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Establishing substantial authority for undisclosed tax positions.

EXECUTIVE SUMMARY

* To avoid the imposition of a penalty for an understatement of tax due to an unreasonable position for an understatement related to an undisclosed position, a practitioner must meet the substantial authority standard with respect to the position.

* Regs. Sec. 1.6662(d)(3)(iii) lists the authorities that may be cited to support that there is substantial authority for the tax treatment of an item. The weight accorded an authority depends on its relevance, its persuasiveness, and its source.

* In analyzing the weight that an authority carries, a practitioner must look to the decisions of the federal appellate circuit in which the taxpayer resides. While there is a distinct hierarchy of authorities observed by all the circuits, there is considerable variance among the circuits on the deference given to the various forms of authority within that hierarchy.

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When CPAs and attorneys engage in tax consulting services, they are advocates for their clients. However, they do not have the luxury afforded other consultants of adopting the attitude that "the client is always right." CPAs and attorneys commonly consult with clients or prospective clients who would like to take an aggressive approach with respect to an undisclosed tax position on a tax return. It is not appropriate to comply with the client's request merely because the taxpayer is willing to run the risk of incurring tax penalties if the IRS audits the return and challenges the tax position.

CPAs and attorneys must meet the ethical standards of their professions when recommending undisclosed tax positions to clients. In addition to professional practice standards, they must also comply with statutory standards of conduct that apply to tax return preparers to avoid the imposition of accuracy-related penalties when there is an understatement of tax liability. When advising on undisclosed positions, practitioners must conduct an analysis of the various tax authorities to determine the likelihood that a position will be sustained on its merits. This article examines:

* The requirement to support undisclosed tax positions in accordance with the applicable statutory standard to avoid accuracy-related penalties;

* The authorities in the regulations that can be cited to support that the statutory standards have been met; and

* The deference given each authority in judicial decisions to the extent that the court has determined its precedential value.

Standards of Conduct

The Internal Revenue Code and related regulations set forth rules on the authority of CPAs, attorneys, enrolled agents, and others representing taxpayers to practice before the IRS. Statutory and administrative authorities set forth the standards of conduct for advising clients about federal tax issues and issuing written opinions with respect to the advice given to clients. Generally, if a return includes adequate disclosure of a position taken on the return and the justification for that position, there will be no accuracy-related penalty imposed for that position on either the taxpayer or the tax return preparer as long as there is a reasonable basis for the position.

Since disclosure of unsettled tax issues will undoubtedly draw the attention of the Service, taxpayers often strongly prefer that their tax return preparers file their returns without disclosing unsettled issues on the face of their returns. Due to this natural tendency of taxpayers to avoid disclosure of questionable tax positions, Congress and the IRS are constantly concerned about taxpayers filing returns with such positions. In order to discourage the filing of tax returns with undisclosed aggressive tax positions, Congress has raised the standards tax return preparers must meet with respect to a return to avoid the imposition of an accuracy-related penalty for an understatement of tax due to an unreasonable position (i.e., a preparer penalty). Under Sec. 6694, as amended by the Emergency Economic Stabilization Act of 2008 (EESA), (1) to avoid a preparer penalty for an undisclosed position, a tax return preparer must be able to show that there is substantial authority for the position.

Substantial Authority in Support of an Undisclosed Tax Position

Regs. Sec. 1.6662-4(d)(3)(i) explains when there is substantial authority in support of a tax position. The regulation provides in part:

   There is substantial authority for the
   tax treatment of an item only if the
   weight of the authorities supporting
   the treatment is substantial in relation
   to the weight of authorities supporting
   contrary treatment. All authorities relevant
   to the tax treatment of an item,
   including the authorities contrary to
   the treatment, are taken into account
   in determining whether substantial
   authority exists. The weight of authorities
   is determined in light of the
   pertinent facts and circumstances in
   the manner prescribed by paragraph
   (d)(3)(ii) of this section. There may be
   substantial authority for more than
   one position with respect to the same
   item. Because the substantial authority
   standard is an objective standard, the
   taxpayer's belief that there is substantial
   authority for the tax treatment of
   an item is not relevant in determining
   whether there is substantial authority
   for that treatment.

Regs. Sec. 1.6694-2 requires the prescribed analysis in Regs. Sec. 1.6662-4(d)(3)(ii) for purposes of determining whether substantial authority is present. A tax return preparer may not rely on unreasonable assumptions, and the authorities contained in Regs. Sec. 1.6662-4(d) (3)(iii) must be considered in determining whether a position satisfies the substantial authority standard of conduct.

