1. Introduction.

      On July 12, 2024, the U.S. Department of the Treasury (“Treasury”) and the Internal Revenue Service (“IRS”) issued proposed regulations that would classify “basket contract transactions”, which are derivatives (i) with a term of more than a year (or that spans two taxable years), (ii) that reference a basket of assets, and (iii) where the taxpayer or an agent of the taxpayer exercises discretion to change the assets in the basket or the trading algorithm for the basket as “listed transactions” under the reportable transaction rules.  Taxpayers engaging in basket contract transactions as described in the proposed regulations will face potentially significant penalties for failing to properly report such transactions—and taxpayers (and their tax advisors) would need to file reports even for transactions entered into prior to the date of the issuance of, or finalization of, these regulations.

      2. Background.

      Section 6011(a)[1] and Treasury Regulations Section 1.6011-4 provide that a taxpayer must disclose to the IRS if such taxpayer has participated in certain types of transactions, such as “listed transactions,” transactions with losses in excess of certain amounts (which are not exempted by other guidance), and “transactions of interest.”  Additionally, material advisors to taxpayers with respect to such transactions must also report their involvement to the IRS.[2]  The intent of these reporting requirements is to provide information to Treasury and the IRS to allow them to investigate transactions that Treasury and the IRS suspect may be causing inappropriate tax avoidance or evasion.  Treasury and the IRS had previously flagged certain types of “basket contracts”, including contracts structured as options, and contracts structured as other financial instruments such as notional principal contracts or forward contracts, as listed transactions or transactions of interest in previous notices.[3]  Basket contract transactions are generally structured so that a taxpayer, using a contract such as an option, notional principal contract, forward contract, or other derivative contract, receives a return based on the performance of a reference basket of assets.  Treasury and the IRS are concerned that taxpayers are using these types of transactions to defer ordinary income and to inappropriately convert what would be short-term capital gain or ordinary income, to long-term capital gain recognized later.  

      3. The Proposed Regulations.

      Treasury and the IRS had concluded, based on their analysis of transactions reported under the prior notices, that basket contracts of all types identified in those notices inappropriately deferred income and/or inappropriately converted ordinary income or short-term capital gain into long-term capital gain.  As such, and also likely to protect their reporting requirements from being set aside as violative of the Administrative Procedure Act[4], Treasury and the IRS issued the proposed regulations to classify all such “basket contracts” as listed transactions.  In particular, the proposed regulations list the various attributes that will cause a transaction to fall under the reporting requirements: (1) the taxpayer enters into a contract with a counterparty to receive a return based on the performance of a reference basket of assets, (2) the contract has a stated term of more than one year or overlaps two or more of the taxpayer’s taxable years, (3) the taxpayer has exercised discretion to change the assets in the reference basket or trading algorithm,[5] (4) the taxpayer’s tax return reflects a tax benefit with respect to the transaction, and (5) the transaction is not subject to the exceptions of paragraph (d) of the proposed regulations.[6]  These exceptions include contracts that are traded on a national securities exchange, contracts that are treated as contingent payment debt instruments, and, with respect to the counterparty, if the taxpayer represents that none of its tax returns ending on or after January 1, 2011 will reflect a benefit with respect to the transaction, or if the counterparty has established that the taxpayer is a nonresident alien that is not engaged in a U.S. trade or business or a foreign corporation that is not engaged in a U.S. trade or business.[7]

      Because Treasury and the IRS are classifying these basket contracts as “listed transactions” in the proposed regulations, the more onerous reporting rules relating to such transactions will apply to taxpayers and their material advisors upon the finalization of the regulations.  In particular, taxpayers will be subject to (1) reporting requirements for prior open tax years as well as any year going forward in which they participate in such a transaction,[8] (2) increased penalties for failing to properly report,[9] (3) an extended period of limitations with respect to assessment of the tax,[10] and (4) possible financial statement reporting.[11]

