Tax-planning services for clients or employers: CPAs should understand their responsibilities.

For several years Congress has challenged the AICPA to explain how its Code of Professional Conduct controls and disciplines members who are involved with abusive tax shelters. Concluding that there was a need for a comprehensive interpretation of member responsibilities that would apply across the spectrum of tax planning and include tax shelters (regardless of how that term is defined), the AICPA tax executive committee issued Interpretation no. 1-2, "Tax Planning," of Statement on Standards for Tax Services no. 1, Tax Return Positions. The interpretation becomes effective on December 31, 2003. (See Official Releases, page 105, for the text of Interpretation 1-2.)

BACKGROUND AND CORE ISSUES

In response to the congressional inquiries, the tax executive committee formed a task force to see whether the AICPA needed to address any real or perceived improper behavior by CPAs with regard to tax shelters and whether the eight statements on standards for tax services (SSTSs) adequately addressed abuses. The task force considered two key questions:

* Do the SSTSs provide members sufficient guidance on tax practice involving tax shelters that includes promotion and marketing, providing opinion letters, recommending tax return positions and preparing or signing returns?

* If not, what additional guidance do members need to help them deal with tax shelters and tax planning?

The task force concluded there was no need for a new standard to address tax shelter issues because SSTS Statement no. 1, Tax Return Positions, and Statement no. 8, Form and Content of Advice to Taxpayers, adequately incorporate these concerns. The task force decided an interpretation could define what constitutes "tax planning" and give members additional guidance. Because it would cover all tax-planning activities, the interpretation need not specifically reference tax shelters, which fall under this umbrella.

The task Force was also concerned that if it specifically addressed tax shelters, it would have to define the term. Legislators and regulators previously had been quite frustrated in coming up with an appropriate definition. (For example, the tax shelter regulations under IRC sections 6011, 6111 and 6112--which focus on disclosure--now refer to "reportable transactions" rather than "tax shelters.") The task force concluded the ever-changing nature of the tax shelter controversy could quickly render any definition obsolete, requiring ongoing modifications. It opted not to try defining this thorny term, a position consistent with the intent of the SSTSs with respect to subjective rules and undefined terms, as stated in the preface to SSTSs nos. 1 to 8 (see Official Releases, JofA, Oct.00, page 140).

This article provides an overview of Interpretation 1-2, some background on how the task force that developed it reached its conclusions and some questions and answers that will help members apply the new rules.

WHAT'S IN AND WHAT'S NOT

In considering the scope and content of this interpretation, the task force decided to include concepts such as "business purpose," "economic substance" and the "likelihood of success" as well as "reliance on others," "reasonableness of assumptions and representations," "diligence as to facts," "content of opinions," "tax opinions provided for nonclients," "marketing of others' tax products" and tax product marketing in general. It concluded that identifying these elements would give members practical parameters they could use in fulfilling their ethical responsibilities in tax planning.

However, the interpretation excludes terms such as "step transactions," "sham transactions" and "form over substance" because they are well-established judicial doctrines members already are aware of as part of their duty to provide competent advice under SSTS no. 8. Interpretation no. 1-2 also excludes "products offered under terms of confidentiality" which is a concern specific to corporate tax shelters and thus inappropriate for a general interpretation of ethical responsibilities. The task force concluded that because the application of antiabuse rules and the concept of "aiding and abetting" arise from regulatory and compliance perspectives they likewise were inappropriate in an ethical interpretation of a tax-planning standard. Finally, the task force decided that SSTS nos. 1 and 8 already adequately cover these concepts by imposing the "realistic possibility of success" standard and the duty to exercise professional judgment in rendering tax advice.

TASK FORCE RECOMMENDATIONS

After considering whether it was more appropriate to use mandatory or "suggestive" language, the task force decided that "should" rather than "must" or "shall" best fit the interpretation's underlying purpose. Because this is an interpretation of an enforceable code of conduct, using language that implied something was mandatory would have left little room for professional judgment. Given the complexities of tax planning and the interaction of a given set of facts with the ever-changing tax law, the task force thought "should" best described the interpretation's applications. This choice also reflects the language in SSTS nos. 1 to 8 and in Interpretation no. 1-1.

Given the differences in competence and experience among AICPA members, the task force concluded it could craft no single requirement that would reflect all members' needs in every circumstance. Each has a duty to determine that a tax opinion meets the interpretation's guidelines and to then be responsible for appropriate due diligence. As a result, Interpretation no. 1-2 of SSTS no. 1 includes these provisions.

