What Are the IRS’ “Listed Transactions?”
April 21, 2023
Through its rulemaking authority, the Internal Revenue Service (IRS) has identified several types of transactions as “listed transactions.” As the IRS explains, a listed transaction is any transaction that is, “the same as, or substantially similar to, one that the IRS has determined to be a tax avoidance transaction and identified by IRS notice or other form of published guidance.” As the IRS also notes, “[t]he parties who participate in listed transactions may be required to disclose the transaction as required by the regulations, register the transaction with the IRS, or maintain lists of investors in the transactions and provide the list to the IRS on request.”
For high-income taxpayers, understanding the IRS’ “listed transactions” is extremely important. Not only can failing to disclose or register a listed transaction as required lead to adverse consequences, but engaging in (or participating in) a listed transaction also significantly increases high-income taxpayers’ risk of facing an IRS audit or criminal tax fraud investigation. These inquiries can result in substantial liability; and, in criminal cases, targeted taxpayers can also face federal imprisonment.
Examples of the IRS’ “Listed Transactions”
So, what qualifies as a “listed transaction” according to the IRS? Some examples of these transactions include:
1. Syndicated Conservation Easements
The IRS labeled syndicated conservation easements as listed transactions in 2017. However, a U.S. Tax Court ruling in 2022 invalidated this decision. In response to the Tax Court’s ruling (which was based on procedural, rather than substantive, issues with the IRS’ syndicated conservation easement rules), the IRS once again proposed rules that would classify certain syndicated conservation easements as listed transactions.
As of April 2023, the IRS’ proposed rules regarding syndicated conservation easements remain pending. However, as combating abusive syndicated conservation easements has long been an IRS priority, it appears likely that the rules will become final later this year. If this happens, many syndicated conservation easements will once again be classified as listed transactions, and this means that high-income taxpayers who use these easements for tax mitigation will need to be very careful to avoid unwanted IRS scrutiny.
2. Basket Option Contracts
As the IRS explains, a basket option contract “attempts to defer income recognition and convert short-term capital gain and ordinary income to long-term capital gain using a contract denominated as an option contract.” Similar to syndicated conservation easements, while basket option contracts can be used as legitimate tax mitigation tools, they also present a significant risk for abuse—according to the IRS. In Internal Revenue Bulletin 2015-46, the IRS identifies the following as grounds for labeling a basket option contract as an abusive tax scheme:
- The counterparty holds the assets in the basket as an agent of the taxpayer, making the taxpayer the beneficial owner of the assets for federal tax purposes;
- The contract is not a true option contract for federal tax purposes;
- Changes to the assets in the basket qualify as a taxable disposition under Section 1001 of the Internal Revenue Code; or,
- The taxpayer owns separate contractual rights to each asset in the basket, such that each change to the assets in the basket is a taxable transaction under Section 1001.
3. Distressed Asset Trusts
With a distressed asset trust, one party “contributes one or more distressed assets . . . with a high basis and low fair market value to a trust or series of trusts and sub-trusts, and a U.S. taxpayer acquires an interest in the trust (and/or series of trusts and/or sub-trusts) for the purpose of shifting a built-in loss from the tax indifferent party to the U.S. taxpayer that has not incurred the economic loss.” Here, too, while these can be valid transactions when structured appropriately and in compliance with the Internal Revenue Code, mistakes and misguided efforts by promotors can leave taxpayers exposed to substantial liability and the risk of an IRS audit or investigation.
4. Loss Importation Transactions
The IRS defines a loss importation transaction as a transaction that involves “us[ing] offsetting positions with respect to foreign currency or other property for the purpose of importing a loss, but not the corresponding gain, in determining U.S. taxable income.” IRS Notice 2007-57 identifies several variations of loss importation transactions, all of which will raise red flags at the IRS despite not necessarily involving attempts to unlawfully evade or defeat taxpayers’ federal obligations.
5. S Corporation Tax Shelters
The IRS classifies S corporation tax shelters as listed transactions if they involve “shareholders attempt[ing] to transfer the incidence of taxation on S corporation income by purportedly donating S corporation nonvoting stock to an exempt organization while retaining the economic benefits associated with that stock.” When this allows “the original shareholders . . . to avoid paying income tax on most of the S corporation’s income over a period of time,” it can be deemed an abusive tax scheme under the Internal Revenue Code.
Again, these are just examples. The IRS has identified several other types of “listed transactions,” all of which present substantial risks for high-income taxpayers who utilize relevant tax planning strategies to mitigate their federal income tax liability.
Understanding the Risks of “Listed Transactions” for High-Income Taxpayers
When engaging in listed transactions, high-income taxpayers must ensure that they comply with all pertinent rules and provisions of the Internal Revenue Code, and they should specifically structure and document these transactions with federal tax law compliance in mind. While listed transactions are not inherently unlawful, they present high risks of triggering IRS scrutiny. Taxpayers who have documentation on hand that they can use to demonstrate compliance will often be able to resolve IRS inquiries relatively quickly—with the help of experienced tax counsel. In contrast, those who don’t can face an uphill battle to avoid liability for back taxes, interest and penalties.
Schedule a Confidential Initial Consultation at Brown Tax, P.C.
If you are a high-income or high-net-worth taxpayer and you have questions or concerns about engaging in one of the IRS’ “listed transactions,” we invite you to contact us for more information. To schedule a confidential initial consultation at Brown Tax, P.C., please call 888-870-0025 or inquire online today.