Excise Taxes on Prohibited Tax Shelter Transactions and Related Disclosure Requirements; Disclosure Requirements With Respect to Prohibited Tax Shelter Transactions; Requirement of Return and Time for Filing, 36927-36939 [E7-12902]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 72, Number 129 (Friday, July 6, 2007)]
[Proposed Rules]
[Pages 36927-36939]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E7-12902]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1, 53, 54 and 301

[REG-142039-06; REG-139268-06]
RIN 1545-BG18; 1545-BG20


Excise Taxes on Prohibited Tax Shelter Transactions and Related 
Disclosure Requirements; Disclosure Requirements With Respect to 
Prohibited Tax Shelter Transactions; Requirement of Return and Time for 
Filing

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking by reference to temporary 
regulations and notice of proposed rulemaking.

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SUMMARY: This document contains proposed regulations that provide 
guidance under section 4965 of the Internal Revenue Code (Code), 
relating to entity-level and manager-level excise taxes with respect to 
prohibited tax shelter transactions to which tax-exempt entities are 
parties; Sec. Sec.  6033(a)(2) and 6011(g), relating to certain 
disclosure obligations with respect to such transactions; and 
Sec. Sec.  6011 and 6071, relating to the requirement of a return and 
time for filing with respect to section 4965 taxes. In the Rules and 
Regulations section of this issue of the Federal Register, the IRS is 
issuing cross-referencing temporary regulations that provide guidance 
under Sec.  6033(a)(2), relating to certain disclosure obligations with 
respect to prohibited tax shelter transactions; and Sec. Sec.  6011 and 
6071, relating to the requirement of a return and time for filing with 
respect to Sec.  4965 taxes. This action is necessary to implement 
Sec.  516 of the Tax Increase Prevention Reconciliation Act of 2005. 
These proposed regulations affect a broad array of tax-exempt entities, 
including charities, state and local government entities, Indian tribal 
governments and employee benefit plans, as well as entity managers of 
these entities.

DATES: Written or electronic comments and requests for a public hearing 
must be received by October 4, 2007.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-142039-06; REG-
139268-06), room 5203, Internal Revenue Service, PO Box 7604, Ben 
Franklin Station, Washington, DC 20044. Submissions may be hand 
delivered Monday through Friday between the hours of 8 a.m. and 4 p.m. 
to: CC:PA:LPD:PR (REG-142039-06, REG-139268-06), Courier's Desk, 
Internal Revenue Service, 1111 Constitution Avenue, NW., Washington, 
DC. Alternatively, taxpayers may submit comments electronically via the 
Federal eRulemaking Portal at https://www.regulations.gov (IRS-REG-
142039-06; REG-139268-06).

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Galina 
Kolomietz, (202) 622-6070 or Michael Blumenfeld, (202) 622-1124; 
concerning submission of comments and requests for a public hearing, 
Richard Hurst, Richard.A.Hurst@irscounsel.treas.gov (not toll-free 
numbers). For questions specifically relating to qualified pension 
plans, individual retirement accounts, and similar tax-favored savings 
arrangements, contact Dana Barry, (202) 622-6060 (not a toll-free 
number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless it displays a valid 
control number assigned by the Office of Management and Budget.
    The collection of information in this proposed regulation is in 
Sec.  301.6011(g)-1. The collection of information in Sec.  
301.6011(g)-1 flows from section 6011(g) which requires a taxable party 
to a prohibited tax shelter transaction to disclose to any tax-exempt 
entity that is a party to the transaction that the transaction is a 
prohibited tax shelter transaction. The likely recordkeepers are 
taxable entities or individuals that participate in prohibited tax 
shelter transactions. Estimated number of recordkeepers: 1,250 to 6500. 
The information that is required to be collected for purposes of Sec.  
301.6011(g)-1 is a subset of information that is required to be 
collected in order to complete and file Form 8886, ``Reportable 
Transaction Disclosure Statement.'' The estimated paperwork burden for 
taxpayers filling out Form 8886 is approved under OMB number 1545-1800 
and is as follows:

Recordkeeping...........................  6 hr., 13 min.
Learning about the law or the form......  4 hr., 28 min.
Preparing, copying, assembling, and       4 hr., 46 min.
 sending the form to the IRS.
 

    Based on the numbers in the preceding paragraph, the total 
estimated burden per recordkeeper complying with the disclosure 
requirement in Sec.  301.6011(g)-1 will not exceed 15 hr., 27 min. This 
burden has been submitted to the Office of Management and Budget for 
review.
    Books and records relating to the collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law.

Background

    The Tax Increase Prevention and Reconciliation Act of 2005, Public 
Law 109-222 (120 Stat. 345) (TIPRA), enacted on May 17, 2006, defines 
certain transactions as prohibited tax shelter transactions and imposes 
excise taxes and disclosure requirements with respect to prohibited tax 
shelter transactions to which a tax-exempt entity is a party. Section 
516 of TIPRA creates new Sec.  4965 and amends Sec. Sec.  6033(a)(2) 
and 6011(g) of the Code.
    On July 11, 2006, the IRS released Notice 2006-65 (2006-31 IRB 
102), which alerted taxpayers to the new provisions and solicited 
comments

[[Page 36928]]

regarding these provisions. One hundred written comments and numerous 
phone calls were received in response to the request for comments 
contained in Notice 2006-65. On February 7, 2007, the IRS released 
Notice 2007-18 (2007-9 IRB 608), which provided interim guidance 
regarding the circumstances under which a tax-exempt entity will be 
treated as a party to a prohibited tax shelter transaction and 
regarding the allocation to various periods of net income and proceeds 
attributable to a prohibited tax shelter transaction, including amounts 
received prior to the effective date of the Sec.  4965 tax. Notice 
2007-18 also solicited comments from the public regarding these and 
other issues raised by Sec.  4965. Eight written comments and numerous 
phone calls were received in response to the request for comments 
contained in Notice 2007-18. See Sec.  601.601(d)(2)(ii)(b).
    The comments received in response to Notice 2006-65 and Notice 
2007-18 addressed all aspects of the new excise taxes and disclosure 
requirements. While some comments discussed the implications of a broad 
application of the new excise taxes and disclosure requirements, 
commentators generally responded favorably to Congress' effort to 
restrict tax-exempt entities from being involved in Federal tax 
avoidance schemes. Commentators noted the lack of meaningful penalties 
prior to TIPRA for tax-exempt entities involved in tax shelter 
transactions and the need for disclosure in the case where a tax-exempt 
entity is improperly using its tax-exempt status to facilitate a tax 
shelter transaction. After consideration of all comments received, the 
IRS and the Treasury Department are issuing the following proposed 
regulations and soliciting comments thereon. The major areas of 
comments and the IRS and Treasury Department's responses thereto are 
discussed in the following sections.

