A complete Form 8886 can satisfy the disclosure needed to avoid the 40% economic-substance penalty, even without a separate Form 8275

Plain-English summary

When the IRS disallows a tax benefit because a transaction lacked "economic substance" (it had no real business purpose beyond tax savings), it can add a 20 percent penalty. That penalty doubles to 40 percent if the taxpayer did not adequately disclose the transaction on the return. This Chief Counsel Advice asks whether a taxpayer who reported a micro-captive insurance deal (a listed abusive transaction) on Form 8886, the reportable-transaction form, but did not also file Form 8275, the separate disclosure statement, has done enough to avoid the higher 40 percent penalty. IRS interim guidance in Notice 2010-62 tells taxpayers to use Form 8275 (and, for transactions that are also reportable, both Form 8886 and Form 8275). But Chief Counsel points out that a 2019 Treasury policy statement bars the IRS from treating that kind of subregulatory notice as having the force of law, and no actual regulation requires a Form 8275 here. So the real test comes from the statute itself and from case law: disclosure is "adequate" if it gives the IRS enough facts to spot the potential controversy. The advice concludes that a timely, complete Form 8886 describing all the material facts likely meets that standard, while a deficient Form 8886 that omits material facts can still be attacked as inadequate.

Ruling snapshot

• Question: Does a taxpayer adequately disclose a noneconomic-substance transaction for the 40% penalty under section 6662(i)(2) by reporting it on Form 8886 but not on a separate Form 8275?
• Outcome: Advice (a complete, timely Form 8886 likely suffices; the IRS cannot enforce Notice 2010-62's Form 8275 requirement as law)
• Key authorities: IRC §§ 6662(i), 6662(b)(6), 6011; Notice 2010-62; 2019 Policy Statement on the Tax Regulatory Process; Elliott v. Commissioner, T.C. Memo. 1997-294

Full text (IRS public release)

           Office of Chief Counsel
           Internal Revenue Service
           Memorandum
           Number: 202244010
           Release Date: 11/4/2022
           CC:PA:01:CWhitcomb
           POSTS-111532-22

 UILC:     6662.00-00

  date:    October 03, 2022

     to:   Dawn Danley-Nichols
           Associate Area Counsel
           (Large Business & International)

  from:    Kevin Gillin, Senior Technician Reviewer (Branch 1)
           (Procedure & Administration)



subject:   Adequate Disclosure Under Section 6662(i)

           This Chief Counsel Advice responds to your request for assistance asking whether
           disclosure of micro-captive insurance transactions on a Form 8886, and not on Form
           8275 as required by Notice 2010-62, is sufficient to avoid the 40 percent penalty for a
           nondisclosed noneconomic substance transaction under 26 U.S.C. § 6662(i). This
           advice may not be used or cited as precedent.

           ISSUE

           Do taxpayers adequately disclose noneconomic substance transactions for purposes of
           section 6662(i)(2) where the material facts of the transactions are disclosed as
           reportable transactions on Forms 8886 but are not separately disclosed on Forms
           8275?

           CONCLUSION

           Yes. To avoid the 40 percent penalty under section 6662(i), Notice 2010-62 requires
           taxpayers to disclose noneconomic substance transactions on Form 8275 or 8275-R.
           Notice 2010-62 further requires that for transactions that are both reportable
           transactions under section 6011 and transactions lacking economic substance under
           section 6662(b)(6), taxpayers must disclose the transaction both on Form 8886 and
           Form 8275. However, the 2019 Policy Statement on the Tax Regulatory Process
POSTS-111532-22                                      2

prevents the IRS from arguing that Notice 2010-62 has the force and effect of law.
https://home.treasury.gov/system/files/131/Policy-Statement-on-the-Tax-Regulatory-
Process.pdf. It is likely that a timely filed Form 8886 that completely describes the
material facts of a micro-captive transaction, or another noneconomic substance
transaction, meets the disclosure requirements under section 6662(i)(2).