Regs. Sec. 1.6662(d)(3)(iii) indicates that only the following are acceptable authorities to determine whether there is substantial authority for the tax treatment of an item:

* Internal Revenue Code and other statutory provisions;

* Proposed, temporary, and final regulations;

* Revenue rulings and revenue procedures;

* Tax treaties and regulations thereunder and Treasury and other official explanations of such treaties;

* Court cases;

* Congressional intent as reflected in committee reports;

* General explanations of tax legislation prepared by the Joint Committee on Taxation (the Blue Book);

* Private letter rulings and technical advice memoranda issued after October 31, 1976;

* Actions on decisions and general counsel memoranda issued after March 12, 1981;

* IRS information or press releases; and

* Notices, announcements, and other administrative pronouncements published by the Service in the Internal Revenue Bulletin.

An authority no longer remains an authority if it is overruled or modified, implicitly or explicitly, by a body with the power to overrule or modify it. There is substantial authority for a tax position if there is substantial authority at the time the taxpayer files the return containing the position, or if there was substantial authority on the last day of the tax year to which the return relates.

Outside of the hypothetical illustrations found in Regs. Sec. 1.6694-2, there is little guidance for tax return preparers on how to navigate through the rules requiring the use of substantial authorities in the analysis needed to comply with the standards of conduct and ensure that an undisclosed tax position will be sustained on its merits. To conduct an informed analysis, preparers should be familiar with the deference the courts have afforded a particular authority. The discussion that follows reviews the authorities set forth in Regs. Sec. 1.6662(d)(3)(iii) that tax return preparers may rely on to provide evidence that there is substantial authority in support of a tax position.

Assessing the Weight of an Authority

As noted above, there is substantial authority for the tax treatment of an item when the weight of authorities supporting the treatment is substantial in relation to the weight of authorities supporting contrary treatment. The weight accorded an authority depends on its relevance, persuasiveness, and the source of the authority.

Whether a taxpayer or tax return preparer can avoid accuracy-related penalties associated with a substantial understatement of tax often depends on the adequacy of the preparer's analysis and the weight accorded the authorities used to support that there is substantial authority for a position. Even if a preparer's interpretation of an authority is faulty, the preparer may be able to avoid the accuracy-related penalty as long as it was reasonable to construe the authority as he or she did.

For example, in Crouch, (2) the Tax Court ruled against the imposition of the accuracy penalty when Crouch, a tax return preparer, relying on Sec. 174, Rev. Rul. 73-395, and [section]2119 of the Tax Reform Act of 1976 (TRA 76), (3) understated his income by taking an improper deduction for prepublication expenses associated with tax guides that he intended to market. The substantial authorities on the issue were inconsistent. Sec. 174 permitted a deduction for research and experimental expenditures, but case law on the issue had held that prepublication expenses did not qualify as research and experimental expenses. Rev. Rul. 73-395 stated that a taxpayer must capitalize expenditures referred to in Sec. 174 over time rather than deducting them in full in the year in which the taxpayer incurred them. However, TRA 76 [section]2119 provided that such expenditures could be expensed under Sec. 174 in disregard of Rev. Rul. 73-395 as long as the party taking the deduction was engaged in a trade or business associated with the deduction.

After reviewing the authorities on the issue, the Tax Court had little difficulty determining that Crouch was not entitled to a deduction for his prepublication expenses. However, the court did conclude that imposition of an accuracy-related penalty was not warranted because the authorities that Crouch relied on were inconsistent, and therefore Crouch could reasonably have construed (albeit incorrectly) that [section]2119's repudiation of Rev. Rul. 73-395 was authority for his position.

In determining whether support for a tax position meets the substantial authority standard, it is necessary to develop an understanding of the relative importance of each of the authorities. A practitioner needs knowledge of the deference given each authority in judicial decisions in order to determine its precedential value. There is a distinct hierarchy to consider in evaluating the importance of each source contributing to an analysis. The remainder of this section examines the relative importance afforded the authorities in Regs. Sec. 1.6662(d)(3)(iii) by the courts in tax decisions.