Explanation of Provisions

Covered Tax-Exempt Entities

    Section 4965(c) defines the term ``tax-exempt entity'' for Sec.  
4965 purposes by reference to Sec. Sec.  501(c), 501(d), 170(c), 
7701(a)(40), 4979(e) (paragraphs (1), (2) and (3)), 529, 457(b), and 
4973(a). The proposed regulations describe the types of entities 
captured by the statutory cross-references in Sec.  4965(c).

Definition of Prohibited Tax Shelter Transactions

    Section 4965(e) defines the term ``prohibited tax shelter 
transaction'' by reference to Sec.  6707A(c)(1) and (c)(2). In 
accordance with the statutory definition, the proposed regulations 
define the term ``prohibited tax shelter transaction'' by reference to 
the definition of the term ``reportable transaction'' in Sec.  
6707A(c)(1) and (c)(2) and the regulations under Sec.  6011. The 
proposed regulations define a subsequently listed transaction as a 
transaction (other than a reportable transaction within the meaning of 
Sec.  6707A(c)(1)) to which a tax-exempt entity becomes a party before 
the transaction becomes a listed transaction within the meaning of 
Sec.  6707A(c)(2).
    Several commentators expressed concern over the severe penalties 
imposed on tax-exempt entities and entity managers for participating in 
many common and legitimate transactions which have no tax avoidance 
purpose, yet may fall within the definition of prohibited tax shelter 
transaction. The commentators suggested that the IRS and the Treasury 
Department carve out certain types of transactions from the definition 
of ``prohibited tax shelter transaction'' or revise current listing 
procedures to give taxpayers an opportunity to object to the 
identification of a specific transaction as a tax avoidance 
transaction. Some commentators recommended that any future published 
guidance which designates a transaction as a listed or reportable 
transaction be issued with a prospective effective date and state that 
it will not apply retroactively. Several commentators requested that 
the proposed regulations identify listed, subsequently listed, 
confidential and contractual protection transactions that would not be 
treated as prohibited tax shelter transactions for purposes of Sec.  
4965. The above recommendations are not adopted in these proposed 
regulations because Sec.  4965 defines the term ``prohibited tax 
shelter transaction'' by reference to the existing reportable 
transaction regime. Any additions to, or exclusions from, the 
definition of reportable transactions, or any changes to the current 
listing procedures, must be made within the framework of Sec.  6011 
rather than Sec.  4965.
    One commentator suggested that the term ``reportable transaction'' 
should be narrowly interpreted for purposes of Sec.  4965. However, 
this term already has been defined under Sec.  6011, and consequently, 
these proposed regulations interpret it consistently for Sec.  4965 and 
Sec.  6011 purposes.

Definition of Tax-Exempt Party to a Prohibited Tax Shelter Transaction

    Excise taxes under Sec.  4965 apply only if a tax-exempt entity is 
a party to a prohibited tax shelter transaction. A number of 
commentators requested guidance in determining when a tax-exempt entity 
is a party to a prohibited tax shelter transaction. Notice 2007-18 
defined the term party as a tax-exempt entity that facilitates a 
prohibited tax shelter transaction by reason of its tax-exempt, tax 
indifferent or tax-favored status. The proposed regulations incorporate 
this definition of the term party. Notice 2007-18 also notified the 
public that the IRS and the Treasury Department would provide a broader 
definition of the term party in future guidance in accordance with 
Sec.  4965. Consistent with Notice 2007-18, the proposed regulations 
define the term ``party'' for purposes of Sec. Sec.  4965 and 
6033(a)(2) to include a tax-exempt entity that enters into a listed 
transaction and reflects on its tax return a reduction or elimination 
of its liability for applicable Federal employment, excise or unrelated 
business income taxes that is derived directly or indirectly from tax 
consequences or tax strategy described in the published guidance that 
lists the transaction.
    Several commentators specifically requested that the proposed 
regulations address under what circumstances, if any, a tax-exempt 
entity may be treated as a party to a prohibited tax shelter 
transaction if the tax-exempt entity is an investor in a partnership, 
hedge fund or other conduit. Invoking the language in the legislative 
history to Sec.  4965, commentators recommended that the IRS and 
Treasury Department establish a rule or a safe harbor that would treat 
an investor in an indirect investment activity as being a party for 
Sec.  4965 purposes only in limited circumstances.
    As illustrated by an example in the proposed regulations, a tax-
exempt entity does not become a party to a prohibited tax shelter 
transaction solely because it invests in an entity that in turn becomes 
involved in a prohibited tax shelter transaction. To be considered a 
``party'' under the proposed regulations, the tax-exempt entity must 
either facilitate the prohibited tax shelter transaction by reason of 
its tax-exempt, tax indifferent or tax-favored status, or must treat 
the prohibited tax shelter transaction on its tax return as reducing or 
eliminating its own Federal tax liability. The IRS and the Treasury 
Department request comments on any further clarifications that may be 
helpful in reflecting the intended application of the statute as 
expressed in the legislative history.

Entity Managers and Related Definitions

    The proposed regulations clarify the definition of the term 
``entity manager'' in Sec.  4965(d) and provide guidance on

[[Page 36929]]

persons who could be entity managers pursuant to a delegation of 
authority from other entity managers.
    The proposed regulations also define the term ``approve or 
otherwise cause.'' Under Sec.  4965(a)(2), an entity manager may be 
liable for the manager-level excise tax only if the manager ``approves 
such entity as (or otherwise causes such entity to be) a party'' to a 
prohibited tax shelter transaction and knows or has reason to know the 
transaction is a prohibited tax shelter transaction. The proposed 
regulations generally limit the definition of ``approving or otherwise 
causing'' to affirmative actions of persons who, individually or as 
members of a collective body, have the authority to commit the entity 
to the transaction.
    One commentator requested guidance on whether entity managers may 
be liable for Sec.  4965 taxes in successor-in-interest situations. 
Several commentators requested guidance on the consequences under Sec.  
4965 of the exercise or nonexercise of certain options pursuant to the 
terms of the transaction. In response to these comments, the proposed 
regulations provide rules for successor-in-interest situations and the 
consequences of the exercise or nonexercise of certain options.

Meaning of ``Knows or Has Reason To Know''

    The level of tax imposed on the tax-exempt entity under Sec.  
4965(b)(1) depends upon whether the entity knows or has reason to know, 
at the time it enters into the transaction, that it is becoming a party 
to a prohibited tax shelter transaction. The liability of the entity 
manager for the tax under Sec.  4965(b)(2) depends on whether the 
entity manager knows or has reason to know that the transaction is a 
prohibited tax shelter transaction at the time of approving or 
otherwise causing the entity to be a party to the transaction. The 
proposed regulations treat the entity as knowing or having reason to 
know if its manager(s) knew or had reason to know and provide rules for 
determining whether entity managers knew or had reason to know. The 
``reason-to-know'' rules in these proposed regulations are consistent 
with the ``reason-to-know'' and ``should have known'' standards under 
other provisions of the Code.
    Commentators recommended that the IRS and the Treasury Department 
not treat receipt of a disclosure statement regarding a transaction by 
the tax-exempt entity as conclusive evidence that the tax-exempt entity 
knew or had reason to know that the transaction was a prohibited tax 
shelter transaction. The proposed regulations adopt this recommendation 
and provide that receipt by an entity manager of a disclosure statement 
in advance of a transaction is a relevant factor but, by itself, does 
not necessarily demonstrate that the tax-exempt entity or any of its 
managers knew or had reason to know that the transaction was a 
prohibited tax shelter transaction.

