This is my first experimental post.
This week the IRS issued Notice 2015-47 and Notice 2015-48. These notices identify certain so-called “basket” trades as listed transactions (in the case of Notice 2005-47) and transactions of interest (in the case of Notice 2015-48). Listed transactions and transactions of interest are generally those transactions that IRS has identified as subject to special disclosure requirements that the IRS generally considers potentially abusive tax shelters. Taxpayers participating in those transactions must generally report those transactions on their tax returns or face penalties. Because the notices are retroactive, taxpayers who have already entered these transactions may be subject to disclosure requirements for existing or prior transactions.
The notices describe the basket transactions at length in a manner that can best be described as boring. In short, a basket trade is where the investor enters into a derivative contract (it can be an option, a swap, yadda, yadda, yadda) that has a final price that’s based on more than one reference asset. It’s like placing a bet on the outcome of two different football games and the bookie netting the wins and losses before paying you. The IRS also specifically references transactions that defer the payment of a substitute dividend payment until termination of the contract.
It seems the IRS’ primary concern here is that taxpayers are using basket contracts to defer gain until termination of the contracts and that taxpayers are converting ordinary income into long-term capital gains. This is because contracts have a term of more than one year (thus long term) and, as mentioned, defer all payments until the end of the term of the contract. In addition, they identify concerns related to non-US holders avoiding withholding.
Of course, this is likely simply additional fallout from the Permanent Subcommittee on Investigations Report addressing certain abuses in basket trades similar to those described in the notice as well as the IRS chief counsel memorandum addressing the same (e.g., AM 2010-005). For the most part, instead of leaving it solely to the auditors to find taxpayers who entered into the same or substantially similar transactions, the notices have added these transactions to their tax shelters list to either (a) motivate taxpayers to disclose or (b) smack taxpayers in the ass.
In later posts (assuming I get around to it), I plan on tackling the various challenges to the taxpayers’ positions that the IRS posited in their notice. It might also be worth asking what is “substantially similar” since that will define the scope of the disclosure.