The Code and Other Statutory Provisions

Statutory interpretation begins with the language or plain meaning of the statute. The plain meaning of a statute comes from its text and structure. If the intent of Congress is clear in the language, the court will give effect to the unambiguously expressed intent of Congress. When a statute is clearly worded, it would take a very clear expression of congressional intent to the contrary to justify a conclusion that the statute does not mean what it plainly seems to say. (4) In addition, when a statute is drawn with care, a court cannot supply omissions because that would be

   not a construction of a statute but, in effect,
   an enlargement of it by the court,
   so that what was omitted, presumably
   by inadvertence, may be included within
   its scope. To supply omissions transcends
   the judicial function. (5)

However, there are many statutory provisions for which the language is not clear, the terms are undefined, and a literal interpretation of the law without analysis may result in a position that is unsustainable on its merits. If the statute is ambiguous, the courts will consult the legislative history, to the extent that it is of value, to aid in its interpretation. (6)

Ambiguity in a statute normally means that there are two or more alternative interpretations, all of which are plausible. In such cases, the courts have held that clear and unambiguous legislative history is a better indicator of Congress's intentions than a presumption. In Ad Global Fund, LLC, (7) the court stated that if the will of Congress is to be implemented, it makes sense to divine that will from Congress's own words when the source is authoritative and the meaning clear, rather than employing a judge-made presumption.

Merkel (8) provides an example of when reliance on a literal reading of the statute without an analysis that takes into account an interpretation of the law will not result in a tax position sustainable on its merits. In Merkel, the issue before the court was whether a contingent obligation to pay is a "liability" for purposes of determining insolvency under Sec. 108(d) (3). The contingent liability arose as a result of a guarantee of corporate debt for which the parties in the case were 50% owners.

The term "liabilities" is not defined in the Code or in any Treasury regulation. Moreover, Sec. 108(d)(3) does not indicate how likely the occurrence of a contingency must be in order to consider the obligation a liability. The court consulted Black's Law Dictionary, which defines liability as a "broad legal term ... including almost every character of hazard or responsibility, absolute, contingent, or likely." (9) Under that definition, the guarantee could be a liability because it is a responsibility that is contingent. However, the court questioned whether Congress intended for all contingent liabilities to be considered in the insolvency calculation under Sec. 108(d)(3).

The court found that the taxpayers failed to prove that they "would be called upon to pay" a claimed liability. Therefore, the contingent liability could not be included in a determination of their net assets. The legislative history showed that Congress intended for only those liabilities in the amount that actually offset assets to be considered in calculating insolvency for purposes of the income tax exclusion.

Proposed, Temporary, and Final Regs.

As the Supreme Court has stated, "Congress has delegated to the Commissioner, not the courts, the task of prescribing 'all needful rules and regulations for enforcement' of the Internal Revenue Code." (10) That delegation helps ensure that like cases are treated alike. (11) It also ensures that the guidelines for application of the statutes are written by those most familiar with the subject and by the division of the government responsible for ensuring that the rules are complied with. (12) However, final Treasury regulations must be consistent with the controlling statute. Generally, courts uphold Treasury regulations found to implement the congressional mandate in some reasonable manner. On the other hand, if a court finds that a regulation alters or amplifies the statute, it is within the court's power to hold that the regulation is unconstitutional. (13)

A tax return preparer can use proposed Treasury regulations as part of his or her informed analysis and to provide guidance for tax planning. However, a preparer should give proposed regulations limited weight as an authority to support a tax position. Tax return preparers seeking to determine the weight they should give to a regulation before it is final will be disappointed to know that Tax Court decisions regarding their value as a legal precedent have been mixed. While courts have held that proposed regulations are not entitled to judicial deference and carry no more weight than a position advanced in a brief by the parties, (14) the courts generally have been hesitant to ignore the validity of the guidance set forth in proposed regulations when such guidance "implements the congressional mandate in some reasonable manner." (15)

Courts have held proposed regulations found to be inconsistent with a statute's legislative history and purpose invalid. This was the case in Scott, in which the issue before the court was the definition of "gross income." (16) The court ruled in favor of the taxpayer and found that the proposed regulation was inconsistent with the statute and that, even if Treasury had adopted it, it would be invalid.

In Garvey, Inc., (17) the taxpayer relied on a proposed amendment, but the court held that reliance on the possible adoption of a proposed regulation was not reasonably justifiable conduct necessary to create an estoppel. In Garvey, the court stated that proposed amendments are merely preliminary proposals that the IRS does not have to adopt. The court further noted that the fact that a set of proposed regulations had been outstanding for a long period of time did not make reliance on them more reasonable.