Taxes on Prohibited Tax Shelter Transactions

    Section 4965(b)(1) provides the rules for computing the entity-
level excise tax with respect to prohibited tax shelter transactions. 
Section 4965(b)(2) imposes a flat $20,000 excise tax on any entity 
manager that approved or otherwise caused the entity to become a party 
to a prohibited tax shelter transaction. The proposed regulations 
follow the computational rules in the statute, define the term 
``taxable year'' for purposes of determining the entity-level tax under 
Sec.  4965, and clarify the timing of the entity manager taxes under 
Sec.  4965. The proposed regulations provide that entity manager 
liability for Sec.  4965 taxes is not joint and several.

Definition of Net Income and Proceeds and Their Allocation to Various 
Periods

    The proposed regulations define the terms ``net income'' and 
``proceeds'' for Sec.  4965 purposes and provide rules regarding the 
allocation of net income or proceeds attributable to a prohibited tax 
shelter transaction to various periods, including the appropriate 
treatment of net income or proceeds received prior to the effective 
date of the Sec.  4965(a) tax.
    Commentators recommended that net income for purposes of Sec.  4965 
be determined in a manner consistent with the determination of net 
income for other purposes of the Code. The proposed regulations adopt 
this recommendation.
    Numerous commentators requested guidance in determining what 
amounts constitute proceeds for section 4965 purposes and urged the IRS 
and the Treasury Department to limit the definition of proceeds to the 
tax-exempt entity's economic return from the transaction. One 
commentator recommended that return of basis and return of capital be 
excluded from the definition of proceeds as these amounts are arguably 
not ``attributable to'' a prohibited tax shelter transaction. Several 
commentators recommended that the IRS and the Treasury Department adopt 
a rule that would exclude from proceeds earnings on certain set-aside 
amounts that are used to defease the tax-exempt entity's obligations 
under so-called sale-in, lease-out (SILO) and lease-in, lease-out 
(LILO) transactions. See Notice 2000-15 (2000-1 CB 826), and Notice 
2005-13 (2005-9 IRB 630). Several commentators suggested that 
nonexercise of options to repurchase in the SILO/LILO context should 
not be treated as giving rise to net income or proceeds. See Sec.  
601.601(d)(2)(ii)(b).
    The proposed regulations define the term proceeds separately for 
tax-exempt entities that are involved in prohibited tax shelter 
transactions to facilitate the tax avoidance of others and tax-exempt 
entities that are involved in listed transactions for their own tax 
benefit. In the case of tax-exempt entities that are involved in 
prohibited tax shelter transactions to facilitate the tax avoidance of 
others, the proposed regulations define proceeds as the gross amount of 
the tax-exempt entity's consideration for facilitating the transaction, 
not reduced by any costs or expenses attributable to the transaction. 
This definition subjects the tax-exempt party's economic return from 
the transaction to the entity-level excise tax. In the case of tax-
exempt entities that are involved in listed transactions to reduce or 
eliminate their own tax liability, the proposed regulations define the 
term proceeds as tax savings purportedly generated by the transaction 
and claimed by the tax-exempt entity in the tax year.
    In Notice 2007-18, the IRS and Treasury Department provided that 
the allocation of net income and proceeds is determined according to 
normal tax accounting rules. The proposed regulations incorporate this 
rule both for purposes of allocating amounts to pre- and post-effective 
date periods, and allocating amounts to pre- and post-listing periods 
where a subsequently listed transaction is involved. Under the proposed 
regulations, tax-exempt entities that have not adopted a method of 
accounting are required to use the cash method. Several commentators 
recommended that the IRS adopt a position that net income or proceeds 
from pre-enactment transactions would not be properly allocable to any 
periods after the effective date of the section 4965(a) tax. The IRS 
and the Treasury Department decline to adopt this blanket rule because 
such rule would be inconsistent with established principles of tax 
accounting and would conflict with the plain language of the effective 
date provisions in section 516 of TIPRA.

Effective Dates of the Taxes

    In accordance with section 516(d) of TIPRA, the proposed 
regulations provide that the taxes under section

[[Page 36930]]

4965 are effective for taxable years ending after May 17, 2006, with 
respect to transactions entered into before, on or after such date, 
except that no tax under section 4965(a) applies with respect to income 
or proceeds that are properly allocable to any period ending on or 
before August 15, 2006. The proposed regulations also provide that the 
100 percent entity-level tax under section 4965(b)(1)(B) with respect 
to knowing transactions does not apply to prohibited tax shelter 
transactions entered into by a tax-exempt entity on or before May 17, 
2006 and that the IRS will not assert an entity manager tax under 
section 4965(b)(2) with respect to any prohibited tax shelter 
transaction entered into by a tax-exempt entity on or before May 17, 
2006. In addition, the proposed regulations provide that the 100 
percent entity-level tax under section 4965(b)(1)(B) and the entity 
manager tax under section 4965(b)(2) do not apply with respect to any 
subsequently listed transaction.
    Numerous commentators questioned whether it would be appropriate to 
apply the new excise taxes to pre-enactment transactions that already 
have closed and advocated a narrow application of the new excise taxes 
to pre-enactment transactions. The commentators argued that it would be 
unfair to apply the new excise taxes to pre-enactment transactions that 
have already closed and subject tax-exempt entities to unforeseen, 
harsh penalties. The commentators recommended that all transactions 
closed prior to May 17, 2006, be ``delisted'' for purposes of section 
4965. The proposed regulations do not adopt these recommendations as 
they are inconsistent with the statutory effective date of section 4965 
and the statutory definition of prohibited tax shelter transaction.
    When finalized, the regulations under section 4965 are proposed to 
be applicable for taxable years ending after July 6, 2007. Taxpayers 
may rely on these proposed regulations for periods ending on or before 
such date.

