In 2005, the Internal Revenue Service finalized substantial revisions to Circular 230 governing the rules for practice before the IRS. The revisions were in response to what was believed by the IRS to be improper practices in the preparation of tax opinions in support of tax-sheltering transactions. The IRS believed that tax practitioners were relying in their opinions on statements and representations from the tax shelter promoters that they knew or had reason to believe were not accurate.
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The IRS addressed these concerns in part through new covered opinion rules under Section 10.35 of Circular 230. Section 10.35 required detailed rules for tax opinions that constituted "covered opinions." These included listed transactions, a transaction with the principal purpose of tax avoidance or evasion, or a transaction with a significant purpose of tax avoidance or evasion if the advice is a reliance opinion, marketed opinion, opinion subject to conditions of confidentiality, or opinion subject to a contractual protection. Any written advice constituting a covered opinion was required under Section 10.35 to state the relevant facts (including assumptions and representations), the application of the law to those facts, and the practitioner's conclusion with respect to the law and facts.
The definition of a covered opinion was so broad and the requirements of Section 10.35 were so extensive that practitioners took extraordinary steps to clarify that written communications were not intended to be tax advice offering penalty protection. Practitioners started adding standard boilerplate disclaimers to letters and e-mails to that effect. The IRS became concerned that the use of disclaimers had become so pervasive that practitioners using the disclaimers felt free to disregard Section 10.35 requirements. There was concern that clients did not understand the disclaimer, and widespread use was causing clients to simply ignore the disclaimer.
Practitioners complained that the requirements were too overbroad and difficult to apply and were not necessarily producing higher-quality tax advice. The IRS also became concerned that some practitioners were offering oral tax advice to avoid the Section 10.35 requirements.
NEW SECTION 10.37
In light of this background, the IRS has now proposed withdrawing the covered opinion requirements of Section 10.35. Released in September 2012, these proposed Circular 230 regulations would replace the covered opinion requirements of Section 10.35 with an expanded Section 10.37, providing general principles for written tax advice, rather than a list of specific requirements. The written tax advice under new Section 10.37 would depend on the scope of the engagement, type of specific advice sought, other appropriate facts and circumstances, and the applicable law. Compliance with Section 10.37 would be analyzed in light of all the facts and circumstances, and not whether each requirement is addressed in the advice. The advice covered extends not only to federal income tax, but also estate and gift taxes and payroll taxes.
There would still be heightened standards where a tax shelter is involved or where the advice is to be used in marketing, promoting or recommending a strategy with a significant purpose of tax avoidance. Practitioners may only rely on other practitioners if the reliance is reasonable and in good faith and there is no basis to believe that the other practitioner should not be relied upon, is incompetent, or has a conflict of interest.
In rendering the written advice, the practitioner must still not take into account the possibility that the tax return will not be audited or the issue raised on audit, but the practitioner may now take into account the possibility that, if the issue is raised by the IRS, the issue will be resolved through settlement. The IRS has come to believe that the old restrictions with respect to settlement might be interfering with a discussion with the client about the hazards of litigation.
It is the hope and expectation of the IRS that this change to Circular 230 will result in an abandonment of the use of boilerplate disclaimers that has become so prevalent since 2005.
OTHER PROPOSED CHANGES
• New Section 10.35. New Section 10.35, as proposed this past September, adds a competency requirement. The practitioner is required to possess the requisite knowledge, skill, thoroughness and preparation necessary for the matter for which the practitioner is engaged. Although, under Section 10.51, a practitioner could be sanctioned for incompetence, there had been no specific requirement to exercise competence.
• Taxpayer refunds. Expanded Section 10.31 would prohibit the practitioner from endorsing or otherwise negotiating, including by electronic means, for deposit or otherwise, any payment from the government to the taxpayer with respect to tax liability.
• Supervisory responsibility. Proposed Circular 230 changes introduced earlier in 2011 expanded Section 10.36 to address supervisory responsibility in connection with amended returns, claims for refunds and other documents submitted to the IRS. Practitioner responsibilities are also expanded to ensure that the firm has adequate procedures in place to achieve Circular 230 compliance by all members, associates and employees. These required procedures are flexible enough to reflect that size and scope of the tax practice in a particular firm.
• Due diligence. Section 10.22 is proposed to be expanded to provide that the tax practitioner must use reasonable care in engaging, supervising, training and evaluating the work of any person relied upon, taking account of the relationship of that person to the practitioner.
• Practitioner's tax obligations. Expedited suspension proceedings under Section 10.82 are expanded to situations in which the practitioner has consistently failed to comply with their own tax filing obligations. The rules would be engaged where an income tax return has not been filed for four out of five years or more frequent returns have not been filed during five of the most recent seven periods. The rules are engaged by failure to file, not failure to pay.
• And more. The proposed Circular 230 changes also clarify that the Office of Professional Responsibility has exclusive jurisdiction for matters relating to practitioner discipline. CPAs and attorneys providing tax advice are practicing before the IRS even though no specific written notification is required to be given to the IRS. Under Section 10.81, a suspended or disbarred practitioner may petition for reinstatement after five years. Also, the proposed state and local bond opinion rules under Section 10.39 are withdrawn. The special rules were considered no longer necessary with the removal of current Section 10.35 and the fact that the general principles of expanded Section 10.37 would also apply to bond opinion rules.
The proposed changes to Circular 230 should overall be good news for practitioners in relaxing the requirements for written tax advice and clarifying other Circular 230 requirements. Based on initial comments and the position of the government in general, it appears that the final rules will not stray far, if at all, from these proposals.
Practitioners will want to focus on being able to document their procedures for ensuring Circular 230 compliance under these new rules as soon as they go into effect. It remains to be seen if the ubiquitous boilerplate disclaimers will start to disappear when these rules are finalized.
George G. Jones, JD, LL.M, is managing editor, and Mark A. Luscombe, JD, LL.M, CPA, is principal analyst, at CCH Tax and Accounting, a Wolters Kluwer business.