Other judicial decisions have been even less favorable for the taxpayer. In North Ridge Country Club, (18) the issue before the court was whether the taxpayer could offset gains from one unrelated business activity with deductions from another such activity. In finding for the IRS, the court stated, "Proposed regulations are not entitled to judicial deference." However, the court's findings were consistent with the proposed regulation. (19)

In Rountree Cotton Co., (20) the taxpayer contended that it had been harmed by the Service's failure for 15 years to issue final regulations setting forth the income and gift tax treatment for certain categories of below-market loans. The taxpayer argued that "proposed regulations do not have the force and effect of law and should not be given any more deference than respondent's litigating position." However, the court held that proposed regulations did provide taxpayers with guidance regarding issues and broad areas Congress mandated for legislative regulations. In this particular instance, the IRS published the proposed regulations well in advance of the taxpayer's entering into the transactions in question. The court held that the approach described in the proposed regulation was an effective way to address the issues of the case.

Revenue Rulings and Revenue Procedures

Although revenue rulings do not constitute binding precedent, they provide some guidance as to the correct interpretation of the Code. A revenue ruling is an interpretation of the law that indicates how the IRS believes the tax law should be applied to a particular set of facts. Tax return preparers can rely on these rulings to the extent that the facts and circumstances in their situations are substantially the same as those in the ruling. Reliance on a revenue ruling is appropriate only if the ruling is consistent with congressional intent and has been unaffected by subsequent legislation, regulations, cases, or other revenue rulings. (21)

Court decisions fall along a full spectrum when affording deference to a revenue ruling. When giving the least amount of deference, the courts have concluded that a revenue ruling represents the position of one of the parties before the court; it is merely an opinion of an IRS attorney. When affording revenue rulings the most weight, the courts have held that they have the force of legal precedents unless unreasonable or inconsistent with the provisions of the Code. (22) However, even in cases in which courts have been favorably disposed to rely on revenue rulings, courts have held that the Service is not bound by a revenue ruling containing a mistake of law and may correct such a mistake by retroactively revoking the ruling, even if a taxpayer may have relied on it to his or her detriment. (23)

Beneficial Foundation (24) involved whether or not a foundation's educational grant program met the requirements for exemption. The court held that published revenue rulings were binding upon the IRS and that such rulings relied upon by Beneficial clearly established that the foundation's grant program was sufficient to meet the requirements for exemption. The court went on to say that as long as the Service has not revoked or modified a ruling, a taxpayer may invoke it as if the IRS issued it to him or her personally, and, to the extent that the facts and circumstances are substantially the same as those in the ruling, the ruling will normally be dispositive.

Tax return preparers should not ignore the guidance provided by revenue rulings and revenue procedures when determining whether it is likely that a tax position will be sustained on its merits. In The Nationalist Movement, (25) the taxpayer challenged the IRS's determination that the entity did not qualify for exemption from federal income taxation under Sec. 501(c) (3). In making its determination, Nationalist based its argument in part on the Service's use of the methodology test (26) in Rev. Proc. 86-43. (27) Nationalist argued that several revenue rulings and Rev. Proc. 86-43 relied upon by the IRS during the administrative process are unconstitutional, vague, and overbroad, both facially and as applied. It argued that as such the Service applied the statements in an unreasonable, arbitrary, and capricious manner.

The court held that although revenue procedures are not binding on it, they do constitute official statements of IRS procedure and as such require the court's consideration of the methodology test as applied to Nationalist by the Service. On review, the court found that Rev. Proc. 86-43 is not unconstitutionally vague or overbroad on its face, nor is it unconstitutional as applied. The court held that the provisions of the revenue procedure are sufficiently understandable, specific, and objective enough to preclude inhibiting expression protected under the First Amendment and to minimize arbitrary or discriminatory application by the IRS. ,Further, it concluded that the revenue procedure focuses on the method rather than the content of the presentation.

Tax Treaties and Regs. Thereunder

Practitioners generally can rely on tax treaties as substantial authority as long as they do not conflict with existing U.S. law. Absent language in the treaty convention to the contrary, treaty provisions do not abrogate U.S. law. Courts generally look to the landmark case Lee Yen Tai (28) for guidance regarding the authority they should afford a treaty provision. In Lee Yen Tai, the court held that a treaty was to be regarded as equivalent to an act of the legislature. Neither is superior. Placed on the same footing as legislation, the one with the latest date will control the other.