Disclosure by Tax-Exempt Entities That Are Parties to Certain 
Reportable Transactions

    Section 6033(a)(2), as amended by TIPRA, requires every tax-exempt 
entity that is a party to a prohibited tax shelter transaction to 
disclose to the IRS, in such form and manner and at such time as 
determined by the Secretary, such entity's being a party to such 
transaction and the identity of any other party to the transaction 
which is known to the tax-exempt entity. The statute gives the IRS 
discretion with respect to the form, manner and timing of this 
disclosure. The proposed regulations provide rules regarding the form, 
manner and timing of this disclosure. With respect to the due date for 
the disclosure, the proposed regulations provide that, in the case of 
tax-exempt entities that are involved in prohibited tax shelter 
transactions to facilitate the tax avoidance of others, the disclosure 
must be filed by May 15 of the calendar year following the close of the 
calendar year during which the tax-exempt entity entered into the 
prohibited tax shelter transaction (or, in the case of subsequently 
listed transactions, by May 15 of the calendar year following the close 
of the calendar year during which the transaction was identified by the 
Secretary as a listed transaction). In the case of tax-exempt entities 
that are involved in listed transactions to reduce or eliminate their 
own tax liability, the proposed regulations provide that the disclosure 
must be filed on or before the date on which the first tax return 
(whether an original or an amended return) is filed on which the tax-
exempt entity reflects a reduction or elimination of its liability for 
applicable Federal employment, excise or unrelated business income 
taxes that is derived directly or indirectly from tax consequences or 
tax strategy described in the published guidance that lists the 
transaction.
    Temporary regulations providing the same rules are being issued 
concurrently with these proposed regulations.
    The temporary regulations under section 6033(a)(2) apply to 
disclosures with respect to transactions entered into by a tax-exempt 
entity after May 17, 2006. Transition relief is provided with respect 
to transactions entered into during a transition period beginning on 
May 18, 2006 and ending on December 31, 2006. The due date for the 
disclosure with respect to the transactions entered into during the 
transition period is November 5, 2007 or, in the case of tax-exempt 
entities that are involved in listed transactions to reduce or 
eliminate their own tax liability, the later of: the date on which the 
first tax return (whether an original or an amended return) is filed on 
which the tax-exempt entity reflects a reduction or elimination of its 
liability for applicable Federal employment, excise or unrelated 
business income taxes that is derived directly or indirectly from tax 
consequences or tax strategy described in the published guidance that 
lists the transaction; or November 5, 2007.

Disclosure by Taxable Party to the Tax-Exempt Entity

    Section 6011(g), as amended by TIPRA, requires any taxable party to 
a prohibited tax shelter transaction to notify any tax-exempt entity 
which is a party to such transaction that the transaction is a 
prohibited tax shelter transaction. The statute is silent as to how and 
when the section 6011(g) disclosure needs to be made. The proposed 
regulations provide rules regarding the form, timing and frequency of 
the section 6011(g) disclosure. The proposed regulations also explain 
to whom the section 6011(g) disclosure must be made. With respect to 
the due date for the disclosure, the proposed regulations provide that 
the disclosure to each tax-exempt entity that is a party to the 
transaction must be made within 60 days after the last to occur of: (1) 
The date the taxable person becomes a taxable party to the transaction; 
or (2) the date the taxable party knows or has reason to know that the 
tax-exempt entity is a party to the transaction. No disclosure is 
required if the taxable party does not know or have reason to know that 
the tax-exempt entity is a party to the transaction on or before the 
first date on which the transaction is required to be disclosed by the 
taxable party under Sec. Sec.  1.6011-4, 20.6011-4, 25.6011-4, 31.6011-
4, 53.6011-4, 54.6011-4, or 56.6011-4.
    One commentator recommended that the IRS provide an exception to 
the disclosure requirements for any transactions for which there would 
be no income or proceeds subject to the taxes imposed by section 4965. 
The proposed regulations do not adopt this recommendation because one 
of the purposes of section 6011(g) disclosure is to notify the tax-
exempt entity that it may have a disclosure obligation under section 
6033(a)(2) with respect to the transaction.
    When finalized, the proposed regulations under section 6011(g) will 
apply to disclosures with respect to transactions entered into by a 
tax-exempt entity after May 17, 2006.

Payment of Section 4965 Taxes

    The proposed regulations amend the existing regulations under 
sections 6011 and 6071 to specify the forms that must be used to pay 
section 4965 taxes and to provide the due dates for filing these forms. 
With respect to the due dates, the proposed regulations provide that a 
return of the entity-level excise tax under section 4965 must be made 
on or before the due date (not including extensions) for filing the 
tax-exempt

[[Page 36931]]

entity's annual information return under section 6033(a)(1). If the 
tax-exempt entity is not required to file an annual information return, 
the return of section 4965 taxes must be made on or before the 15th day 
of the fifth month after the end of the tax-exempt entity's annual 
accounting period. A return of manager-level excise tax under section 
4965 must be made on or before the 15th day of the fifth month 
following the close of the entity manager's taxable year during which 
the entity entered into the prohibited tax shelter transaction.
    Temporary regulations providing the same rules are being issued 
concurrently with these proposed regulations.
    A commentator recommended that the IRS and the Treasury Department 
not make the section 4965 excise taxes effective prior to the issuance 
of final regulations in cases where application of the new law or 
provisions of the new law is unclear. The proposed regulations do not 
adopt this recommendation because the effective date for the section 
4965 taxes is statutory.
    One commentator recommended that the IRS waive the excise taxes 
under section 4965 in appropriate circumstances. The proposed 
regulations do not adopt this recommendation as the obligation to pay 
section 4965 taxes flows directly from the statute, which does not 
authorize the IRS to waive the entity-level or manager-level taxes.
    The amendments and additions to the regulations under sections 6011 
and 6071 will be effective on July 6, 2007. Transition relief is 
provided with respect to returns of section 4965 taxes due on or before 
October 4, 2007. These returns will be deemed timely if the return is 
filed and the tax paid before October 4, 2007.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
12866. Therefore, a regulatory assessment is not required. It has also 
been determined that section 553(b) of the Administrative Procedure Act 
(5 U.S.C. chapter 5) does not apply to this notice of proposed 
rulemaking. It is hereby certified that the collection of information 
in Sec.  301.6011(g)-1 will not have a significant economic impact on a 
substantial number of small entities. Accordingly, a regulatory 
flexibility analysis under the Regulatory Flexibility Act (5 U.S.C. 
601) (RFA) is not required.
    The effect of these proposed regulations on small entities flows 
directly from the statutes these regulations implement. Section 
6011(g), as amended by TIPRA, requires any taxable party to a 
prohibited tax shelter transaction to notify any tax-exempt entity 
which is a party to such transaction that the transaction is a 
prohibited tax shelter transaction. In implementing this statute, Sec.  
301.6011(g)-1 of the proposed regulations requires every taxable party 
to a prohibited tax shelter transaction (or a single taxable party 
acting by designation on behalf of other taxable parties) to provide to 
every tax-exempt entity that the taxable party knows or has reason to 
know is a party to the transaction a single statement disclosing that 
the transaction is a prohibited tax shelter transaction within 60 days 
after the last to occur: (1) The date the taxable person becomes a 
taxable party to the transaction; or (2) the date the taxable party 
knows or has reason to know that the tax-exempt entity is a party to 
the transaction. Moreover, it is unlikely that a significant number of 
small businesses will engage in transactions that are subject to 
disclosure under 301.6011(g). The IRS and the Treasury Department 
request comments concerning the likelihood that small businesses are 
engaging in transactions subject to disclosure under this provision.
    Pursuant to section 7805(f) of the Code, this regulation as been 
submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on its impact on small business.

