Reportable Transactions and Transactions of Interest

The Internal Revenue Service (IRS) requires taxpayers to disclose certain transactions that have the potential for tax avoidance or evasion. Understanding what constitutes a reportable transaction and the specific Transactions of Interest identified by the IRS is crucial for tax compliance and avoiding penalties.

What is a Reportable Transaction?

A reportable transaction is any transaction that the IRS has determined has the potential for tax avoidance or evasion. Taxpayers who participate in such transactions are required to disclose them to the IRS on Form 8886, Reportable Transaction Disclosure Statement. The disclosure requirements help the IRS identify potentially abusive tax avoidance schemes and ensure proper tax compliance.

Categories of Reportable Transactions

The IRS categorizes reportable transactions into several types:

1. Listed Transactions: Specific transactions identified by the IRS as tax avoidance schemes. These are transactions that the IRS has determined are the same as, or substantially similar to, tax avoidance transactions identified in published guidance. Listed transactions are a subset of reportable transactions that the IRS has definitively determined to be abusive tax avoidance schemes.

2. Confidential Transactions: Transactions offered under conditions of confidentiality. This includes transactions where the advisor places limitations on disclosure of the tax treatment or tax structure of the transaction.

3. Transactions with Contractual Protection: Transactions where the taxpayer has the right to a full or partial refund of fees if the tax benefits are not realized, or where fees are contingent on the taxpayer's realization of tax benefits.

4. Loss Transactions: Transactions that result in the taxpayer claiming a loss under Section 165 of the Internal Revenue Code in an amount that equals or exceeds certain thresholds in a single year or over multiple years.

5. Transactions of Interest: Transactions that the IRS and the Treasury Department believe have the potential for tax avoidance or evasion but lack sufficient information to determine whether they should be identified specifically as a tax avoidance transaction.

The Difference Between Reportable Transactions and Listed Transactions

It is important to understand the distinction between reportable transactions generally and listed transactions specifically. Reportable transactions is a broad category that encompasses all transactions the IRS requires to be disclosed, including listed transactions, transactions of interest, confidential transactions, transactions with contractual protection, and loss transactions.

Listed transactions are a specific subset of reportable transactions. The key difference is that listed transactions are transactions that the IRS has definitively determined to be abusive tax avoidance schemes. When the IRS identifies a transaction as a listed transaction, it is making a determination that the transaction is wrongful—it is designed to avoid or evade taxes in an abusive manner. The IRS will challenge and disallow the tax benefits claimed from listed transactions.

In contrast, other reportable transactions (such as Transactions of Interest) represent transactions that may have potential for abuse, but the IRS lacks sufficient information to definitively determine whether they should be identified as tax avoidance schemes. Transactions of Interest, for example, are transactions the IRS believes may be abusive but requires more information before making a definitive determination.

The consequences differ significantly. Taxpayers who participate in listed transactions face not only disclosure requirements but also the certainty that the IRS will challenge and likely disallow the tax benefits claimed. Taxpayers may be required to pay additional taxes, interest, and penalties on disallowed amounts. The penalties for failing to disclose listed transactions are also substantially higher (up to $200,000) compared to other reportable transactions.

For Transactions of Interest and other non-listed reportable transactions, the disclosure requirement serves primarily to provide the IRS with information to evaluate whether the transaction should be identified as a listed transaction in the future. While the IRS may still challenge these transactions, the determination that they are abusive has not yet been made.

What are Transactions of Interest?

Transactions of Interest (TOI) represent a specific category of reportable transactions. These are transactions that the IRS and Treasury Department believe may have the potential for tax avoidance or evasion, but they do not yet have sufficient information to determine whether the transaction should be specifically identified as a tax avoidance transaction.

The TOI category applies to transactions entered into on or after November 2, 2006. Transactions that are the same as, or substantially similar to, identified Transactions of Interest are subject to disclosure requirements under Section 6011 (Form 8886), material advisor disclosure statement requirements under Section 6111, and list maintenance requirements under Section 6112.