In Snap-on Tools, Inc., (29) an issue before the court was whether the U.S.-U.K. Income Tax Convention barred Snapon Tools from applying Sec. 902(c)(1). Snap-on Tools argued that Sec. 901(c) (1) entitled the corporation to treat a dividend paid by its foreign subsidiary, Snap-on Tools, Ltd., a resident corporation of the United Kingdom, within the first 60 days of 1979 as having been paid from 1978 profits, rendering the tax paid as a result of the same dividend creditable to the corporation in the same year. While the particular dividend and related tax were distributed and paid before the treaty in question was ratified in 1980, the instruments of treaty ratification set the effective date of the provisions dealing with dividend distribution and the related tax as April 6, 1975. The IRS argued that the tax applicable to the dividend was not creditable because it was not an "income, war, profits or excess profits" tax, as required by Sec. 902(a). Because the U.K. tax is not imposed on the receipt of income, absent a provision in the U.S.-U.K. treaty, the tax would not be creditable.

The court did not find any language in the U.S.-U.K. treaty that expressly overruled the statutory provisions of Sec. 902(c)(1). The tax convention was silent on the 60-day rule. However, it did include a provision indicating that payment of the tax on dividends would be a creditable corporate income tax. Accordingly, given the absence of an agreement in the treaty to disallow creditability of the tax or repeal the 60-day rule, Snap-on Tools prevailed.

Court Cases

Considerable weight can be given to the decisions of the court to which the taxpayer has the right of appeal. However, when a precedent does not exist in the circuit, the Tax Court can look to another jurisdiction for guidance. A Tax Court opinion is not overruled or modified by a court of appeals to which a taxpayer does not have a right of appeal unless the Tax Court adopts the holding of the court of appeals of another circuit.

A case in point is the adoption of the hypothetical independent investor test to determine the reasonableness of compensation of shareholder-employees of closely held C corporations by the Second and Seventh Circuits. After the Ninth Circuit advocated viewing the determination of reasonable compensation from the perspective of the hypothetical independent investor in the Elliotts case, (30) the Second Circuit adopted a similar approach. (31) The Seventh Circuit, after observing a diversity of approaches among the various circuits, (32) embraced the approach adopted by the Ninth Circuit in Elliotts and extended it by creating a presumption of reasonableness of a shareholder-employee's compensation when the corporation that employs him or her generates a higher return on shareholder equity than the industry average. (33)

In Miller and Sons Drywall, Inc., (34) the Tax Court applied the hypothetical independent investor approach in deciding reasonableness even though further appeal of the case would have been to the Eighth Circuit, which had not yet embraced the approach. Across the circuits there are three different approaches to determining reasonableness of compensation for shareholder-employees of C corporations, and the approach a given tax return preparer considers in the search for substantial authority will be affected by the circuit in which the taxpayer resides.

Congressional Intent as Reflected in Committee Reports

If a statute remains ambiguous after the court attempts to consider the plain meaning of the text, a court may rely on legislative history to interpret the meaning of the ambiguous terms. However, legislative history itself is often murky, ambiguous, and contradictory, and not all legislative history is entitled to equal regard. The reports from the committees that studied, drafted, and proposed the legislation are the most persuasive sort of legislative history.

A committee report represents the considered and collective understanding of those members of Congress involved in drafting and studying proposed legislation. The Supreme Court has held that "congressional inaction lacks persuasive significance because several equally tenable inferences may be drawn from such inaction." (35) In addition, subsequent legislative history is less reliable than concurrent committee reports and is worthy of little weight. (36)

In Ad Global Fund, the issue before the court was whether Sec. 6629 can extend the statute of limitation period found in Sec. 6501. The two Code sections are ambiguous as to which dictates the duration of the limitation period. The issue called for the court to interpret the Code. In expressing its opinion, the court stated:

   This opinion applies a conservative use
   of legislative history with the following
   modest objectives: to construe language
   that, only after every effort has been
   made to honor its plain meaning, has
   been deemed ambiguous, and next to
   identify the strongest and most explicit
   and consistent expression of legislative
   intent that yields a reliable interpretation,
   and failing that and only then, to
   call on a presumption that aids in resolving
   issues of construction.

The court did not afford any weight to committee reports published after Sec. 6229 was enacted. The court afforded little weight to congressional documents prepared before the section was enacted. It gave considerable weight to the history of the enacting legislature. However, it did little to influence the court's decision. The court held that it was not reliable and that it did not make clear the enacting legislature's understanding as to the meaning of Sec. 6229. Finally, the court relied on two earlier court decisions establishing that when the sources available to the court for review do not resolve the ambiguity, it should be resolved in favor of the government. Sec. 6229 was held to contain an extension of time, not a separate statute of limitation on partnership items.