Comments and Requests for a Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any comments (a signed original and 
eight (8) copies) that are submitted timely to the IRS at the address 
listed in the Addresses section of this document. The IRS and the 
Treasury Department specifically request comments on the clarity of the 
proposed rule and how it may be made easier to understand. All comments 
will be available for public inspection and copying.
    A public hearing may be scheduled if requested in writing by a 
person who timely submits written comments. If a public hearing is 
scheduled, notice of the date, time, and place will be published in the 
Federal Register.

Drafting Information

    The principal authors of these regulations are Galina Kolomietz and 
Dana Barry, Office of Division Counsel/Associate Chief Counsel (Tax 
Exempt and Government Entities). However, other personnel from the IRS 
and the Treasury Department participated in their development.

List of Subjects

26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 53

    Excise taxes, Foundations, Investments, Lobbying, Reporting and 
recordkeeping requirements.

26 CFR Part 54

    Excise Taxes, Pensions, Reporting and recordkeeping requirements.

26 CFR Part 301

    Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income 
taxes, Penalties, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR parts 1, 53, 54, and 301 are proposed to be 
amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 continues to read, 
in part, as follows:

    Authority: 26 U.S.C. 7805 * * *

    Par. 2. Section 1.6033-5 is added to read as follows:


Sec.  1.6033-5  Disclosure by tax-exempt entities that are parties to 
certain reportable transactions.

    [The text of this section is the same as the text of Sec.  1.6033-
5T published elsewhere in this issue of the Federal Register].

PART 53-- FOUNDATION AND SIMILAR EXCISE TAXES

    Par. 3. The authority citation for part 53 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *

    Par. 4. Sections 53.4965-1 through 53.4965-9 are added to read as 
follows:


Sec.  53.4965-1  Overview.

    (a) Entity-level excise tax. Section 4965 imposes two excise taxes 
with respect to certain tax shelter transactions to which tax-exempt 
entities are parties. Section 4965(a)(1) imposes an entity-level excise 
tax on certain tax-exempt entities that are parties to ``prohibited tax 
shelter transactions,'' as defined in section 4965(e). See Sec.  
53.4965-2 for the discussion of covered tax-exempt entities. See Sec.  
53.4965-3 for the

[[Page 36932]]

definition of prohibited tax shelter transactions. See Sec.  53.4965-4 
for the definition of tax-exempt party to a prohibited tax shelter 
transaction. The entity-level excise tax under section 4965(a)(1) is 
imposed on a specified percentage of the entity's net income or 
proceeds that are attributable to the transaction for the relevant tax 
year (or a period within that tax year). The rate of tax depends on 
whether the entity knew or had reason to know that the transaction was 
a prohibited tax shelter transaction at the time the entity became a 
party to the transaction. See Sec.  53.4965-7(a) for the discussion of 
the entity-level excise tax under section 4965(a)(1). See Sec.  
53.4965-6 for the discussion of ``knowing or having reason to know.'' 
See Sec.  53.4965-8 for the definition of net income and proceeds and 
the standard for allocating net income and proceeds that are 
attributable to a prohibited tax shelter transaction to various 
periods.
    (b) Manager-level excise tax. Section 4965(a)(2) imposes a manager-
level excise tax on ``entity managers,'' as defined in section 4965(d), 
of tax-exempt entities who approve the entity as a party (or otherwise 
cause the entity to be a party) to a prohibited tax shelter transaction 
and know or have reason to know, at the time the tax-exempt entity 
enters into the transaction, that the transaction is a prohibited tax 
shelter transaction. See Sec.  53.4965-5 for the definition of entity 
manager and the meaning of ``approving or otherwise causing,'' and 
Sec.  53.4965-6 for the discussion of ``knowing or having reason to 
know.'' See Sec.  53.4965-7(b) for the discussion of the manager-level 
excise tax under section 4965(a)(2).
    (c) Effective/applicability dates. See Sec.  53.4965-9 for the 
discussion of the relevant effective dates.


Sec.  53.4965-2  Covered tax-exempt entities.

    (a) In general. Under section 4965(c), the term ``tax-exempt 
entity'' refers to entities that are described in sections 501(c), 
501(d), or 170(c) (other than the United States), Indian tribal 
governments (within the meaning of section 7701(a)(40)), and tax-
qualified pension plans, individual retirement arrangements and similar 
tax-favored savings arrangements that are described in sections 
4979(e)(1), (2) or (3), 529, 457(b), or 4973(a). The tax-exempt 
entities referred to in section 4965(c) are divided into two broad 
categories, non-plan entities and plan entities.
    (b) Non-plan entities. Non-plan entities are--
    (1) Entities described in section 501(c);
    (2) Religious or apostolic associations or corporations described 
in section 501(d);
    (3) Entities described in section 170(c), including states, 
possessions of the United States, the District of Columbia, political 
subdivisions of states and political subdivisions of possessions of the 
United States (but not including the United States); and
    (4) Indian tribal governments within the meaning of section 
7701(a)(40).
    (c) Plan entities. Plan entities are--
    (1) Entities described in section 4979(e)(1) (qualified plans under 
section 401(a), including qualified cash or deferred arrangements under 
section 401(k) (including a section 401(k) plan that allows designated 
Roth contributions));
    (2) Entities described in section 4979(e)(2) (annuity plans 
described in section 403(a));
    (3) Entities described in section 4979(e)(3) (annuity contracts 
described in section 403(b), including a section 403(b) arrangement 
that allows Roth contributions);
    (4) Qualified tuition programs described in section 529;
    (5) Eligible deferred compensation plans under section 457(b) that 
are maintained by a governmental employer as defined in section 
457(e)(1)(A);
    (6) Arrangements described in section 4973(a) which include--
    (i) Individual retirement plans defined in sections 408(a) and (b), 
including--
    (A) Simplified employee pensions (SEPs) under section 408(k);
    (B) Simple individual retirement accounts (SIMPLEs) under section 
408(p);
    (C) Deemed individual retirement accounts or annuities (IRAs) 
qualified under a qualified plan (deemed IRAs) under section 408(q)); 
and
    (D) Roth IRAs under section 408A.
    (ii) Arrangements described in section 220(d) (Archer Medical 
Savings Accounts (MSAs));
    (iii) Arrangements described in section 403(b)(7) (custodial 
accounts treated as annuity contracts);
    (iv) Arrangements described in section 530 (Coverdell education 
savings accounts); and
    (v) Arrangements described in section 223(d) (health savings 
accounts (HSAs)).


Sec.  53.4965-3  Prohibited tax shelter transactions.

