Circular 230: new rules on written tax advice.
What Are "Best Practices"?
According to Section 10.33(a), best practices include the need for clear communication between practitioners and clients as to:
1. The terms and purpose of the engagement;
2. Use of the written advice for promotion of a transaction;
3. Reliance on the written advice to help avoid imposition of a penalty under the "reasonable cause" standards; and
4. Limits the client is willing to accept on using the written advice for the proposed transaction.
Under Section 10.33 (a) (2), a practitioner must be aware of all the facts relating to a transaction, and then ascertain which ones are relevant to the conclusions in an opinion. The practitioner is also expected to evaluate the reasonableness of any assumptions or representations used in constructing the opinion's conclusions.
Practitioners are expected to relate applicable law to all relevant facts, and to arrive at conclusions supported by the facts and the law, according to Section 10.33(a)(2).They are also expected to advise clients on the import of any conclusions reached, the most common situation being advising a client as to whether the opinion can be used to avoid an accuracy-related penalty if the client acts and relies on the opinion; see Section 10.33(a)(3).
A practitioner must act fairly and with integrity when practicing before the IRS; see Section 10.33(a)(4).
In addition to these "aspirational" rules, Section 10.33(b) also contains procedures on how a firm should operate to ensure best practices. Persons having responsibility for overseeing a firm's practice of providing advice on Federal tax issues or of preparing submissions to the IRS should take reasonable steps to ensure that the procedures the firm uses are consistent with Section 10.33(a)'s best practices.
Unanswered questions: These best practices raise several issues that will require experience with these regulations before clear answers emerge. Will the Office of Professional Responsibility (OPR) treat all firms equally in determining whether they are trying to comply with the best practices? Firms with large tax departments will most likely be able to formalize their procedures in manuals and directives, for example. Many smaller firms or sole practitioners with limited resources most likely do not have the structure to comply fully with the best practices rules. Will the OPR, in the event of a violation, be even-handed, or be less willing to "understand" the reasons for a violation in a large firm versus a small one?
Because practitioners are required to advise a client about the significance of conclusions reached, the assumption in Section 10.33 seems to be that the advice relates to a tax shelter-type transaction to which accuracy-related penalties apply. Why, then, should simple and routine tax advice be subject to these covered opinion requirements, if these rules are primarily intended for tax shelter transactions?
Taxpayers are required to act in good faith in reporting transactions. If a client asks an adviser whether an accuracy-related penalty can be avoided by relying on the adviser's opinion, does this mean the client did not act in good faith? If the Service believes the client did not, will it be less inclined to consider abatement of any assessed penalties?
Once a client requests an opinion on a transaction, the practitioner must determine the opinion's purpose. If it is to provide maximum protection from penalties, it most likely will be a covered opinion. The rules on the preparation and issuance of covered opinions are not optional; they must be closely followed, or the practitioner may face sanctions from the Service through the OPR.
Definition: A covered opinion is written advice about a transaction that is a tax avoidance transaction identified as a listed transaction in published guidance or which has as a principal purpose the avoidance or evasion of any tax imposed by the Code (Section 10.35(b)(2)).
What is interesting in this definition is the use of the phrase "avoidance or evasion." Often, written tax advice on avoidance transactions are opinions applicable to routine transactions sanctioned by the law. For example, should advice on a corporate reorganization or Sec. 1031 like-kind exchange be subject to the covered opinion rules? Such transactions are a far cry from many of the listed transactions the IRS has identified as tax avoidance transactions in published guidance. The regulations should be revised to distinguish clearly between application of the rules to transactions structured to legally avoid tax versus those to evade tax.
Process: If clients request a "covered opinion," they should be made aware of the process for creating such an opinion. They need to recognize that, under Section 10.35(c)(1), the practitioner must use reasonable efforts to discover the facts relevant to the written advice. In addition, practitioners have to analyze all the assumptions on which the facts rest to be sure they are reasonable, including a review of financial forecasts and appraisals. All factual assumptions relied on are required to be separately stated in the opinion.
Under Section 10.35(c)(2), the opinion also has to relate the tax law to the facts and assumptions. It cannot be based on an unreasonable legal assumption, nor assume the issue will result in a favorable determination.
According to Section 10.35(c)(3), the opinion must consider "all significant Federal tax issues." To meet these requirements, it must also reach a conclusion about the likelihood of the taxpayer prevailing on each issue, including a description of the reasons for the conclusions reached. An additional related question is which other taxes become the subject of the written advice. If the transaction involves an airline, for example, are all the related excise taxes required to be covered? If this transaction involves telecommunications, do the excise taxes have to be covered? Are payroll and FUTA taxes required to be covered in the written tax advice?
