On July 6, 2010, the IRS issued final regulations regarding excise taxes imposed under section 4965 of the Internal Revenue Code on prohibited tax shelter transactions (PTSTs). Section 4965 defines certain transactions as PTSTs and imposes excise taxes and disclosure requirements with respect to PTSTs to which a tax-exempt entity is a party. When section 4965 was enacted, there was uncertainty and concern within the tax-exempt community as to whether a tax-exempt investor in a partnership that engages in a PTST would be considered “a party” to a PTST. The final regulations clarify that a tax-exempt organization will not be considered a party to a PTST merely because it invests in a partnership that engages in a PTST.
Under the final regulations a tax-exempt entity is a party to a PTST if the entity – (1) facilitates a PTST by reason of its tax-exempt, tax indifferent or tax-favored status; or (2) is identified in published guidance, by type, class or role, as a party to a PTST. Therefore, as long as a tax-exempt organization’s investment in a partnership that engages in a PTST does not trigger either of these prongs, the tax-exempt organization will not be considered a “party to” a PTST. The preamble to the regulations also provides that a tax-exempt entity that enters into a transaction to reduce or eliminate its own tax liability generally will not be considered a party to a PTST. However, the IRS and the Treasury Department have reserved the ability to identify in published guidance specific transactions or circumstances in which a tax-exempt entity that enters into a transaction to reduce or eliminate its own tax liability will be treated as a party to a PTST for purposes of section 4965. The regulations are effective for taxable years ending after July 6, 2007.