    (a) In general. Under section 4965(e), the term prohibited tax 
shelter transaction means--
    (1) Listed transactions within the meaning of section 6707A(c)(2), 
including subsequently listed transactions described in paragraph (b) 
of this section; and
    (2) Prohibited reportable transactions, which consist of the 
following reportable transactions within the meaning of section 
6707A(c)(1)--
    (i) Confidential transactions, as described in Sec.  1.6011-4(b)(3) 
of this chapter; or
    (ii) Transactions with contractual protection, as described in 
Sec.  1.6011-4(b)(4) of this chapter.
    (b) Subsequently listed transactions. A subsequently listed 
transaction for purposes of section 4965 is a transaction that is 
identified by the Secretary as a listed transaction after the tax-
exempt entity has entered into the transaction and that was not a 
prohibited reportable transaction (within the meaning of section 
4965(e)(1)(C) and paragraph (a)(2) of this section) at the time the 
entity entered into the transaction.
    (c) Cross-reference. The determination of whether a transaction is 
a listed transaction or a prohibited reportable transaction for section 
4965 purposes shall be made under the law applicable to section 
6707A(c)(1) and (c)(2).


Sec.  53.4965-4  Definition of tax-exempt party to a prohibited tax 
shelter transaction.

    (a) In general. For purposes of sections 4965 and 6033(a)(2), a 
tax-exempt entity is a party to a prohibited tax shelter transaction if 
the entity--
    (1) Facilitates a prohibited tax shelter transaction by reason of 
its tax-exempt, tax indifferent or tax-favored status;
    (2) Enters into a listed transaction and the tax-exempt entity's 
tax return (whether an original or an amended return) reflects a 
reduction or elimination of its liability for applicable Federal 
employment, excise or unrelated business income taxes that is derived 
directly or indirectly from tax consequences or tax strategy described 
in the published guidance that lists the transaction; or
    (3) Is identified in published guidance, by type, class or role, as 
a party to a prohibited tax shelter transaction.
    (b) Published guidance may identify which tax-exempt entities, by 
type, class or role, will not be treated as a party to a prohibited tax 
shelter transaction for purposes of sections 4965 and 6033(a)(2).
    (c) Examples. The following examples illustrate the principles of 
this section:

    Example 1. A tax-exempt entity enters into a transaction 
(Transaction A) with an S corporation. Transaction A is the same as 
or substantially similar to the transaction identified by the 
Secretary as a listed transaction in Notice 2004-30 (2004-1 CB 828). 
The tax-exempt entity's role in

[[Page 36933]]

Transaction A is similar to the role of the tax-exempt party, as 
described in Notice 2004-30. Under the terms of the transaction, as 
described in Notice 2004-30, the tax-exempt entity receives the S 
corporation stock and, due to the tax-exempt entity's tax-exempt 
status, aids the S corporation and its shareholders in avoiding 
taxable income. The tax-exempt entity facilitates Transaction A by 
reason of its tax-exempt, tax indifferent or tax-favored status. 
Accordingly, the tax-exempt entity is a party to Transaction A for 
purposes of sections 4965 and 6033(a)(2). See Sec.  
601.601(d)(2)(ii)(b) of this chapter.
    Example 2. A tax-exempt entity is a partner in a partnership. 
The partnership has a number of other taxable and tax-exempt 
partners. The tax-exempt entity does not control the partnership. 
The partnership enters into a number of transactions, including a 
transaction (Transaction B) which is the same as or substantially 
similar to the transaction identified by the Secretary as a listed 
transaction in Notice 2002-35 (2002-1 CB 992) (as clarified and 
modified by Notice 2006-16 (2006-9 IRB 538). The partnership's role 
in Transaction B is similar to the role of T, as described in Notice 
2002-35, that is, the role of the taxpayer claiming the tax benefits 
from the transaction. The tax-exempt entity's tax returns do not 
reflect a reduction or elimination of its liability for applicable 
Federal taxes as a result of Transaction B. The tax and economic 
consequences from Transaction B to the other partners are not 
dependent on the tax-exempt entity's tax-exempt, tax indifferent or 
tax-favored status. Accordingly, the tax-exempt entity does not 
facilitate Transaction B by reason of its tax-exempt, tax 
indifferent or tax-favored status. Because the tax-exempt entity's 
tax returns do not reflect a reduction or elimination of its 
liability for applicable Federal taxes that is derived directly or 
indirectly from tax consequences or tax strategy described in the 
published guidance that lists the transaction, the tax-exempt entity 
is not a party to Transaction B by reason of paragraph (a)(2) of 
this section. The tax-exempt entity also has not been identified, by 
type, class or role, as a party to a prohibited tax shelter 
transaction in published guidance. Therefore, the tax-exempt entity 
is not a party to Transaction B for purposes of sections 4965 and 
6033(a)(2). See Sec.  601.601(d)(2)(ii)(b) of this chapter.

    (d) Effective/applicability dates. See Sec.  53.4965-9 for the 
discussion of the relevant applicability dates.


Sec.  53.4965-5  Entity managers and related definitions.

    (a) Entity manager of a non-plan entity--(1) In general. Under 
section 4965(d)(1), an entity manager of a non-plan entity is--
    (i) A person with the authority or responsibility similar to that 
exercised by an officer, director, or trustee of an organization (that 
is, the non-plan entity); and
    (ii) With respect to any act, the person who has final authority or 
responsibility (either individually or as a member of a collective 
body) with respect to such act.
    (2) Definition of officer. For purposes of paragraph (a)(1)(i) of 
this section, a person is considered to be an officer of the non-plan 
entity (or to have similar authority or responsibility) if the person--
    (i) Is specifically designated as such under the certificate of 
incorporation, by-laws, or other constitutive documents of the non-plan 
entity; or
    (ii) Regularly exercises general authority to make administrative 
or policy decisions on behalf of the non-plan entity.
    (3) Exception for acts requiring approval by a superior. With 
respect to any act, any person is not described in paragraph (a)(2)(ii) 
of this section if the person has authority merely to recommend 
particular administrative or policy decisions, but not to implement 
them without approval of a superior.
    (4) Delegation of authority. A person is an entity manager of a 
non-plan entity within the meaning of paragraph (a)(1)(ii) of this 
section if, with respect to any prohibited tax shelter transaction, 
such person has been delegated final authority or responsibility with 
respect to such transaction (including by transaction type or dollar 
amount) by a person described in paragraph (a)(1)(i) of this section or 
the governing board of the entity. For example, an investment manager 
is an entity manager with respect to a prohibited tax shelter 
transaction if the non-plan entity's governing body delegated to the 
investment manager the final authority to make certain investment 
decisions and, in the exercise of that authority, the manager committed 
the entity to the transaction. To be considered an entity manager of a 
non-plan entity within the meaning of paragraph (a)(1)(ii) of this 
section, a person need not be an employee of the entity. A person is 
not described in paragraph (a)(1)(ii) of this section if the person is 
merely implementing a decision made by a superior.
    (b) Entity manager of a plan entity--(1) In general. Under section 
4965(d)(2), an entity manager of a plan entity is the person who 
approves or otherwise causes the entity to be a party to the prohibited 
tax shelter transaction.
    (2) Special rule for plan participants and beneficiaries who have 
investment elections--(i) Fully self-directed plans or arrangements. In 
the case of a fully self-directed qualified plan, IRA, or other savings 
arrangement (including the case where a plan participant or beneficiary 
is given a list of prohibited investments, such as collectibles), if 
the plan participant or beneficiary selected a certain investment and, 
therefore, approved the plan entity to become a party to a prohibited 
tax shelter transaction, the plan participant or the beneficiary is an 
entity manager.
    (ii) Plans or arrangements with limited investment options. In the 
case of a qualified plan, IRA, or other savings arrangement where a 
plan participant or beneficiary is offered a limited number of 
investment options from which to choose, the person responsible for 
determining the pre-selected investment options is an entity manager 
and the plan participant or the beneficiary generally is not an entity 
manager.
    (c) Meaning of ``approves or otherwise causes''--(1) In general. A 
person is treated as approving or otherwise causing a tax-exempt entity 
to become a party to a prohibited tax shelter transaction if the person 
has the authority to commit the entity to the transaction, either 
individually or as a member of a collective body, and the person 
exercises that authority.
    (2) Collective bodies. If a person shares the authority described 
in paragraph (c)(1) of this section as a member of a collective body 
(for example, board of trustees or committee), the person will be 
considered to have exercised such authority if the person voted in 
favor of the entity becoming a party to the transaction. However, a 
member of the collective body will not be treated as having exercised 
the authority described in paragraph (c)(1) of this section if he or 
she voted against a resolution that constituted approval or an act that 
caused the tax-exempt entity to be a party to a prohibited tax shelter 
transaction, abstained from voting for such approval, or otherwise 
failed to vote in favor of such approval.
    (3) Exceptions--(i) Successor in interest. If a tax-exempt entity 
that is a party to a prohibited tax shelter transaction is dissolved, 
liquidated, or merged into a successor entity, an entity manager of the 
successor entity will not, solely by reason of the reorganization, be 
treated as approving or otherwise causing the successor entity to 
become a party to a prohibited tax shelter transaction, provided that 
the reorganization of the tax-exempt entity does not result in a 
material change to the terms of the transaction. For purposes of this 
paragraph a material change includes an extension or renewal of the 
agreement (other than an extension or renewal that results from another 
party to the transaction unilaterally exercising an option granted by 
the agreement) or a more than incidental change to any payment under