ANALYSIS

Taxpayers are liable for 20 percent accuracy-related penalties under section 6662(b)(6)
for the disallowance of tax benefits as a result of a transaction lacking economic
substance. These penalties are increased to 40 percent under section 6662(i) when
taxpayers fail to adequately disclose transactions lacking economic substance on a
return or statement attached to a return. 26 U.S.C. § 6662(i)(2).

No regulations have been promulgated under section 6662(i). Interim guidance
regarding section 6662(i) is set forth in Notice 2010-62 which provides a method for
taxpayers to make a disclosure that is adequate for purposes of section 6662(i)(2), in
part by filing a Form 8275 or 8275-R. Notice 2010-62 further provides that
noneconomic substance transactions under section 6662(b)(6) that are also reportable
transactions under section 6011 must be disclosed both on Form 8886 and on Form
8275.

However, the IRS cannot contend that Notice 2010-62 imposes an obligation for
taxpayers to file a Form 8275 because that position would not adhere to a March 5,
2019, Policy Statement on the Tax Regulatory Process. That policy statement states
that “[s]ubregulatory guidance is not intended to affect taxpayer rights or obligations
independent from underlying statutes or regulations” and that the “Treasury Department
and the IRS . . . will not argue that subregulatory guidance has the force and effect of
law.” There are no regulations that require taxpayers to file a Form 8275 to disclose
noneconomic substance transactions to defend against section 6662(i) penalties. 1

Thus, in the absence of regulations requiring a Form 8275 to disclose a noneconomic
substance transaction, the IRS must rely on the language of section 6662(i)(2) and
relevant case law to determine whether a disclosure is adequate. Section 6662(i)(2)
defines a “nondisclosed noneconomic substance transaction” as “any portion of a
transaction described in subsection (b)(6) with respect to which the relevant facts
affecting the tax treatment are not adequately disclosed in the return nor in a statement
attached to the return.” 26 U.S.C. § 6662(i)(2).

Although courts have not addressed what constitutes an adequate disclosure under
section 6662(i)(2), case law interpreting similar disclosure requirements provides helpful
examples on what constitutes an adequate disclosure. The Tax Court has explained

1 Treas. Reg. § 1.6662-3(c)(2) provides that taxpayers must disclose positions contrary to a rule or

regulation on a Form 8275 or 8275-R in order to avoid penalties under section 6662(b)(1). Treas. Reg.
§ 1.6662-4(f)(1) prescribes the same disclosure requirement to avoid penalties for substantial
understatement of income tax under section 6662(d)(2)(B).
POSTS-111532-22                             3

that “[w]hat is critical is whether the taxpayer adequately disclosed enough relevant data
concerning the treatment of the item to alert the Commissioner to potential controversy.”
Elliott v. Commissioner, T.C. Memo. 1997-294; Estate of Ervin A. Reinke v.
Commissioner, T.C. Memo. 1993-197 (adequate disclosure under old section 6661
requires that petitioner “disclose the relevant facts”), aff’d, 46 F.3d 760, 765 (8th Cir.
1995) (“To satisfy the disclosure requirement, the tax return must at least provide
sufficient information to enable the Commissioner to identify the potential controversy
involved.”); see also Crouch v. Commissioner, T.C. Memo. 1995-289 (Form 8275 not
per se sufficient for adequate disclosure under section 6662(b)(1) if a “material fact” is
not disclosed).

Therefore, where Form 8886 is timely filed with a return or a qualified amended return
and provides a complete description of the relevant facts of a noneconomic substance
transaction, taxpayers have a strong argument that they have adequately informed the
IRS of the transaction consistent with the requirements of section 6662(i). In contrast,
Forms 8886 that are deficient or omit material facts regarding the transaction can be
argued to fall short of the disclosure required by section 6662(i).


Please call (202) 317-4210 if you have any further questions.