1 -- INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 1.6662-0 is amended by revising the introductory language and adding an entry for section 1.6662-7T to read as follows:

SECTION 1.6662-0 TABLE OF CONTENTS.

This section lists the captions that appear in sections 1.6662-1 through 1.6662-7T.

* * * * *

SECTION 1.6662-7T OMNIBUS BUDGET RECONCILIATION ACT OF 1993 CHANGES TO THE ACCURACY-RELATED PENALTY (TEMPORARY).

(a) In general.

(1) Scope.

(2) Effective date.

(b) No disclosure exception for negligence penalty.

(c) Disclosure standard for other penalties is reasonable basis.

(d) Definition of reasonable basis.

(1) In general. [Reserved].

(2) Relationship to other standards.

Par. 3. Section 1.6662-7T is added to read as follows:

SECTION 1.6662-7T OMNIBUS BUDGET RECONCILIATION ACT OF 1993 CHANGES TO THE ACCURACY-RELATED PENALTY (TEMPORARY).

(a) IN GENERAL -- (1) SCOPE. The Omnibus Budget Reconciliation Act of 1993 made certain changes to the accuracy-related penalty in section 6662. This section provides rules reflecting those changes.

(2) EFFECTIVE DATE. This section applies to returns that are due (without regard to extensions of time for filing) after December 31, 1993. However, the provisions of these regulations relating to the penalties for negligence or disregard of rules or regulations will not apply to returns (including qualified amended returns) that are filed on or before [INSERT DATE THIS DOCUMENT IS FILED WITH THE FEDERAL REGISTER].

(b) NO DISCLOSURE EXCEPTION FOR NEGLIGENCE PENALTY. The penalty for negligence in section 6662(b)(1) may not be avoided by disclosure of a return position.

(c) DISCLOSURE STANDARD FOR OTHER PENALTIES IS REASONABLE BASIS. The penalties for disregarding rules or regulations in section 6662(b)(1) and for a substantial understatement of income tax in section 6662(b)(2) may be avoided by adequate disclosure of a return position only if the position has at least a reasonable basis. See sections 1.6662-3(c) and 1.6662-4(e) and (f) for other applicable disclosure rules.

(d) DEFINITION OF REASONABLE BASIS -- (1) IN GENERAL. [Reserved].

(2) RELATIONSHIP TO OTHER STANDARDS. The reasonable basis standard is significantly higher than the not frivolous standard applicable to preparers under section 6694 and defined in section 1.6694-2(c)(2).