* The minimum standard for tax planning should be a realistic possibility of success. However, a member may recommend a nonfrivolous position if he or she also recommends appropriate disclosure. These minimum standards are consistent with the SSTS rules already in force. This clarification introduces no new terms or requirements, reducing the likelihood a member would become confused about which standard applies. Although the task force encourages all members to adhere to higher standards, it concluded no ethical violation would occur if a CPA met these minimum standards.

* A five-step process should precede rendering a tax-planning opinion. Members should

1. Provide a "due diligence" review of all relevant facts.

2. Consider the reasonableness of assumptions and representations.

3. Apply the pertinent tax law to the relevant facts.

4. Consider the business purpose and economic substance of the transaction if they are relevant to its tax consequences.

5. Reach a conclusion as to the transaction's likelihood of success based on the other four factors.

These five steps represent the minimum requirements members should follow in developing a tax opinion. Although CPAs may find parts of these guidelines in the proposed and final IRS rules in Circular 230, the task force believes these core requirements apply to all tax-planning situations and are consistent with the current due diligence requirements in the SSTSs.

* Members also should apply the five-step process when reviewing a third party's tax-planning opinion. When a client obtains an opinion from a third party and asks a member to evaluate it, he or she should consider whether the opinion indicates the third party followed the five steps outlined above.

In evaluating the need for further due diligence, the reviewing member may consider the source, relevance and persuasiveness of the third-party opinion, but should exercise independent professional judgment and "look behind" the opinion. The task force rejected a number of other options including permitting the member to accept the opinion unless it appeared unreasonable, or the member knew of factual errors or omissions, requiring a factual due diligence review but permitting the member to accept the tax law conclusions unless they appeared unreasonable, and requiring a reviewing member to comply with the same requirements as if he or she had actually issued the opinion.

POTENTIAL CONCERNS

Here are the answers to some key questions members might have about Interpretation no. 1-2 and its application to tax planning:

Does tax planning include tax return preparation? Yes, this interpretation applies to both prospective and completed transactions, including recommending or expressing oral and written opinions on tax return positions.

Does the interpretation apply to members in industry? Yes, the introduction to SSTS no. 1 says the standards apply to members when the taxpayer is a client, a third-party recipient of tax services or a member's employer. The key concept is that members must use their professional judgment in conveying appropriate information to the taxpayer or the individual who is ultimately responsible for tax return positions. For a member in industry this might mean the company's CFO. In a smaller business where the tax planner himself or herself is responsible for tax return positions, no further information exchange would be necessary.

Must all transactions have a business purpose and economic substance? This is not necessary in every case. The requirement that a member consider a transaction's business purpose and economic substance does not mean it must have both. Nor does it mean a transaction must make sense beyond its tax implications. There are situations where an applicable statute or regulation clearly contemplates a transaction's objective--for example, investing in low-income housing to take advantage of the IRC section 42 credit.

However, when a transaction lacks economic substance or a business purpose, members should challenge its appropriateness. The realistic possibility of success standard in Interpretation no. 1-1, says members should have a "good-faith belief that the position is warranted by existing law or can he supported by a good-faith argument for an extension, modification, or reversal of the existing law" and that belief should be based on a reasonable interpretation of the law.

How can a member determine the reasonableness of assumptions and representations? Members must use their professional judgment to analyze a situation and make determinations. Among other factors, the determination will depend on the

* Amounts involved.

* Significance of the advice to the recipient.

* Significance of the transaction.

* Reputation or experience of the taxpayer.

The source of the reformation the CPA is evaluating also is critical. For example, if the source is someone selling or otherwise promoting the transaction to the taxpayer, members should test the information more rigorously. Is the information consistent with other reformation the member is aware of, and does it appear to be correct and complete on its face? Members should also refer to SSTS no. 3, Certain Procedural Aspects of Preparing Returns, for additional guidance.

The requirement to question the information does not preclude members from making "what if" calculations on a taxpayer's behalf. However, members should challenge the appropriateness of the assumptions these hypothetical computations use.

If a member fails to sign a return under certain circumstances, won't he or she be subject to penalties? No. Illustration 3 in the interpretation describes a situation in which regulations require the taxpayer to disclose specific information in a tax return, but he or she declines to do so. SSTS no. 2, Answers to Questions on Returns, says a member "should not omit an answer (to a request for information on a tax return) merely because it might prove disadvantageous to a taxpayer."