Penalties for Non-Compliance

Failure to comply with disclosure requirements can result in significant penalties. Material advisors who fail to file required disclosure statements may be subject to penalties under Section 6707(a). Material advisors who fail to maintain or provide investor lists may be subject to penalties under Section 6708(a). Additionally, the IRS may impose accuracy-related penalties under Section 6662 on parties involved in these transactions.

Identified Transactions of Interest

The IRS has identified several specific Transactions of Interest. Below is a detailed description of each:

Notice 2007-72: Contribution of Successor Member Interest

Published: August 14, 2007

This transaction involves a taxpayer directly or indirectly acquiring certain rights in real property or in an entity that directly or indirectly holds real property. The taxpayer then transfers these rights more than one year after the acquisition to an organization described in Section 170(c) of the Internal Revenue Code (a charitable organization). The taxpayer claims a charitable contribution deduction under Section 170 that is significantly higher than the amount that the taxpayer paid to acquire the rights. This transaction structure allows taxpayers to claim inflated charitable deductions by transferring property rights to charitable organizations at values that exceed their actual acquisition costs. The IRS is concerned that taxpayers may be using inflated appraisals or valuation methods to claim deductions that do not reflect the true economic value of the contributed rights.

Example: A taxpayer purchases a membership interest in a limited liability company (LLC) that owns commercial real estate for $100,000. More than one year later, the taxpayer transfers this membership interest to a qualified charitable organization. The taxpayer obtains an appraisal valuing the membership interest at $500,000 and claims a charitable contribution deduction of $500,000 on their tax return, despite having only paid $100,000 for the interest. The IRS would view this as a transaction of interest because the claimed deduction significantly exceeds the taxpayer's basis in the property, potentially allowing for an inappropriate tax benefit.

Full Notice: Notice 2007-72 PDF

Notice 2007-73: Grantor Trust Transactions

Published: August 14, 2007

This transaction uses a grantor trust and the purported termination and subsequent re-creation of the trust's grantor trust status. The purpose is to allow the grantor to claim a tax loss greater than any actual economic loss sustained by the taxpayer or to avoid inappropriately the recognition of gain. By manipulating the grantor trust status through termination and re-creation, taxpayers attempt to generate artificial tax losses or defer the recognition of taxable gains that would otherwise be required. The IRS views these transactions as potentially abusive because they rely on technical interpretations of grantor trust rules to achieve tax results that do not reflect the underlying economic reality of the transactions.

Example: A taxpayer creates a grantor trust and transfers assets with a basis of $500,000 into the trust. The assets decline in value to $400,000. The taxpayer then arranges for the trust to terminate its grantor trust status and immediately re-creates grantor trust status. The taxpayer claims a tax loss of $500,000 (the full basis) on the termination, even though the actual economic loss is only $100,000. Alternatively, if the assets had appreciated, the taxpayer might claim that the termination and re-creation allows them to avoid recognizing the gain. The IRS would view this as a transaction of interest because the taxpayer is claiming a tax loss greater than the actual economic loss sustained, or avoiding gain recognition, through manipulation of grantor trust status.

Full Notice: Notice 2007-73 PDF

Notice 2008-99: Sale of Charitable Remainder Trust Interests

Published: October 31, 2008

This transaction involves a sale or other disposition of all interests in a charitable remainder trust subsequent to the contribution of appreciated assets to and their reinvestment by the trust. The transaction results in the grantor or other noncharitable recipient receiving the value of that person's trust interest while claiming to recognize little or no taxable gain. This structure allows taxpayers to effectively monetize appreciated assets through charitable remainder trusts while avoiding the recognition of capital gains that would typically be required upon disposition of the assets. The IRS is concerned that these transactions may be structured to allow taxpayers to receive the economic benefit of their appreciated assets without paying the taxes that would normally be due, undermining the intended tax treatment of charitable remainder trusts.