In R JR Nabisco, Inc., (37) the taxpayer argued that an advance tax payment it made tolled the interest on a disputed tax amount. During the period that the tax was in dispute, Congress amended Sec. 6622 to require that interest assessed on tax deficiencies be compounded daily. The effective date of the amendment applied to interest accruing after December 31, 1982. On February 1, 1982, Nabisco paid $60 million to the IRS. At the time, taxpayers were permitted to make advance payments while a tax dispute was pending in order to terminate the running of simple interest on the disputed tax. The question before the court was whether the change in the law imposed compound interest on RJR Nabisco's debt, which consisted solely of simple interest accrued prior to the effective date of the new law.

Because of the statute's ambiguity, the court turned to the legislative history to reach its decision. It found that both the conference committee report and the joint committee report supported the government's argument that Congress had intended that the simple-interest debt should be subject to the compounding of interest. The court noted that indications of congressional intent contained in a conference committee report deserve great deference by the court because "the conference report represents the final statement of terms agreed to by both houses, [and] next to the statute itself it is the most persuasive evidence of congressional intent." (38)

General Explanations of Tax Legislation

The staff of the Joint Committee on Taxation prepare general explanations of tax legislation (Blue Books) for the purpose of providing a single, comprehensive source of legislative history for a major tax act. They are not signed by any member of Congress and are not approved by the full membership of either body. Blue Books are written after passage of the legislation and therefore do not reflect the deliberations of the members of Congress who voted in favor of the act. While Blue Books can aid in a tax return preparer's analysis, as a post-enactment explanation the interpretation contained therein is entitled to little weight as an authority. Tax return preparers can use Blue Books in interpreting the statute but should accord them no weight as a binding authority on legislative intent.

However, the Tax Court has relied on a Joint Committee explanation in interpreting the meaning of a tax statute. In Todd, (39) the issue before the court was the interpretation of the words "attributable to." The IRS argued that the Todds' underpayment of taxes was attributable to a valuation understatement and, in accordance with Sec. 6659, they should be assessed a penalty equal to 30% of the underpayment. In its deliberations, the court found that none of the formal legislative history provided a method for determining whether a given tax underpayment is attributable to a valuation understatement. However, the court did find such guidance in The General Explanation of the Economic Recovery Tax Act--the Blue Book--prepared by the staff of the Joint Committee on Taxation. The court was persuaded that the explanation in the Blue Book provided evidence of congressional intent with respect to calculating underpayments subject to the penalty and relied on it in its decision to affirm the Tax Court's ruling.

In contrast, in Allen, (40) the Tax Court rejected the reliance by Allen and the IRS on The General Explanation of the Tax Reform Act of 1986 to determine whether wages must be adjusted by the amount allowed as a targeted jobs tax credit when computing a taxpayer's alternative minimum tax. Instead the court indicated that the legislative history should not be used to displace the plain and unambiguous reading of the relevant statutory provisions.

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Letter Rulings and Technical Advice Memoranda

The IRS issues a private letter ruling at the request of an individual taxpayer. It issues a technical advice memorandum (TAM) in response to a district director's request regarding issues arising out of tax return audits. It issues TAMs to help IRS personnel close cases and ensure that the Service's position on an issue is applied consistently.

The extent to which a taxpayer may rely on IRS statements and positions (issued after October 31, 1976) in seeking either to support a tax position or to refute the Service's position is a recurring question. (41) IRS administrative documents are not citable as precedent. (42) The prohibition against using or citing such rulings or memoranda as precedent is printed on the front of such determinations. In Hill, the Supreme Court reversed a Claims Court decision that had found a TAM "instructive," admonishing that the "Code specifically provides that such memorandum may not be used or cited as precedent." (43)

A tax return position will not be sustainable on its own merits when the substantial authority for the position is limited to IRS statements and positions. However, the court in International Business Machine Corp. (IBM) (44) slightly expanded the realm in which taxpayers may cite or use private letter rulings. In IBM, the court suggested that letter rulings might be used to demonstrate that the commissioner had abused his discretion by issuing rulings that treated competing taxpayers differently.

IBM and a lone competitor requested rulings within months of one another regarding virtually identical products. IBM received an unfavorable ruling, while its competitor received a favorable ruling that was later determined to have been issued erroneously by the Service. The court remedied the situation by allowing IBM to recover taxes paid during the period in which its lone competitor was not required to pay the tax.