      Treasury and the IRS also discuss the various potential challenges they planned to bring against taxpayers who had engaged in “basket contracts” that meet the requirements of the proposed regulations.  These include the argument that the counterparty in the transaction holds the assets in the reference basket as an agent of the taxpayer and that the taxpayer is actually the beneficial owner of the assets for tax purposes, the argument that changes to the assets in the reference basket materially modify the contract and therefore result in a taxable event under Section 1001, and the argument that the taxpayer is mischaracterizing the transaction as an option or other derivative to avoid the application of Section 1260 (with respect to constructive ownership transactions) or Section 1291 (with respect to passive foreign investment companies), or both.  Note that just because a basket contract is a listed transaction does not mean Treasury or the IRS will win any challenge under the grounds they list—it merely triggers the reporting requirements discussed above.  However, the identification of a transaction as a “listed transaction” is a strong signal that Treasury and the IRS are highly suspicious of the transactions and could pursue audits with intensity and may indicate a lower willingness to provide favorable settlement terms.

      4. Conclusion.

      As stated previously, the IRS’s and Treasury’s chief concern is that basket contracts represent tax ownership of the underlying basket because the taxpayer has control over its assets, and secondarily, that changes to the basket give rise to taxable events.  Taxpayers and their material advisors should be aware of the proposed regulations, and ensure that if they participate in the transactions described, they are able to comply with the disclosure requirements.  As stated above, listed transactions involve more onerous reporting requirements, including the need to look back to past tax years, as well as more significant penalties for failure to comply.


      [1] All references to “Section” are to the Internal Revenue Code of 1986, as amended, or to the Treasury Regulations promulgated thereunder.

      [2] In the proposed regulations, material advisors will be required to report transactions for prior years if they have made a tax statement on or after the date that is six years prior to the date of publication of the final regulations.

      [3] Notice 2015-73 (basket contracts structured as options, when certain other requirements are met, are listed transactions); Notice 2015-74 (other basket contracts, when certain other requirements are met, are transactions of interest).

      [4] See e.g., Mann Construction, Inc., v. United States, 27 F.4th 1138 (6th Cir. 2022) and CIC Servs., LLC v. IRS, No. 3:17-cv-110, 2022 BL 97539 (E.D. Tenn. Mar. 21, 2022).  

      [5] This control requirement is the key feature which distinguishes basket contract transactions from other more common financial derivatives, such as swaps on the S&P 500.

      [6] Proposed Regulation Section 1.6011-16(c).

      [7] Proposed Regulation Section 1.6011-16(d).

      [8] Treasury Regulations Sections 1.6011-4(d) and (e).

      [9] Section 6707A and Sections 6662A(a) and (c).

      [10] Section 6501(c)(10).

      [11] Section 6707A(e).

      Photo of Richard M. Corn Richard M. Corn

      Richard M. Corn is a partner in the Tax Department. He focuses his practice on corporate tax structuring and planning for a wide variety of transactions, including:

      • mergers and acquisitions
      • cross-border transactions
      • joint ventures
      • structured financings
      • debt and equity issuances
      • restructurings
      • bankruptcy-related transactions

      Richard M. Corn is a partner in the Tax Department. He focuses his practice on corporate tax structuring and planning for a wide variety of transactions, including:

      • mergers and acquisitions
      • cross-border transactions
      • joint ventures
      • structured financings
      • debt and equity issuances
      • restructurings
      • bankruptcy-related transactions

      Richard advises both U.S. and international clients, including multinational financial institutions, private equity funds, hedge funds, asset managers and joint ventures. He has particular experience in the financial services and sports sectors. He also works with individuals and tax-exempt and not-for-profit organizations on their tax matters.

      Richard began his career as a clerk for the U.S. Court of Appeals for the Fourth Circuit Judge J. Michael Luttig and then went on to clerk at the U.S. Supreme Court for Associate Justice Clarence Thomas. Prior to joining Proskauer, he most recently practiced at Sullivan & Cromwell as well as Wachtell, Lipton, Rosen and Katz.

