2004 Jobs Act: Overhaul of Tax Shelter Rules

New tax legislation imposes significant new penalties on the failure of taxpayers to disclose their participation in a wide range of potentially abusive transactions.

The American Jobs Creation Act of 2004 was enacted on October 22, 2004. While the Act made changes in many areas of the tax law, the rules relating to tax shelters were significantly overhauled - principally by imposing various draconian penalties that will apply to taxpayers who fail to disclose their participation in a wide range of transactions (usually, but not always, tax-motivated) that are thought to be potentially abusive.

These legislative changes are the most recent in a long series of initiatives undertaken over the past seven years by Congress, the Department of the Treasury and the Internal Revenue Service to shut down the tax shelter industry. Prior to the Act, the last legislative attempt to deter the proliferation of tax shelter transactions came in 1997 when Congress enacted enhanced registration and penalty requirements relating to certain specified tax-motivated transactions. Although the Treasury Department went on to promulgate several sets of tax shelter regulations in 2002 and 2003, Congress believed that the various rules relating to taxpayer disclosure, tax shelter registration and investor list maintenance should be revised and streamlined so as to better address the current tax shelter landscape, and enforced through the imposition of meaningful penalties. As a result, the new legislation has amended the Internal Revenue Code to require the disclosure of a wide range of potentially abusive transactions by both taxpayers and certain "material advisors," and has introduced a series of substantial monetary and other penalties to punish any failure to comply with these disclosure requirements.

Reportable Transactions

The new enhanced penalty and other provisions described below will generally apply only to the extent that a taxpayer has participated in a "reportable transaction" and has failed to disclose it to the IRS as required. There are currently six different types of "reportable transactions":

Listed Transactions. Any transaction designated as such by the IRS, together with any "substantially similar" transaction. Most abusive tax avoidance transactions that have been widely used and/or highly publicized have been designated as "listed" transactions by the IRS.

Confidential Transactions. Any transaction that is offered to a taxpayer under...