IRS Provides Interim Guidance on New Tax Shelter Rules for Exempt Organizations

On February 7, the IRS released Notice 2007-18, providing interim guidance on the scope of new tax shelter reporting and penalty rules enacted by the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA). TIPRA created a new Section 4965, which subjects exempt organizations and their managers to penalties for engaging in “prohibited tax shelter transactions.” The legislation created considerable uncertainty with respect to, among other things, whether a number of common business transactions, including investments by exempt organizations in “plain vanilla” investment funds that at some point engage in transactions covered by Section 4965, would be swept into the definition of prohibited tax shelter transactions to which an exempt organization was a “party.”

Under the interim guidance, most common investments would not be affected by the TIPRA rules. An exempt organization will only be treated as a party to a transaction if it facilitates the transaction’s purported tax benefits by reason of its tax-exempt, tax-indifferent, or tax-favored status or if the organization has been identified by the IRS in published guidance—by type, class, or role—as a party to a prohibited tax shelter transaction. An example in the guidance notes that an organization would not be a party to a prohibited tax shelter transaction in a situation in which the organization joins a partnership with a number of taxable and tax-exempt organizations and the partnership then engages in a series of investment transactions, including one or more that would constitute prohibited tax shelter transactions. This example will be helpful in clarifying that an exempt organization that invests in a typical investment fund is not as a result subject to the TIPRA penalties. The notice recognizes that the definition of “party” in the new statutory provision enacted by TIPRA may be broader than the definition provided by the notice and requests comments on a number of items by March 23, 2007.

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