Raises Standard for Tax Practitioners Providing Tax Opinions
Robert E. Demmett
U.S. Treasury Department’s continuing effort to stop
abusive tax shelters and restore integrity to the tax system,
the IRS announced earlier this year three provisions that
make it more difficult for tax advisors to issue tax opinions
and for taxpayers to avoid the imposition of the tax accuracy–related
penalties. The first provision holds tax advisors to a higher
standard when issuing tax opinions. The second and third provisions
require taxpayers to make additional disclosures that would
assist the IRS in identifying abusive tax positions in a more
timely manner. In addition, the disclosure provisions act
as a deterrent to taxpayers entering into tax-motivated transactions.
Opinions That Support Tax-Motivated Transactions
December 2003, the Treasury Department proposed modifications
to Circular 230 (regulations that govern individuals eligible
to practice before the IRS). Section 10.33 was amended to
provide that tax professionals should adhere to “best
practices” when providing tax advice. The IRS describes
best practices as including:
Ensuring that the taxpayer understands the scope, purpose,
and use of the advice.
Establishing the facts and evaluating the reasonableness
of assumptions or representations.
Relating the applicable law (including potentially applicable
judicial doctrines) to the relevant facts.
Arriving at a conclusion that is supported by the law
and the facts.
Advising the taxpayer of the import of the conclusion,
including whether penalties can be avoided if he relies
on the advice.
Acting fairly and with integrity in practice before the
section 10.33 provided rules for practitioners regarding
tax shelter opinions. Generally, a practitioner was required
to inquire about all relevant facts and to be satisfied
about the accuracy and completeness of all material facts.
The tax professional could accept a valuation or a projection
from the taxpayer as long as it was prepared by a competent
person and made sense on its face.
old section 10.33 was replaced with the new section 10.35,
which provides requirements for issuing tax shelter opinions.
Section 10.35 applies to “more likely than not”
tax shelter opinions and “marketed” tax shelter
opinions. A “more likely than not” tax shelter
opinion is an opinion that reaches the conclusion that the
taxpayer’s position has a more than 50% chance to
be resolved in her favor. A “marketed” tax shelter
opinion will be used by someone other than the author in
promoting, marketing, or recommending the tax shelter.
new section 10.35 requires reasonable efforts to identify
and ascertain all relevant facts. In addition, the tax professional
must not base the opinion on any unreasonable factual assumptions
or representations that the practitioner knows or should
know are incorrect. The practitioner must relate the applicable
law to the relevant facts and must not base an opinion on
unreasonable legal assumptions, representations, or conclusions.
10.35 allows limited-scope opinions (except for in “marketed”
tax shelter opinions), which must disclose in their opening
paragraph their limitation to one or more tax issues that
have been agreed upon by the taxpayer. Limited-scope opinions,
as well as all other opinions, must clearly state the tax
advisor’s overall conclusion about the likelihood
that the federal tax treatment of the tax shelter item is
proper, as well as the reasons for that conclusion. If the
advisor cannot reach an overall conclusion, the opinion
must describe the reasons why.
proposed modifications to Circular 230 supersede proposed
amendments issued in January 2001. While the definition
of “tax shelter” in section 6662 remains, the
IRS excluded preliminary advice from the definition of a
tax shelter opinion in circumstances where an opinion that
satisfies the requirements of section 10.35 will subsequently
10.35 also provides for certain mandatory disclosures in
the beginning of the opinion. Any compensation or referral
arrangement between the tax advisor and the promoter or
marketer must be disclosed. In addition, a “marketed”
tax shelter opinion must state that the taxpayer should
seek advice from her own tax advisor based upon individual
circumstances, and it must state that the opinion may not
be sufficient to avoid penalties.
ensure compliance, section 10.35 requires that tax advisors
overseeing a firm’s practice of providing tax opinions
implement procedures to be followed by all members, associates,
and employees of the firm. Failure to take reasonable steps
to establish procedures will subject the practitioner to
to the Accuracy-Related Penalty
way to defend against the imposition of the 20% penalty
for negligence or disregard of rules and regulations is
to show that the taxpayer had reasonable cause and acted
in good faith. Reliance on tax advice generally demonstrates
that the taxpayer acted in good faith. Regulations proposed
in December 2002, however, provided that this exception
was not available to taxpayers who failed to disclose a
“reportable” transaction as defined in Treasury
Regulations section 1.6011-4(b). In response to comments
by the public, the Treasury Department relaxed this provision
in the final regulations it issued in December 2003. The
final regulations provide that failure to disclose is a
strong indication that a taxpayer failed to act in good
faith, but does not automatically prevent the taxpayer from
raising the reasonable-cause defense to the penalty.
proposed regulation also provided that taxpayers taking
a position that a regulation is invalid must disclose this
position in order to raise the reasonable-cause and good-faith
defense to the penalty. While some practitioners complained
that taxpayers might not know whether an advisor is taking
a position that a regulation is invalid, this provision
was retained in the final regulations.
of Confidential Transactions
6011 and the regulations thereunder require disclosure of
reportable transactions. Reportable transactions are defined
as transactions that fall into any of six listed categories.
One category included transactions marketed under conditions
of confidentiality. In February 2003, the Treasury Department
issued final regulations under section 6011, including a
definition of “conditions of confidentiality.”
Treasury received numerous comments from practitioners that
the definition of a confidential transaction in the final
regulations was overly broad. As a result, in December 2003
the Treasury Department issued changes to the final regulation
which clarified that a confidential transaction does not
include a transaction in which confidentiality is imposed
by a party to the transaction. A confidential transaction
is limited to situations in which an advisor is paid a minimum
fee and imposes a limitation on disclosure that protects
the confidentiality of his tax strategy. The changes to
the regulation define the minimum fee for such purpose and
describe what services are includible in determining the
some of the changes described above provide taxpayers with
some relief, others create additional responsibility for
tax advisors. The Treasury Department made it clear in its
announcement that it was increasing the standards placed
on tax advisors. A top priority for the Treasury Department
is to stop the promotion of tax shelters, and it has shown
that it will continue to change the rules to accomplish
this, even after the rules are finalized. The government’s
strategy is to force disclosure to ensure that it becomes
aware of tax shelters faster, and to penalize taxpayers
that enter into the transactions, as well as the tax advisors
that promote them.
E. Demmett, CPA, is a tax partner at Eisner &
Lubin LLP, and an adjunct professor in the graduate division
of Queens College.