Form 8275 Disclosure Statement: A Tax Practitioner's Best Friend Forever

There is no denying it. My Best Friend Forever, my BFF, is IRS Form 8275 – which I affectionately call Disclosure Statement.  The reason being, Form 8275 keeps me and my clients (mostly) out of trouble.  And it can do the same for you and your clients. 

For those of you not familiar with Disclosure Statement, Form 8275 is used by taxpayers and tax return preparers to disclose items or positions that are not otherwise adequately disclosed on a tax return to avoid certain penalties.   So long as the tax reporting position has a reasonable basis, a properly completed Form 8275 will (i) immunize taxpayers from an accuracy-related penalty due to disregard of rules or to a substantial understatement of income tax for non-tax shelter items, (ii) eliminate exposure to a 40% penalty for transactions lacking in economic substance, and (iii) mitigate return preparer penalties for tax understatements due to unreasonable positions or disregard of rules.  All of this may be accomplished in one single Form.

Form 8275, however, is not just a good penalty-defense maneuver.  It is also a cost-savings mechanism.   Generally speaking, there are two ways to support a tax position:   with substantial authority or with reasonable basis accompanied with a Form 8275.   Substantial authority requires that the weight of authorities supporting the tax position must be substantial compared to those not supporting it.   This requires more expansive research analysis to evaluate compared to determining reasonable basis, which requires only that the position be reasonably based on one or more tax authorities taking into account the  relevance and persuasiveness of the authorities, and subsequent developments.   Less work means less professional fees, which, putting self-interest aside, is a better result for my clients.

Truth be told, I’ve not always been friends with Form 8275.   Early in my career, I viewed Disclosure Statement as the equivalent of a “Kick Me” sign placed on the back of a book-smart school kid (a not-so-fun flashback for some of us).   In other words, I was convinced it was an audit flag for the IRS.  And there was some legitimacy to that concern given the tax/IRS climate of the day and lack of widespread use of the form.  But in today’s era of aggressive IRS enforcement, more practitioners are filing Form 8275 – sometimes only as a precautionary measure.  And with the IRS labeling an increasing number of transactions as abusive and requiring annual disclosures of such “reportable” transactions on Form 8886, the addition of a Form 8275 to a tax return is more akin to a ripple than a splash in the IRS audit pool.

On the topic of Form 8886, let me make an obvious but important point:   It is not a Form 8275.  And that matters because without a Form 8275, the taxpayer is exposed to a potential 40% penalty for a nondisclosed noneconomic substance transaction.  IRC Sec. 6662(i).  Stated differently, even when a Form 8886 disclosure form is included with the return, such as to disclose participation in a microcaptive transactions, the taxpayer is still exposed to a potential 40% penalty.   This is a real threat, as the IRS is frequently attacking transactions based on a lack of economic substance under Code Section 7701(o), codified in 2010.  In my experience, the IRS is asserting a 40%  penalty as a matter of routine in virtually all microcaptive audits based on the alleged finding of lack of economic substance.


So the take home message:   Make a new best friend.   Consider Form 8275 Disclosure Statement as a potential planning tool and IRS penalty defense weapon.  

If you have any questions about this blog post or any other tax-related matter, please do not hesitate to contact me at (214) 749-2464 or adaddino@meadowscollier.com.