Disclosures: In addition, a covered opinion must contain the following disclosures regarding various relationships under Section 10.35(e):
1. Any financial relationship between the promoter and practitioner must be disclosed, including referral fees, commissions, fee-sharing, etc.
2. A referral arrangement between the promoter and practitioner.
Other opinions: Under Section 10.35(b)(2)(i)(C), a covered opinion is also a written opinion on Federal tax issues about "[a]ny partnership or other entity, any investment plan or arrangement ... a significant purpose of which is the avoidance or evasion of any tax imposed by the Internal Revenue Code." Written advice covered under this rule includes:
1. A reliance opinion--written advice that concludes at a more-likely--than-not level (i.e., greater than 50%) that the taxpayer will prevail; see Section 10.35(b)(4).This type of opinion is not a covered opinion if there is a prominent disclosure in the advice that it cannot be relied on for protection from accuracy-related penalties.
2. A marketed opinion--under Section 10.35(b)(5), an opinion in which the practitioner knows (or has reason to know) that the written advice will be used to promote the transaction. Classification as a covered opinion can be avoided if the penalty disclaimer is part of the opinion and there is a disclaimer stating that the opinion was written to support the sale of the product and that the taxpayer (client) should seek independent advice on the transaction.
3. An opinion subject to the conditions of confidentiality--written advice that contains limits on disclosing the advice; see Section 10.35(b)(6).
4. An opinion subject to contractual protection--if an arrangement guarantees the taxpayer a right to a refund of any fees, etc., if the transaction's tax result is not achieved; see Section 10.35(b)(7).
Exclusions: A limited scope opinion, defined in Section 10.35(c)(3) (v), is written tax advice that considers less than all the significant tax issues. It will not be treated as a covered opinion if:
1. The limited scope is agreed to between the practitioner and the client;
2. The client understands that reliance on the opinion for penalty relief is limited to the tax issues addressed in the opinion;
3. The opinion does not address a listed transaction, a "principal purpose" transaction or a marketed transaction; and
4. All appropriate disclosures are contained in the written advice.
A practitioner giving a limited scope opinion may make reasonable assumptions about a favorable outcome of a Federal tax issue and must identify such issues in a separate section of the written advice.
As with other written advice, a limited scope opinion must contain the overall conclusion as to the transaction's proper treatment, and state the reasons for such conclusion. If an overall conclusion cannot be reached, the written advice must also state the reason why; see Section 10.35(c) (4)(i).
Written advice (other than advice involving listed or principal purpose transactions) can also be excluded from these requirements if it is (1) included in documents to be filed with the Securities and Exchange Commission, according to Section 10.35(b)(2)(ii) (B)(3); or (2) prepared for a client "after" a return is filed, but only if the practitioner believes no amended return will be filed, under Section 10.35(b)(2)(ii)(C).
If the advice is negative (i.e., it concludes the transaction will not resolve the issue in the taxpayer's favor), the opinion will not be treated as a covered opinion, under Section 10.35(b)(2)(ii)(E).
Analysis: What does this all mean for practitioners and clients? The most obvious issue with which practitioners have to deal is deciding whether to put penalty disclaimer language in an opinion. To be sure, clients will ask, "Why am I paying you if I cannot use your opinion to help avoid penalties?" The answer may be difficult to explain.
Many commentators have expressed concern that routine client communications via fax, e-mail, memoranda, etc., providing an "answer" to a routine tax question, might be deemed an opinion subject to the new rules. Consequently, many tax practitioners are putting blanket disclaimers on all communications to clients. Although some might view this as overkill, until the IRS provides additional guidance on how routine tax advice will be treated under the new regulations, it is probably better, in most cases, to be safe than sorry.
Another important issue is justifying the additional fees necessary to produce a covered opinion on which a client can rely (especially if it applies to an avoidance transaction allowed by statute).
The new Circular 230 rules are an appropriate tool for the IRS to use to determine whether transactions are evasive, but when a transaction is an avoidance transaction allowed by law, the current regulations are too broad and need to be revised appropriately. Until the Service revises them, disclaimers related to the nonuse of written tax advice to avoid penalties are the best way to avoid the "covered opinion" definition.
FROM STEPHEN R. BUSCHEL, CPA, MBA, BDO SEIDMAN, LLP, NEW YORK, NY