IRS Releases Notices Designating Certain “Basket Contracts” As Listed Transactions And Others As Reportable Transactions Of Interest -

On Wednesday, July 8, the IRS released two notices addressing “basket contracts,” which are generally derivative instruments linked to a basket of reference assets that, among other things, allow the holder to vary the basket over the instrument’s life. According to the IRS, these types of contracts have the potential for tax avoidance because taxpayers account for gain or loss on the contract once the contract terminates instead of when changes to the underlying assets are made. This may result in deferral and conversion of short-term capital gain into long-term capital gain and other tax discontinuities. Basket contracts were first scrutinized in AM 2015-005, where the IRS recharacterized option contracts as direct ownership in the underlying assets.

The two notices denominate certain basket contract transactions as “listed transactions,” and others as “transactions of interest.” Both listed transactions and transactions of interest are “reportable transactions,” requiring the taxpayer and the taxpayer’s material advisors to disclose the transaction on their tax returns. Among other things, penalties for failing to disclose a listed transaction are more severe than penalties for failing to disclose other types of reportable transactions.