The 773 Tax Penalty for Abusive Tax Shelters

The Internal Revenue Code contains specific penalties to discourage the creation and sale of illegitimate tax avoidance schemes. One such provision penalizes promoters of arrangements the Internal Revenue Service (IRS) deems abusive. This penalty serves as a deterrent against marketing tax shelters that lack a legitimate business purpose and are designed to generate unavailable tax benefits. The focus is on the supply side of abusive transactions—the individuals and entities who devise and sell these plans.

Who is Subject to the Penalty

The penalty for promoting abusive tax shelters can be applied to a wide range of individuals and entities. The term “person” is interpreted broadly by the IRS to include individuals, partnerships, trusts, and other entities that participate in the promotion or sale of an abusive tax plan. This ensures that all parties involved in bringing an abusive shelter to market can be held accountable.

Professionals such as accountants, attorneys, and financial advisors are not immune. They may be classified as promoters if their involvement crosses a specific line, occurring when they do more than render independent advice and instead actively participate in the organization or sale of the shelter. An attorney who drafts the documents for an abusive trust or an accountant who markets the scheme to their clients could be subject to the penalty.

The penalty targets anyone who organizes, assists in the organization of, or participates in the sale of any interest in the plan. This includes the principal architects of the scheme as well as any salesperson or intermediary who facilitates a taxpayer’s investment. The risk of a significant financial penalty is intended to make professionals and other potential participants think twice before getting involved in a questionable tax arrangement.

Activities That Trigger the Penalty

The penalty for promoting abusive tax shelters is triggered by specific actions outlined in Internal Revenue Code Section 6700. This section establishes two main categories of prohibited conduct that can lead to the penalty. A promoter does not need to engage in both types of activities; committing just one is sufficient to be penalized.

False or Fraudulent Statements

The first category of prohibited conduct involves making false or fraudulent statements regarding the tax benefits of a particular plan. This applies when a person makes a statement about the allowability of a deduction or credit that they know or have reason to know is untrue. The “reason to know” standard is broader than actual knowledge, meaning a promoter cannot claim ignorance if a reasonable person in their position would have recognized the statement as false. For example, a promoter who tells investors they can claim a charitable deduction for an amount far exceeding what is legally permissible would fall under this rule.

Gross Valuation Overstatements

The second category of conduct is making or furnishing a gross valuation overstatement. This is defined as a statement of value for any property or service that is more than 200 percent of its correct value. The valuation must be directly related to the amount of a deduction or credit claimed by a participant in the plan.

This rule is aimed at schemes that generate improper tax deductions through inflated appraisals of assets, such as art or conservation easements. For instance, if a promoter arranges for an appraiser to value a donated property at $500,000 when its actual fair market value is only $100,000, this would constitute a gross valuation overstatement. The Secretary of the Treasury may waive this penalty if the promoter can show there was a reasonable basis for the valuation and it was made in good faith.

How the Penalty is Calculated

The financial penalty for promoting an abusive tax shelter is calculated based on the specific violation. For making a false or fraudulent statement about tax benefits, the penalty is 50 percent of the gross income the promoter has derived, or expects to derive, from the activity.

For promoting a plan involving a gross valuation overstatement, the penalty is $1,000 for each activity. This amount can be reduced if the promoter can prove that 100 percent of the gross income derived from the activity is a lesser figure.

“Gross income derived” includes all compensation, such as fees for organizing the shelter and commissions from sales. The penalty is assessed on a per-activity basis; the organization of an abusive plan is one activity, and each sale of an interest is a separate activity. For example, a promoter who organizes one abusive partnership and sells interests to 50 investors could face 51 separate penalties.

Relationship to Other Promoter Penalties

The penalty for promoting abusive tax shelters does not exist in isolation. It is part of a broader enforcement framework the IRS uses to combat abusive tax avoidance schemes. A promoter may be liable for multiple penalties arising from the same course of conduct.

One related provision is Internal Revenue Code Section 6707, which imposes a penalty on material advisors who fail to file a required disclosure statement for a reportable transaction. Material advisors are often the same individuals or firms that would be considered promoters. If a promoter organizes a reportable transaction and fails to file the necessary disclosure with the IRS, they could be subject to a penalty of $50,000. If the arrangement is a “listed transaction”—a scheme the IRS has officially identified as a tax avoidance transaction—the penalty increases to the greater of $200,000 or 50 percent of the gross income derived from the activity.

Another related penalty is found in Internal Revenue Code Section 6708, which penalizes the failure to maintain a list of investors in a potentially abusive tax shelter. Promoters and material advisors are required to keep records of everyone who invests in their schemes and must provide this list to the IRS upon request. Failure to make the list available can result in a penalty of $10,000 for each day the failure continues after the 20th business day following the IRS’s written request.