IRS Identifies New “Transaction of Interest” Requiring Disclosure by Taxpayers and Material Advisors: Subpart F Income Partnership Blocker

January 8, 2009

On December 30, 2008, the IRS issued Notice 2009-7, identifying a transaction as a “transaction of interest” subject to disclosure and list maintenance requirements. The IRS issued this Notice only three months after issuing, on September 11, 2008, a series of proposed and temporary regulations that address the imposition of penalties for failure to include on a tax return any information required to be disclosed with respect to a reportable transaction (including transactions of interest).

Transactions of interest are not necessarily transactions the IRS considers abusive. Instead, they are transactions the IRS believes are the same as or substantially similar to transactions previously identified by the IRS as listed transactions. The IRS believes that these types of transactions have a potential for tax avoidance or evasion, but the IRS lacks sufficient information to determine if the transaction should be specifically identified as a tax avoidance transaction.

Nonetheless, in proposed regulations issued on November 2, 2006 and finalized on July 31, 2007, the IRS identified transactions of interest as reportable transactions subject to a variety of disclosure rules, list maintenance requirements, and potential penalties. The more recent proposed and temporary regulations further discuss the penalties applicable when taxpayers do not properly disclose reportable transactions, including transactions of interest.

Subpart F Income Partnership Blocker

Notice 2009-7 describes a transaction using partnership structures (such as a lower-tier controlled foreign corporation held by a domestic partnership) to claim that the partners do not owe taxes on Subpart F income under tax code Section 951(a).

In a typical transaction of this type, a United States taxpayer owns two controlled foreign corporations (“CFC’s”) which are partners in a domestic partnership. The domestic partnership in turn owns 100 percent of the stock of a third CFC. Some or all of the income of the third CFC is Subpart F income. The United States taxpayer takes the position that the Subpart F income of the third CFC is currently included in the income of the partnership (which is not subject to United States tax) but is not included in the income of the United States taxpayer.

As a result of the claimed tax treatment, income that would otherwise be currently taxable to the taxpayer under Subpart F is not taxable to the taxpayer because of the interposition of the domestic partnership in the CFC structure. Without the interposition of the domestic partnership, the Section 951(a) inclusion resulting from the Subpart F income of the third CFC would be currently taxable to the taxpayer. In variations of this transaction, (1) more than one person that owns the stock of one or both of the first two CFCs, (2) the United States partnership may own less than all of the stock of the third CFC, (3) a domestic trust may be used instead of a domestic partnership, or (4) the Section 951(a) inclusion amount may result from an amount determined under Section 956.

In Notice 2009-8, the IRS announced its concern with taxpayer claims that these types of structures result in no income inclusion to the taxpayer under Section 951. The IRS believes the taxpayer position is contrary to the purpose and intent of the provisions of Subpart F of the Internal Revenue Code. Therefore, the IRS has identified these transactions, as well as substantially similar transactions, as transactions of interest when the taxpayer takes the position that there is no income inclusion to the taxpayer under Section 951. Notice 2009-7 also makes it clear that the taxpayer and the domestic partnership are participants in this transaction for each year in which their respective returns reflect the tax consequences or a tax strategy described in the Notice.


Taxpayers who have entered into these types of transactions, and advisors who have advised any taxpayers with respect to these types of transactions, may face fairly substantial disclosure and list maintenance requirements. There are substantial penalties for both taxpayers and material advisors who fail to comply with these rules in a timely manner. In addition, failure to properly disclose these transactions will extend the statute of limitations for the years in which the transactions occurred. As a result, the potential audit risk will be extended.

The McGuireWoods LLP Civil and Criminal Tax Controversy/Litigation Group routinely handles tax controversies and litigation against the Internal Revenue Service and has broad experience representing clients in matters related to reportable transactions, related penalty examinations, and transaction and penalty disclosure requirements.

If you have any questions, please do not hesitate to contact us at your convenience.