The decisions following IBM involving the use of private letter rulings to demonstrate disparate treatment of direct competitors have been mixed. In a more recent case, Computer Sciences Corp., (45) the court held that the IRS had abused its discretion by issuing a revenue ruling that prospectively denied a favorable tax treatment to taxpayers who had not yet filed their returns. The court cited earlier letter rulings as evidence that the Service had previously authorized the favorable tax treatment on the issue. On the other hand, the courts have also indicated that it is their responsibility to apply the law to the facts of the case before them, and how the IRS may have treated other taxpayers is irrelevant in that determination. (46)

Decisions and General Counsel Memoranda

General Counsel memoranda (GCMs) issued after March 12, 1981, can be used in research to help support a tax return preparer's position, but they are not an authority with precedential value. Such memoranda are entitled to no more weight or deference than any other informal agency interpretation, including a position taken on brief. (47) GCMs can provide insight into the IRS's interpretation of its own regulations and procedures. As the Fourth Circuit stated in Sims:

   Administrative interpretations are not
   absolute rules of law which must necessarily
   be followed in every instance, but
   are only helpful guides to aid courts in
   their task of statutory construction. The
   extent to which a court will place reliance
   upon an administrative interpretation
   depends on the circumstances,
   including the general purpose of the act,
   the authoritative source of the regulator
   or ruling, the clarity of the statutory
   language, the consistency of administrative
   policy, and whether administrative
   interpretation was brought to the attention
   of the legislators when they reenacted,
   modified, or refused to change
   the statute. (48)

When the IRS uses a GCM to interpret an ambiguity in one of its statements, positions, revenue rulings, or revenue procedures, substantial deference may be paid to the GCM. In American Express Co., (49) the court agreed that the term "services" used in a revenue procedure was ambiguous as to whether it included credit. The Service subsequently issued a GCM to reflect its interpretation of the term to exclude bank credit card fees as amounts paid for services. American Express argued that the court should afford no deference to the GCM interpretation. The court disagreed, citing Auer v. Robbins, (50) in which the Supreme Court established that agency interpretations of its own regulations are entitled to substantial deference. (51)

The IRS, however, will argue the authority afforded a GCM in whatever manner suits the facts and circumstances of the case at hand. In Morganbesser, (52) the Service argued that a pension plan trust could not rely on GCMs to determine its exempt status as a labor organization because GCMs lack precedential value. Absent an official definition, the IRS had issued a series of GCMs containing criteria on what constitutes a labor organization; its own interpretation suggested that the trust could be classified as a labor organization. The court held that while it is true that GCMs have no precedential value, they are helpful in interpreting the Code when faced with an almost total absence of case law and are useful in instructing the court on how the Service interprets the law. Consequently, relying on the interpretation of the law in the GCMs, the court held that the pension plan trust qualified as an exempt labor organization.

Other IRS Publications

Other IRS publications, such as information or press releases, notices, announcements, and other administrative pronouncements published by the Service in the Internal Revenue Bulletin, provide tax advisers with good sources with which to supplement their arguments in favor of a particular position. They may lend support to a particular interpretation of other, more substantive authority or offer some insight into future approaches that the IRS intends to take. However, it is doubtful that a position based entirely on one or more of these sources would stand much chance of meeting the substantial authority standard.

Conclusion

EESA has reduced the standard of conduct necessary to avoid the Sec. 6694 preparer penalty from the more-likely-than-not standard (53) to substantial authority. While this is a welcome development, because of the rushed situation in which EESA was enacted, Congress did not go through the usual deliberative process. Consequently, there is very little guidance regarding what is required of tax return preparers to meet the substantial authority standard, and there are no congressional committee reports to consult for guidance regarding the lawmakers' intentions.

There is unquestionably a pressing need for new Treasury regulations that more clearly define the substantial authority conduct standard. However, even when Congress or Treasury develops an objective definition for the standard, there may still be little guidance on how tax professionals should navigate through the rules requiring the use of authorities in the analysis required to comply with the standards of conduct.

The recent legislative changes on tax return preparer standards of conduct should have little impact on the preparation of simple, routine tax returns. However, tax return preparers confronted with relatively complex tax issues that revolve around unsettled tax law are now required to have a reasonable belief that an undisclosed tax position would meet the substantial authority standard if the IRS challenged it. Under this standard, merely finding authority to support a position will likely not be acceptable. In order to comply with the higher standard, tax return preparers will have to research authorities much more thoroughly and document a stronger belief than was required when the realistic possibility standard applied.

Editor Notes

Claire Nash is an assistant professor of accounting at Florida Atlantic University in Port St. Lucie, FL. James Parker is a professor of business law at Christian Brothers University in Memphis, TN. For more information about this article, please contact Prof. Nash at cnash8@ fau.edu.

