Everything You Ever Wanted To Know About Adequate Disclosure But Were Afraid to Ask

By Megan L. Brackney
Journal of Passthrough Entities
September - October 2015 Edition

Adequate disclosure can be a defense to the application of the extended six-year statute of limitations for assessment for tax based on a substantial understatement of gross income, a defense to substantial understatement penalties, and a defense to preparer penalties, as well as an important factor in whether the IRS exercises its discretion to impose penalties in other situations. Because the method and manner of disclosure differs in each of these situations, it is crucial to understand these rules in order to counsel your clients on whether and how to disclose a tax return position on their returns. 

Adequate Disclosure as a Defense to the Extended Six-Year Statute of Limitations for Substantial Understatement

Under Code Sec. 6501(a), the IRS must assess a tax deficiency within three years after the return was filed. There are numerous exceptions to this rule, including Code Sec. 6501(e)(1)(A), which extends the time period for assessment to six years if the taxpayer omits an amount in excess of 25% of the gross income stated on the return. The purpose of the extended statue of limitations for assessment in cases of substantial omissions of gross income is to "level the playing field when the taxpayer's omission of income places the IRS at a disadvantage in discovering errors." Accordingly, an amount is not considered to have been omitted from gross income if it was "disclosed on the return, or in a statement attached to the return, in a manner adequate to apprise the Secretary of the nature and amount of such item."

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