Exempt Organizations Advisory - IRS and Treasury Issue Final Regulations Regarding Excise Taxes on Prohibited Tax Shelter Transactions and Related Disclosure Requirement

Catherine W. Wilkinson (cwilkinson@steptoe.com)
Suzanne Ross McDowell (smcdowell@steptoe.com)           

Today, the IRS and Treasury issued final regulations under section 4965 and section 6011(g) relating to entity-level and manager-level excise taxes with respect to prohibited tax shelter transactions to which tax-exempt entities are parties. The final regulations replace proposed regulations that were issued in 2007. The IRS and Treasury also issued final regulations under sections 6011, 6033, and 6071 relating to certain disclosure and return filing obligations with respect to such transactions. The final regulations replace temporary regulations that were issued in 2007. In both cases, the final regulations adopt the earlier regulations with certain minor modifications. 

• Section 4965 was enacted as part of the Tax Increase Prevention and Reconciliation Act of 2005 and imposes two excise taxes with respect to certain tax shelter transactions to which tax-exempt entities are parties.  Section 4965(a)(1) imposes an entity-level excise tax on certain tax-exempt entities that are parties to “prohibited tax shelter transactions.” Section 4965(a)(2) imposes a manager-level excise tax on “entity managers,” as defined in section 4965(d), of tax-exempt entities who approve the entity as a party (or otherwise cause the entity to be a party) to a prohibited tax shelter transaction and know or have reason to know, at the time the tax- exempt entity enters into the transaction, that the transaction is a prohibited tax shelter transaction.
• Under the final regulations, a tax-exempt entity is a party to a prohibited tax shelter transaction if the entity (1) facilitates a prohibited tax shelter transaction by reason of its tax-exempt, tax indifferent or tax-favored status; or (2) is identified in published guidance, by type, class or role, as a party to a prohibited tax shelter transaction. The final regulations eliminated the part of this definition in the proposed regulations that included a tax-exempt entity that enters into a transaction to reduce or eliminate its own tax liability. However, the preamble to the final regulations notes that that the IRS and Treasury may identify in published guidance specific transactions or circumstances in which a tax-exempt entity that enters into a transaction to reduce or eliminate its own tax liability will be treated as a party to a prohibited tax shelter transaction for purposes of section 4965.
• The final regulations also slightly modify the rule in the proposed regulations regarding the required disclosure by a taxable party to a prohibited tax shelter transaction. Under the final regulations, a taxable party to a prohibited tax shelter transaction must disclose by statement to each tax-exempt entity that the taxable party knows or has reason to know is a party to such transaction that the transaction is a prohibited tax shelter transaction. Under the final regulations, the taxable party must make this disclosure within 60 days after the last to occur of (1) the date the person becomes a taxable party to the transaction, (2) the date the taxable party knows or has reason to know that the tax-exempt entity is a party to the transaction, or (3) the date the final regulations are published in the Federal Register.
• The regulations can be accessed here.