(1) Emergency Economic Stabilization Act of 2008, P.L. 110-343.

(2) Crouch, T.C. Memo. 1990-309.

(3) Tax Reform Act of 1976, P.L. 94-455.

(4) Aaron, 446 U.S. 680 (1980).

(5) Iselin, 270 U.S. 245, 251 (1926).

(6) American Trucking Ass'ns, Inc., 310 U.S. 534 (1940).

(7) Ad Global Fund. LLC, 67 Fed. Cl. 657 (2005).

(8) Merkel, 192 F.3d 844 (9th Cir. 1999), aff'g 109 T.C. 463 (1997).

(9) Id., quoting Black's Law Dictionary 914 (6th ed. 1990).

(10) Correll, 389 U.S. 299 (1967), quoting Sec. 7805(a).

(11) National Muffler Dealers Ass'n, 440 U.8. 472 (1979).

(12) Moore, 95 U.S. 760 (1878).

(13) Snap-on Tools, Inc., 26 Cl. Ct. 1045 (1992).

(14) Natomas N. Am. Inc., 90 T.C. 710 (1988).

(15) Scott, 84 T.C. 683 (1985).

(16) Id.

(17) Garvey, Inc., 1 Cl. Ct. 108 (1983).

(18) North Ridge Country Club, 89 T.C. 563 (1989).

(19) Note that the Ninth Circuit reversed the Tax Court's decision on the netting of unrelated business income. North Ridge County Club, 877 F.2d 750 (9th Cir. 1989).

(20) Rountree Cotton Co., Inc., 113 T.C. 422 (1999).

(21) Regs. Sec. 601.601(d)(2)(v)(c).

(22) Vons Companies, Inc., 51 Fed. Cl. 1 (2001).

(23) Dixon, 381 U.S. 68 (1965).

(24) Beneficial Foundation, Inc., 8 Cl. Ct. 639 (1985).

(25) The Nationalist Movement, 102 T.C. 558 (1994).

(26) Used to determine whether the method the organization uses to develop and present its views is educational.

(27) Rev. Proc. 86-43, 1986-2 C.B. 729.

(28) Lee Yen Tai, 185 U.S. 213 (1902).

(29) Snap-on Tools, Inc., 26 Cl. Ct. 1045 (1992).

(30) Elliotts, Inc., 716 F.2d 1241 (9th Cir. 1983).

(31) Dexsil Corp., 147 F.3d 96 (2d Cir. 1998).

(32) Exacto Spring Corp., 196 F.3d 833 (7th Cir. 1999).

(33) Id. at 838-39.

(34) Miller and Sons Drywall, Inc., T.C. Memo. 2005-114.

(35) Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164 (1994).

(36) Ad Global Fund, LLC, 67 Fed. Cl. 657 (2005).

(37) RJR Nabisco, Inc., 955 F.2d 1457 (11th Cir. 1992).

(38) Id., quoting Demby v. Schweiker, 671 F.2d 507, 510 (D.C. Cir. 1981).

(39) Todd, 89 T.C. 912 (1987).

(40) Allen, 118 T.C. 1 (2002).

(41) Vons Companies, Inc., 51 Fed. Cl. 1 (2001).

(42) Sec. 6110(k)(3).

(43) Hill, 506 U.S. 546 (1993).

(44) International Bus. Mach. Corp., 343 F.2d 914 (Ct. Cl. 1965).

(45) Computer Sciences Corp., 50 Fed. Cl. 388 (2001).

(46) Davis, 65 T.C. 1014 (1976).

(47) Vons Companies, Inc., 51 Fed. Cl. 1 (2001).

(48) Sims, 252 F.2d 434 (4th Cir. 1958), aff'd, 359 U.S. 108 (1959).

(49) American Express Co., 262 F.3d 1376 (Fed. Cir. 2001).

(50) Auer v. Robbins, 519 U.S. 452 (1997).

(51) American Express Co. at 1382.

(52) Morganbesser, 984 F.2d 560 (2d Cir. 1993).

(53) The standard was changed in 2007 to the more-likely-than-not standard by the Small Business and Work Opportunity Tax Act of 2007, P.L. 110-28. Prior to this change, the standard a tax return preparer had to meet to avoid the preparer penalty was the realistic possibility standard. For more background on these changes, see Tillinger, "An Analysis of the New Preparer Penalty Proposed Regulations," 39 The Tax Adviser 576 (September 2008).

By: Claire Y. Nash, Ph.D., CPA James Parker, J.D., M.L.T.

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