IRS Listed Transactions and How to Spot Them in the Wild

Everybody hears stories of tax schemes and transactions either in the news, at social events, or through their profession that make them question the creation, structure, and end result for that business or individual. In history books and in the news, you find tales of celebrities and their tax evasion schemes—from Chicago gangster Al Capone, who was held on San Francisco’s Alcatraz Island, to the pop singer Shakira, who was recently accused by the Spanish government of defrauding the country of 14.5 million euros. Having a specific financial transaction end up on the Internal Revenue Service (IRS) website as a reportable transaction is the equivalent of a financial advisor ending up on the list of America’s Most Wanted.

The IRS has a list of transactions that they consider to be tax evasion or avoidance in nature and has rigorously and comprehensively documented them for those individuals who have enough assets or cash to live life on the riskier side. There are five categories of reportable transactions: confidential transactions, transactions with contractual protection, loss transactions, transactions of interest, and listed transactions. These five categories are considered reportable because they have the potential to be abusive in nature. A “listed transaction” is a transaction that is the same as or substantially similar to one of the types of transactions that the IRS has determined to be a tax avoidance transaction and has been identified by notice, regulation, or some other form of published guidance confirming its listed transaction status. At the current time there are only 36 transactions that are considered listed—so there’s plenty of space for people to get more creative and add to the IRS’s Most Wanted list.

Below are just a few examples of the complicated tax avoidance transactions that are considered listed by the IRS:

1. Intercompany financing through partnerships. These are transactions in which corporations claim inappropriate deductions for payments made through a partnership, identified as “listed transactions” on April 1, 2004.
2. S corporation tax shelter involving shifting income to a tax-exempt organization. These are transactions in which S corporation shareholders attempt 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, identified as “listed transactions” on April 1, 2004.
3. Transfers of compensatory stock options to related persons. These are transactions involving compensatory stock options and related persons to avoid or evade federal income and employment taxes, identified as “listed transactions” on July 1, 2003.

As you can see from just the brief sampling above, these are not everyday transactions that are routinely handled or encountered by most individuals. A lot of these transactions become popular and on the IRS radar as those of the upper echelon start looking for ways to save on estate taxes, offload assets, and protect their estate for heirs. Certain financial transactions start to become popular and done at a higher level, which then peaks the IRS’s attention. At that point the IRS will review and release an official decision through a public notice on whether they feel the transaction is promoting tax avoidance or skirting along the edge of a dance with the devil.

This article is limited in its ability to do a deep dive into the world or reportable transactions, but this is always something to keep on your radar as potential clients come to your office.