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Tax Shelters and Small Businesses: Reform Would Curb Penalties for not Reporting 'Listed Transactions'

By Caleb Groos on June 15, 2009 12:43 PM

We will likely soon see legislation to curb IRS enforcement of penalties against small businesses for engaging in 'listed transactions.' Fees for not reporting these transactions aim to curb the use of abusive tax shelters. They target businesses and individuals abusing transactions such as certain benefits plans to avoid taxes. Its unintended victims: small businesses who purchased benefits plans from financial planners without knowing they were participating in any problem transaction, and ended up owing enormous penalties.

The scenario is enough to scare any small business owner. You purchase a retirement or life insurance plan to offer your employees. Four years later you get audited and learn that the IRS finds the plan to be one of its listed transactions. For not reporting the transaction (even if it became listed after the fact), your business owes the IRS $1,200,000. The kicker -- this applies even if you got no tax benefit from the transaction. The second kicker (as if you needed one) -- the fine amount is set and you can't dispute it in court.

As reported by the AP, the chairmen of the House and Senate tax committees intend to change this. They want to pass legislation lowering the fines for not reporting listed transactions. In the meantime, they've asked the IRS to stop enforcing the penalty fees against small businesses where the penalty fee exceeds any tax benefit gained.

Called Section 6707A penalties, these fines amount to $100,000 per individual and $200,000 per business entity for each year that a listed transaction should have been reported. An additional rub for small businesses -- they often get hit for both individual and business entity fees, totaling $300,000 per year. Current law forbids even the IRS from rescinding these penalties.

These penalties apply equally, regardless not only of any tax benefit gained or any ill-intent, but also regardless of business size. In fact, small businesses can get hit with higher penalties because they often draw both individual and business entity liability while large corporations typically only receive the business entity fines.

The biggest problem small businesses have with the current rule, however, is that you can violate it without ever knowing or intending to violate it. Small business are much less likely than financial planners or tax lawyers to know the specifics about what types of transactions have been forbidden as abusive tax shelters.

Hopefully, new legislation will bring more fairness to Section 6707A penalties.

What can small businesses do in the meantime? Even if we get changes to the tax code, it's a good idea to:

  1. Make sure they are up to speed and keep you up to speed on any similarities between benefit plans you purchase and listed transactions; and
  2. Make sure your tax preparer double checks your plans against the listed transactions.

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