I have not seen any discussion of this point, and I may be off-base, but has anyone focused on section 211 of H.R. 4297, the pending tax reconciliation bill?  The bill would add, in new § 4965 of the Code, a hefty excise tax on a tax-exempt organization that "is a party to a prohibited tax shelter transaction," defined by reference to Code § 6077A(c) and Code § 6011 as a "listed" transaction and other "reportable" transactions.  New Code § 4965 also would impose a hefty excise tax on an entity manager of an exempt organization if the manager knows or had reason to know that the transaction was a prohibited tax shelter transaction. New Code § 6033(a)(2), in turn, would impose disclosure obligations on the tax-exempt entity, with hefty penalties on the entity and individual for failure to disclose any such transaction. New Code § 6011(g) would require other parties to a prohibited tax shelter transaction to disclose to an exempt organization party that the transaction was a prohibited tax shelter transaction.

What are the limitations on Treasury’s authority in defining the transactions subject to these rules?  Is it appropriate to apply the tax shelter rules willy nilly to charitable organizations?  I may be barking up the wrong tree, as Independent Sector wrote a letter last Friday to the Senate Finance Committee in support of these rules:

The package of charitable incentives and reforms that is now being offered to the conference by the Senate Finance Committee will strengthen the work of our sector by deterring and punishing abuses by individuals who exploit charitable organizations for their personal gain, without imposing unnecessary costs or hardships on reputable charities. Moreover, the proposed reforms strike the right balance between legitimate government oversight and protecting the independence that charitable organizations need to remain innovative and effective. We strongly encourage you to include them in the tax bill you are now debating.

Comments are open.

Update:  The ABA Tax Section raised questions about this proposal in a February 3, 2006 letter to the Senate Finance Committee and House Ways and Means Committee:

We applaud the objective … to prevent and penalize participation by exempt organizations in abusive tax shelters. We believe, however, that section 311 as currently drafted is overbroad and could inhibit the participation of exempt organizations in common transactions that are not abusive.

By imposing an excise tax on an exempt organization that is a party to a "prohibited tax shelter transaction" in addition to imposing a penalty on an exempt organization that fails to disclose such transaction, section 311 treats exempt organizations more harshly than taxable organizations and individuals who are subject to penalty under section 6707A of the Code. Such taxpayers may avoid section 6707A penalties with respect to reportable and listed transactions by making the required disclosure with a return. In addition, a taxable person who realizes a tax benefit from the transaction has the opportunity to challenge the Internal Revenue Service’s position that the transaction is objectionable and, if successful, avoids any additional tax or penalty.

The excise tax proposed by section 311, on the other hand, is a "no-fault" penalty, imposed irrespective of whether the listed or reportable transaction is ultimately determined to be abusive. Such a tax might be warranted if the "listed" and "reportable" transaction definitions were more precisely targeted to encompass only transactions that are clearly abusive. Those definitions are designed to encourage disclosure of a wide range of transactions, however, and are therefore likely to remain broad and imprecise, and to include within their scope legitimate transactions that should not give rise to penalties.

For example, under section 6707A(c)(2), a "listed transaction" includes a transaction "substantially similar" to an existing listed transaction. Because various legitimate financial products, such as equity swaps, may be "substantially similar" to contingent notional principal contracts designated as listed transactions by IRS Notice 2002-35, many taxpayers have made protective filings with the Internal Revenue Service to avoid possible penalties for failing to disclose participation in common investment management transactions. Under proposed section 311, exempt organizations would have to refrain from entering into such legitimate transactions to avoid the potential imposition of the no-fault penalty.

With respect to "reportable transactions" that are confidential transactions or transactions with contractual protection, in contrast to listed transactions, the IRS has made no determination that any such transaction is an abusive tax shelter. Indeed, the proposed legislation misconstrues the role of the reporting requirements related to potential tax shelters. These requirements are intended to provide the IRS with information on a timely basis so that the IRS may subsequently determine which transactions to examine, and from those examined, which transactions to challenge. Moreover, due to the penalties imposed on those who fail to comply with these reporting requirements, taxpayers tend to err on the side of over-reporting. As a result, a large portion of the transactions reported to the IRS may be in compliance with applicable tax laws. We understand, for example, that certain low-income housing transactions (which often involve exempt organization participants) are reported because they could be construed as having contractual protection, notwithstanding that the underlying tax benefits are clearly sanctioned by Congress. Customary agreements by investment managers not to expose exempt organizations to unrelated business income tax could also be construed to involve "contractual protection," and therefore be reportable transactions subject to penalty. There is an insufficient correlation between the enumerated transactions that are reportable or reported, on the one hand, and the presence of an actual abusive tax shelter, on the other hand, to justify the imposition of penalties on tax-exempt entity participants.

We thus suggest that the application of section 311 be limited to imposing an excise tax for failure to disclose "prohibited tax shelter transactions," rather than for entering into such transactions.

If any excise tax is imposed on an exempt organization in connection with a listed or reportable transaction, there should be mechanisms put in place that are reasonably designed to alert exempt organizations to the types of transactions that may be encompassed by the definition of "prohibited tax shelter transactions." Most exempt organizations (as well as many professional advisors who practice primarily in the exempt organizations area) are unfamiliar with the concepts of listed and reportable transactions, and would be at a loss as to what resources to consult in order to identify listed and reportable transactions.

We recommend that any excise tax apply only with respect to participation in those listed transactions that have been specifically identified as such and described in plain language in an IRS Notice or other publication that is directed specifically to exempt organizations. Appropriate notice would include, for example, listing on the IRS web site pages for Charities and Non-Profits. Appropriate references to the site in forms commonly used by charities, such as IRS forms 1023, 1024, and 990, would also be helpful.

If any excise tax will apply to an exempt organization that is a party to a reportable transaction that is not a listed transaction, we suggest that section 311 of S. 2020 be revised to clarify that an exempt organization will not be deemed to know or have reason to know that a transaction was a "reportable transaction" unless and until the exempt organization receives the disclosure described in new section 6011(g), as added by section 311(b)(2) of S. 2020. This clarification is necessary because a reportable transaction may fall into that category as a result of provisions in documents that are provided only to other parties to the transaction, and not to the exempt organization. Section 6011(g) should also be amended to require disclosure to the exempt organization at the inception of the exempt organization’s participation in the transaction. An organization that does not receive the required disclosure should not avoid penalties, however, if the provision causing the transaction to be reportable is contained in a document to which the exempt organization is a party (such as a confidentiality agreement).

We also note the absence of any guidance as to when a tax-exempt entity would be considered to be "a party to" a transaction, as that term is used in new Code section 4965. This determination is critical to evaluating whether the tax-exempt entity may be subject to the proposed tax penalties. The sparse legislative history uses "participate" interchangeably with being a "party," but this does little to elaborate on the nature of tax-exempt entity involvement with a transaction that could expose it to the new penalties. See Joint Committee on Taxation, "Description of the Chairman’s Modification to the Provisions of the ‘Tax Relief Act of 2005,’" 28-29, Nov. 14, 2005, JCX-77-05.

Finally, we recommend that new Code section 4965(a)(2) be revised to clarify that the excise tax on an entity manager would apply only if the manager knew or had reason to know that the transaction was a prohibited tax shelter transaction, determined under the standards recommended above.