Example: A taxpayer owns appreciated stock worth $2 million with a basis of $200,000. The taxpayer contributes this stock to a charitable remainder trust, and the trust sells the stock and reinvests the proceeds in other assets. The trust makes periodic payments to the taxpayer as the income beneficiary. After the trust has reinvested the proceeds, the taxpayer sells all of their interests in the charitable remainder trust (both the income interest and any remainder interest) to a third party for a substantial cash payment. The taxpayer claims that the sale of their trust interests results in little or no taxable gain, even though they are receiving the economic value of the appreciated assets that were contributed to the trust. The IRS would view this as a transaction of interest because the taxpayer has effectively monetized the appreciated assets while avoiding the capital gains tax that would normally be due upon the sale of such assets.

Full Notice: Notice 2008-99 PDF

Notice 2009-7: Domestic Partnership Subpart F Income

Published: December 29, 2008

This transaction uses a domestic partnership to prevent the inclusion of subpart F income. In this transaction, a U.S. taxpayer that owns controlled foreign corporations (CFCs) that hold stock of a lower-tier CFC through a domestic partnership takes the position that subpart F income of the lower-tier CFC or an amount determined under Section 956(a) related to holdings of United States property by the lower-tier CFC does not result in income inclusions under Section 951(a) for the U.S. taxpayer. By interposing a domestic partnership in the ownership chain, taxpayers attempt to avoid the immediate inclusion of subpart F income that would otherwise be required for U.S. shareholders of controlled foreign corporations. The IRS views these transactions as potentially abusive because they may be designed to exploit technical interpretations of the subpart F rules to defer or avoid U.S. taxation on foreign income that should be currently includible.

Example: A U.S. taxpayer owns 100% of a controlled foreign corporation (CFC-1), which directly owns 100% of a lower-tier CFC (CFC-2). CFC-2 earns $5 million in subpart F income, which would normally require the U.S. taxpayer to include this income under Section 951(a) because they are a U.S. shareholder of CFC-1, which owns CFC-2. However, the taxpayer restructures the ownership so that CFC-1 holds its stock in CFC-2 through a domestic partnership, rather than directly. The taxpayer then takes the position that because CFC-1's ownership of CFC-2 is held through a domestic partnership, the subpart F income of CFC-2 (or amounts determined under Section 956(a) related to U.S. property holdings) does not result in an income inclusion for the U.S. taxpayer under Section 951(a). The IRS would view this as a transaction of interest because the domestic partnership structure appears designed to prevent the inclusion of subpart F income that would otherwise be required, potentially allowing indefinite deferral of U.S. tax on foreign income.

Full Notice: Notice 2009-7 PDF

Notice 2015-74: Basket Contracts

Published: November 16, 2015

This notice describes certain transactions denominated as an option, notional principal contract, forward contract, or other derivative contract to receive a return based on the performance of a basket of referenced assets (the "reference basket"). The assets that comprise the reference basket may include interests in entities that trade securities, commodities, foreign currency, or similar property (referred to as "hedge fund interests"), as well as securities, commodities, foreign currency, or similar property or positions in such property. The Basket Contracts attempt to defer income recognition and may attempt to convert short-term capital gain and ordinary income to long-term capital gain. These derivative contracts are structured to provide returns based on the performance of underlying assets while attempting to achieve more favorable tax treatment than would be available through direct ownership of those assets. The IRS is concerned that these contracts may be used to inappropriately defer income that should be currently recognized or to convert income that should be taxed as ordinary income or short-term capital gain into long-term capital gain.

Example: A taxpayer enters into a contract with a financial institution that is denominated as an option, notional principal contract, forward contract, or other derivative. The contract provides returns based on the performance of a reference basket that includes interests in hedge funds, securities, commodities, foreign currency, or similar property. The taxpayer actively manages the assets in the reference basket, generating trading gains and income. The contract is structured so that the taxpayer takes the position that income is not recognized until the contract terminates or is settled, potentially deferring recognition for multiple years. Additionally, the taxpayer may claim that when gains are recognized, they qualify as long-term capital gains, even though the underlying trading activity would generate ordinary income or short-term capital gains if the assets were held directly. The IRS would view this as a transaction of interest because the basket contract appears designed to defer income recognition and convert ordinary income and short-term capital gains into long-term capital gains, achieving more favorable tax treatment than would be available through direct ownership of the assets.