      Photo of Robert A. Friedman Robert A. Friedman

      Robert Friedman is a partner in the Tax Department whose practice focuses on representing clients in all facets of corporate and partnership related tax matters. In particular, Robert provides tax advice on public and private mergers, acquisitions, joint ventures, divestitures, private equity fund…

      Robert Friedman is a partner in the Tax Department whose practice focuses on representing clients in all facets of corporate and partnership related tax matters. In particular, Robert provides tax advice on public and private mergers, acquisitions, joint ventures, divestitures, private equity fund formation, financial products and electric and gas utility tax issues.

      Photo of Martin T. Hamilton Martin T. Hamilton

      Martin T. Hamilton is a partner in the Tax Department. He primarily handles U.S. corporate, partnership and international tax matters.

      Martin’s practice focuses on mergers and acquisitions, cross-border investments and structured financing arrangements, as well as tax-efficient corporate financing techniques and the tax…

      Martin T. Hamilton is a partner in the Tax Department. He primarily handles U.S. corporate, partnership and international tax matters.

      Martin’s practice focuses on mergers and acquisitions, cross-border investments and structured financing arrangements, as well as tax-efficient corporate financing techniques and the tax treatment of complex financial products. He has experience with public and private cross-border mergers, acquisitions, offerings and financings, and has advised both U.S. and international clients, including private equity funds, commercial and investment banks, insurance companies and multinational industrials, on the U.S. tax impact of these global transactions.

      In addition, Martin has worked on transactions in the financial services, technology, insurance, real estate, health care, energy, natural resources and industrial sectors, and these transactions have involved inbound and outbound investment throughout Europe and North America, as well as major markets in East and South Asia, South America and Australia.

      Photo of David S. Miller David S. Miller

      David Miller is a partner in the Tax Department. David advises clients on a broad range of domestic and international corporate tax issues. His practice covers the taxation of financial instruments and derivatives, cross-border lending transactions and other financings, international and domestic mergers…

      David Miller is a partner in the Tax Department. David advises clients on a broad range of domestic and international corporate tax issues. His practice covers the taxation of financial instruments and derivatives, cross-border lending transactions and other financings, international and domestic mergers and acquisitions, multinational corporate groups and partnerships, private equity and hedge funds, bankruptcy and workouts, high-net-worth individuals and families, and public charities and private foundations. He advises companies in virtually all major industries, including banking, finance, private equity, health care, life sciences, real estate, technology, consumer products, entertainment and energy.

      David is strongly committed to pro bono service, and has represented more than 200 charities. In 2011, he was named as one of eight “Lawyers Who Lead by Example” by the New York Law Journal for his pro bono service. David has also been recognized for his pro bono work by The Legal Aid Society, Legal Services for New York City and New York Lawyers For The Public Interest.

      Photo of Amanda H. Nussbaum Amanda H. Nussbaum

      Amanda H. Nussbaum is the chair of the Firm’s Tax Department as well as a member of the Private Funds Group. Her practice concentrates on planning for and the structuring of domestic and international private investment funds, including venture capital, buyout, real estate…

      Amanda H. Nussbaum is the chair of the Firm’s Tax Department as well as a member of the Private Funds Group. Her practice concentrates on planning for and the structuring of domestic and international private investment funds, including venture capital, buyout, real estate and hedge funds, as well as advising those funds on investment activities and operational issues. She also represents many types of investors, including tax-exempt and non-U.S. investors, with their investments in private investment funds. Business partners through our clients’ biggest challenges, Amanda is a part of the Firm’s cross-disciplinary, cross-jurisdictional Coronavirus Response Team helping to shape the guidance and next steps for clients impacted by the pandemic.

      Amanda has significant experience structuring taxable and tax-free mergers and acquisitions, real estate transactions and stock and debt offerings. She also counsels both sports teams and sports leagues with a broad range of tax issues.

      In addition, Amanda advises not-for-profit clients on matters such as applying for and maintaining exemption from federal income tax, minimizing unrelated business taxable income, structuring joint ventures and partnerships with taxable entities and using exempt and for-profit subsidiaries.

      Amanda has co-authored with Howard Lefkowitz and Steven Devaney the New York Limited Liability Company Forms and Practice Manual, which is published by Data Trace Publishing Co.

      Photo of Gregory Zeien Gregory Zeien

      Gregory Zeien is a law clerk in the Tax Department.