[[Page 36934]]

the agreement. A change for the sole purpose of substituting the 
successor entity for the original tax-exempt party is not a material 
change.
    (ii) Exercise or nonexercise of options. Nonexercise of an option 
pursuant to a transaction involving the tax-exempt entity generally 
will not constitute an act of approving or causing the entity to be a 
party to the transaction. If, pursuant to a transaction involving the 
tax-exempt entity, the entity manager exercises an option (such as a 
repurchase option), the entity manager will not be subject to the 
entity manager-level tax if the exercise of the option does not result 
in the tax-exempt entity becoming a party to a second transaction that 
is a prohibited tax shelter transaction.
    (4) Example. The following example illustrates the principles of 
paragraph (c)(3)(ii) of this section:

    Example. In a sale-in, lease-out (SILO) transaction described in 
Notice 2005-13 (2005-9 IRB 630), X, which is a non-plan entity, has 
purported to sell property to Y, a taxable entity and lease it back 
for a term of years. At the end of the basic lease term, X has the 
option of ``repurchasing'' the property from Y for a predetermined 
purchase price, with funds that have been set aside at the inception 
of the transaction for that purpose. The entity manager, by deciding 
to exercise or not exercise the ``repurchase'' option is not 
approving or otherwise causing the non-plan entity to become a party 
to a second prohibited tax shelter transaction. See Sec.  
601.601(d)(2)(ii)(b) of this chapter.

    (5) Coordination with the reason-to-know standard. The 
determination that an entity manager approved or caused a tax-exempt 
entity to be a party to a prohibited tax shelter transaction, by 
itself, does not establish liability for the section 4965(a)(2) tax. 
For rules on determining whether an entity manager knew or had reason 
to know that the transaction was a prohibited tax shelter transaction, 
see Sec.  53.4965-6(b).
    (d) Effective/applicability dates. See Sec.  53.4965-9 for the 
discussion of the relevant applicability dates.


Sec.  53.4965-6  Meaning of ``knows or has reason to know.''

    (a) Attribution to the entity. An entity will be treated as knowing 
or having reason to know for section 4965 purposes if one or more of 
its entity managers knew or had reason to know that the transaction was 
a prohibited tax shelter transaction at the time the entity manager(s) 
approved the entity as (or otherwise caused the entity to be) a party 
to the transaction. The entity shall be attributed the knowledge or 
reason to know of any entity manager described in Sec.  53.4965-
5(a)(1)(i) even if that entity manager does not approve the entity as 
(or otherwise cause the entity to be) a party to the transaction.
    (b) Determining whether an entity manager knew or had reason to 
know--(1) In general. Whether an entity manager knew or had reason to 
know that a transaction is a prohibited tax shelter transaction is 
based on all facts and circumstances. In order for an entity manager to 
know or have reason to know that a transaction is a prohibited tax 
shelter transaction, the entity manager must have knowledge of 
sufficient facts that would lead a reasonable person to conclude that 
the transaction is a prohibited tax shelter transaction. An entity 
manager will be considered to have ``reason to know'' if a reasonable 
person in the entity manager's circumstances would conclude that the 
transaction was a prohibited tax shelter transaction based on all the 
facts reasonably available to the manager at the time of approving the 
entity as (or otherwise causing the entity to be) a party to the 
transaction. Factors that will be considered in determining whether a 
reasonable person in the entity manager's circumstances would conclude 
that the transaction was a prohibited tax shelter transaction include, 
but are not limited to--
    (i) The presence of tax shelter indicia (see paragraph (b)(2) of 
this section);
    (ii) Whether the entity manager received a disclosure statement 
prior to the consummation of the transaction indicating that the 
transaction may be a prohibited tax shelter transaction (see paragraph 
(b)(3) of this section); and
    (iii) Whether the entity manager made appropriate inquiries into 
the transaction (see paragraph (b)(4) of this section).
    (2) Tax-shelter indicia. The presence of indicia that a transaction 
is a tax shelter will be treated as an indication that the entity 
manager knew or had reason to know that the transaction was a 
prohibited tax shelter transaction. Tax shelter indicia include but are 
not limited to--
    (i) The transaction is extraordinary for the entity considering 
prior investment activity;
    (ii) The transaction promises an economic return for the 
organization that is exceptional considering the amount invested by, 
the participation of, or the absence of risk to the organization; or
    (iii) The transaction is of significant size relative to the 
receipts of the entity.
    (3) Effect of disclosure statements. Receipt by an entity manager 
of a statement, including a statement described in section 6011(g), in 
advance of a transaction that the transaction may be a prohibited tax 
shelter transaction (or a statement that a partnership, hedge fund or 
other investment conduit may engage in a prohibited tax shelter 
transaction in the future) is a factor relevant in the determination of 
whether the entity manager knew or had reason to know that the 
transaction is a prohibited transaction. However, an entity manager 
will not be treated as knowing or having reason to know that the 
transaction was a prohibited tax shelter transaction solely because the 
entity manager receives such a disclosure.
    (4) Appropriate inquiries. What inquiries are appropriate will be 
determined from the facts and circumstances of each case. For example, 
if one or more tax shelter indicia are present or if an entity manager 
receives a disclosure statement described in paragraph (b)(3) of this 
section, an entity manager has a responsibility to inquire further 
whether the transaction is a prohibited tax shelter transaction.
    (c) Reliance on professional advice--(1) In general. An entity 
manager is not required to obtain the advice of a professional tax 
advisor to establish that the entity manager made appropriate 
inquiries. Moreover, not seeking professional advice, by itself, shall 
not give rise to an inference that the entity manager had reason to 
know that a transaction is a prohibited tax shelter transaction.
    (2) Reliance on written opinion of professional tax advisor. An 
entity manager may establish that he or she did not have a reason to 
know that a transaction was a prohibited tax shelter transaction at the 
time the tax-exempt entity entered into the transaction if the entity 
manager reasonably, and in good faith, relied on the written opinion of 
a professional tax advisor. Reliance on the written opinion of a 
professional tax advisor establishes that the entity manager did not 
have reason to know if, taking into account all the facts and 
circumstances, the reliance was reasonable and the entity manager acted 
in good faith. For example, the entity manager's education, 
sophistication, and business experience will be relevant in determining 
whether the reliance was reasonable and made in good faith. In no event 
will an entity manager be considered to have reasonably relied in good 
faith on an opinion unless the requirements of this paragraph (c)(2) 
are satisfied. The fact that these requirements are satisfied, however, 
will not necessarily establish that the entity manager reasonably 
relied on the opinion in good faith. For example, reliance may not be 
reasonable or in