Full Notice: Notice 2015-74 PDF

Notice 2016-66: Section 831(b) Micro-Captive Insurance

Published: November 1, 2016

This notice describes transactions in which a taxpayer attempts to reduce the aggregate taxable income of the taxpayer, related persons, or both, using contracts that the parties treat as insurance contracts and a related company that the parties treat as a captive insurance company. Each entity that the parties treat as an insured entity under the contracts claims deductions for premiums for insurance coverage. The related company that the parties treat as a captive insurance company elects under Section 831(b) of the Internal Revenue Code to be taxed only on investment income and therefore excludes the payments directly or indirectly received under the contracts from its taxable income. The manner in which the contracts are interpreted, administered, and applied is inconsistent with arm's length transactions and sound business practices. These micro-captive insurance arrangements are structured to create tax deductions for insurance premiums while the related captive insurance company avoids taxation on those premium payments through the Section 831(b) election. The IRS is concerned that these arrangements may lack the characteristics of genuine insurance and may be primarily designed to achieve tax benefits rather than provide legitimate insurance coverage.

Example: A business owner creates a captive insurance company and elects to have it taxed under Section 831(b), which allows small insurance companies (with annual premiums of $2.2 million or less, adjusted for inflation) to be taxed only on investment income. The business owner's operating companies pay substantial premiums to the captive insurance company for various types of insurance coverage, claiming deductions for these premium payments. The captive insurance company, which is owned by the business owner or related parties, receives these premiums but pays out very few claims, and the premiums are often invested and eventually returned to the business owner or related parties through loans or other mechanisms. The IRS would view this as a transaction of interest because the arrangement may lack the risk distribution and risk shifting characteristics of genuine insurance, and the premiums may be excessive compared to the actual risk being insured, suggesting the primary purpose is tax avoidance rather than legitimate insurance coverage.

Note: Notice 2017-8 amended the due date for filing of a disclosure with the Office of Tax Shelter Analysis for Notice 2016-66 transactions.

Full Notice: Notice 2016-66 PDF

Disclosure Requirements

Form 8886: Reportable Transaction Disclosure Statement

Taxpayers who participate in reportable transactions must file Form 8886 with their tax return for each year in which they participate in the transaction. The form must also be filed with the Office of Tax Shelter Analysis (OTSA) at:

Internal Revenue Service
OTSA Mail Stop 4915
1973 Rulon White Blvd
Ogden, UT 84201

Material Advisor Requirements

Material advisors (persons who provide material aid, assistance, or advice with respect to organizing, managing, promoting, selling, implementing, or carrying out any reportable transaction) must:

1. File disclosure statements under Section 6111
2. Maintain lists of investors under Section 6112
3. Provide such lists to the IRS upon request

Important Considerations

Timing of Disclosure

Disclosure requirements apply to transactions entered into on or after November 2, 2006. Taxpayers should carefully review any transaction that may fall into one of the reportable transaction categories.

Substantially Similar Transactions

Transactions that are the same as, or substantially similar to, identified Transactions of Interest are subject to the same disclosure requirements. Taxpayers should not assume that minor variations in structure will avoid disclosure obligations.

Professional Advice

Given the complexity of these rules and the significant penalties for non-compliance, taxpayers should consult with qualified tax professionals when evaluating whether a transaction may be reportable.

Conclusion

Understanding reportable transactions and Transactions of Interest is essential for tax compliance. The IRS requires disclosure of these transactions to identify potentially abusive tax avoidance schemes. Taxpayers who participate in transactions that are the same as, or substantially similar to, identified Transactions of Interest must comply with disclosure requirements or face significant penalties.

If you believe you may have participated in a reportable transaction, it is important to consult with a qualified tax professional to ensure proper disclosure and compliance with IRS requirements.