If the nondisclosure is material, the member cannot sign the return until the taxpayer agrees to comply with the disclosure requirements. If the taxpayer and member cannot agree, the member will need to consider withdrawing from preparing the return and from continuing a professional or employment relationship with the taxpayer. (See SSTS no. 6, Knowledge of Error: Return Preparation.) If the member is a "nonsigning preparer," he or she should recommend the proper level of disclosure to the taxpayer. However, if the nonsigning member becomes aware the taxpayer did not comply with the recommendation, that member should also consider whether to continue a professional or employment relationship with the taxpayer.

Can't a member just rely on a third-party opinion without going through additional steps? No. Members should determine the level of due diligence the third party applied. If this isn't obvious on the face of the opinion, members should consider discussing the opinion with the third party.

Isn't Interpretation no. 1-2 really a new, additional standard? No, the interpretation does not change or elevate any standard or level of conduct the SSTSs prescribe. It clarifies existing standards and lays out the steps members already should follow whenever they provide tax-planning services. These steps will vary depending on the member's familiarity with the client and its industry, the client's sophistication, the specific tax-planning issue and the nature of the engagement. Members may continue to respond to "simple" client questions over the phone, but the key issue is giving correct and appropriate responses.

PROFESSIONAL CONDUCT

By their nature, ethical standards encompass a range of appropriate behaviors. These standards may, in turn, be clarified by interpretations that address a broad variety of personal and professional situations. The SSTSs and interpretation nos. 1-1 and 1-2 fulfill this role by giving members guidelines and illustrations to help them comply with their ethical tax responsibilities. In tax practice, with constantly changing substantive rules and growing complexity, it isn't always clear that a member has met his or her ethical responsibilities. As members aspire to the best professional conduct, guidance such as that in Interpretation no. 1-2 can help them make the right decisions on tax planning matters.

AICPA

TAX ETHICAL STANDARDS

Members can get additional information on ethical standards for tax practitioners online:

* Statements on Standards for Tax Services nos. 1 to 8 and Interpretation 1-1 at www.aicpa.org/download/ tax/sstsfinal.pdf.

* Interpretation 1-2 at www.aicpa.org/download/tax/ 2003_10_interp1-2_sstal.pdf.

* Journal of Accountancy article explaining the SSTSs at www.aicpa.org/pubs/jofa/nov2000/swails.htm.

EXECUTIVE SUMMARY

* THE AICPA ISSUED INTERPRETATION NO. 1-1, "Tax Planning," of Statement on Standards for Tax Services no, "1, Tax Return Positions, partly in response to congressional inquiries about how the AICPA Code of Professional Conduct disciplines members who are involved with abusive tax shelters. It is effective December 31, 2003.

* AN AICPA TASK FORCE CONCLUDED THE EXISTING standards adequately incorporate core tax shelter issues. By issuing an interpretation, the AICPA believed it could provide broader guidance on tax planning, which would include tax shelter transactions.

* INTERPRETATION NO. 1-2 SAYS THE MINIMUM STANDARD for tax planning is a "realistic possibility of success." It also provides members with a five-step process they should use to provide tax-planning opinions. CPAs should use the same process when reviewing a third-party's opinion.

* THE INTERPRETATION COVERS MEMBERS IN PUBLIC practice as well as those in industry. It also applies both to prospective and completed transactions, including recommending or expressing oral and written opinions on tax return positions, and to tax return preparation. The interpretation does not, however, change or elevate any standard or level of conduct.

PRACTICAL TIPS TO REMEMBER

* When providing a tax-planning opinion to clients or employers, members should follow a five-step process. They should follow a similar process when reviewing a third party's tax-planning opinion.

* Members should use their professional judgment in conveying appropriate information to a taxpayer or to the individual who is ultimately responsible for a tax return position.

* Members should keep in mind that the requirement to consider a transaction's business purpose and economic substance does not mean it must have both. However, when a transaction lacks either, members should challenge its appropriateness.

* To determine the reasonableness of assumptions and representations, CPAs should consider the amounts involved, the significance of the advice to the recipient and of the transaction and the taxpayer's reputation or experience, as well as the source of the information the member is evaluating.

EDWARD KARL, CPA, is a director of the AICPA tax division in Washington, D.C. His e-mail address is [e-mail]. Mr. Karl is an employee of the AICPA, and his views, as expressed in this article, do not necessarily reflect the views of the Institute. Official positions are determined through certain specific committee procedures, due process and deliberation.