[[Page 36935]]

good faith if the entity manager knew, or reasonably should have known, 
that the advisor lacked knowledge in the relevant aspects of Federal 
tax law.
    (i) All facts and circumstances considered. The advice must be 
based upon all pertinent facts and circumstances and the law as it 
relates to those facts and circumstances. The requirements of this 
paragraph (c)(2) are not satisfied if the entity manager fails to 
disclose a fact that it knows, or reasonably should know, is relevant 
to determining whether the transaction is a prohibited tax shelter 
transaction.
    (ii) No unreasonable assumptions. The advice must not be based on 
unreasonable factual or legal assumptions (including assumptions as to 
future events) and must not unreasonably rely on the representations, 
statements, findings, or agreements of the entity manager or any other 
person (including another party to the transaction or a material 
advisor within the meaning of sections 6111 and 6112).
    (iii) ``More likely than not'' opinion. The written opinion of the 
professional tax advisor must apply the appropriate law to the facts 
and, based on this analysis, must conclude that the transaction was not 
a prohibited tax shelter transaction at a ``more likely than not'' 
level of certainty at the time the entity manager approved the entity 
(or otherwise caused the entity) to be a party to the transaction.
    (3) Special rule. An entity manager's reliance on a written opinion 
of a professional tax advisor will not be considered reasonable if the 
advisor is, or is related to a person who is, a material advisor with 
respect to the transaction within the meaning of sections 6111 and 
6112.
    (d) Subsequently listed transactions. An entity manager will not be 
treated as knowing or having reason to know that a transaction (other 
than a prohibited reportable transaction as defined in section 
4965(e)(1)(C) and Sec.  53.4965-3(a)(2)) is a prohibited tax shelter 
transaction if the entity enters into the transaction before the date 
on which the transaction is identified by the Secretary as a listed 
transaction.
    (e) Effective/applicability dates. See Sec.  53.4965-9 for the 
discussion of the relevant applicability dates.


Sec.  53.4965-7  Taxes on prohibited tax shelter transactions.

    (a) Entity-level taxes--(1) In general. Entity-level excise taxes 
apply to non-plan entities (as defined in Sec.  53.4965-2(b)) that are 
parties to prohibited tax shelter transactions.
    (i) Prohibited tax shelter transactions other than subsequently 
listed transactions--(A) Amount of tax if the entity did not know and 
did not have reason to know. If the tax-exempt entity did not know and 
did not have reason to know that the transaction was a prohibited tax 
shelter transaction at the time the entity entered into the 
transaction, the tax is the highest rate of tax under section 11 
multiplied by the greater of--
    (1) The entity's net income with respect to the prohibited tax 
shelter transaction (after taking into account any tax imposed by 
Subtitle D, other than by this section, with respect to such 
transaction) for the taxable year; or
    (2) 75 percent of the proceeds received by the entity for the 
taxable year that are attributable to such transaction.
    (B) Amount of tax if the entity knew or had reason to know. If the 
tax-exempt entity knew or had reason to know that the transaction was a 
prohibited tax shelter transaction at the time the entity entered into 
the transaction, the tax is the greater of--
    (1) 100 percent of the entity's net income with respect to the 
transaction (after taking into account any tax imposed by Subtitle D, 
other than by this section, with respect to such transaction) for the 
taxable year; or
    (2) 75 percent of the proceeds received by the entity for the 
taxable year that are attributable to such transaction.
    (ii) Subsequently listed transactions--(A) In general. In the case 
of a subsequently listed transaction (as defined in section 4965(e)(2) 
and Sec.  53.4965-3(b)), the tax-exempt entity's income and proceeds 
attributable to the transaction are allocated between the period before 
the transaction became listed and the period beginning on the date the 
transaction became listed. See Sec.  53.4965-8 for the standard for 
allocating net income or proceeds to various periods. The tax for each 
taxable year is the highest rate of tax under section 11 multiplied by 
the greater of--
    (1) The entity's net income with respect to the subsequently listed 
transaction (after taking into account any tax imposed by Subtitle D, 
other than by this section, with respect to such transaction) for the 
taxable year that is allocable to the period beginning on the later of 
the date such transaction is identified by the Secretary as a listed 
transaction or the first day of the taxable year; or
    (2) 75 percent of the proceeds received by the entity for the 
taxable year that are attributable to such transaction and allocable to 
the period beginning on the later of the date such transaction is 
identified by the Secretary as a listed transaction or the first day of 
the taxable year.
    (B) No increase in tax. The 100 percent tax under section 
4965(b)(1)(B) and Sec.  53.4965-7(a)(1)(i)(B) does not apply to any 
subsequently listed transaction (as defined in section 4965(e)(2) and 
Sec.  53.4965-3(b)) entered into by a tax-exempt entity before the date 
on which the transaction is identified by the Secretary as a listed 
transaction.
    (2) Taxable year. The excise tax imposed under section 4965(a)(1) 
applies for the taxable year in which the entity becomes a party to the 
prohibited tax shelter transaction and any subsequent taxable year for 
which the entity has net income or proceeds attributable to the 
transaction. A taxable year for tax-exempt entities is the calendar 
year or fiscal year, as applicable, depending on the basis on which the 
tax-exempt entity keeps its books for Federal income tax purposes. If a 
tax-exempt entity has not established a taxable year for Federal income 
tax purposes, the entity's taxable year for the purpose of determining 
the amount an