Long-awaited final Circular 230 regulations, issued Dec. 17, 2004, govern the latest set of standards on attorneys, accountants and other professionals providing not only tax shelter opinions but also tax advice in general. It is how these standards relate to general tax advice that concerns the vast majority of tax practitioners. These regs are part of a multi-pronged effort on the part of the Internal Revenue Service to deter the involvement of promoters, advisors and investors in abusive transactions.
Key parts of the new rules of practice are more practitioner-friendly than the proposed rules had been. Unfortunately, other parts remain vague, especially in their application to aggressive or "cutting edge" tax planning. Ultimately, their impact will depend upon how the IRS chooses to interpret and enforce them.
The final Circular 230 rules provide a six-month transition period for practitioners to digest the changes before they are enforced. They apply to covered opinions issued after June 18, 2005. What this likely means for behavior prior to the June 19 date is that the more general standard of "due diligence" would be applied until then. Of course, how this general standard differs from the new, more specific standards is itself open to a debate that likely will continue beyond mid-year.
Opinions on tax advice
The final rules create two standards for tax advice: one for "covered opinions" and another for all other advice. Unfortunately, both may be read strictly and, therefore, continue the uncertainty among practitioners over what actions will be sanctioned. While the new rules clearly can be imposed on practitioners involved in blatant tax shelter activities, they at least hypothetically may apply to any practitioner who simply might interpret the tax law in a way contrary to IRS guidance.
In preparing a "covered opinion," the new Circular 230 rules require the practitioner to use reasonable efforts to identify and ascertain all relevant facts, relate the applicable law to the relevant facts, evaluate significant federal tax issues and provide an overall conclusion. While this may be considered to be the same standard as general "due diligence," it is new in specifically not permitting advice to be conditioned on a taxpayer's sole statements as to the applicable facts.
A "covered opinion" under new Circular 230 is written advice, including e-mail, by a practitioner concerning one or more federal tax issues arising from:
* A listed transaction;
* Any plan or arrangement, the principal purpose of which is the avoidance or evasion of any tax; or,
* Any plan or arrangement, a significant purpose of which is the avoidance or evasion of tax if the written advice (a) is a reliance opinion, (b) is a marketed opinion, (c) is subject to conditions of confidentiality, or (d) is subject to contractual protection.
A "reliance opinion" is advice that concludes, at a confidence level of at least more likely than not (greater than 50 percent likelihood), that one or more significant federal tax issues would be resolved in the taxpayer's favor. However, the new rules allow one giant loophole: If the practitioner prominently discloses in the advice that it was not written to be used and cannot be used for the purpose of avoiding penalties, it will not be considered a "reliance opinion."
Perhaps some inventive practitioners may think of disclaimer language that looks "nondescript and standard" that clients will ignore but that retains the character of a "prominent disclosure." Placing such language prominently, however, is nevertheless important if the "niceties of language" make it confusing to the taxpayer whether the confidence level is more likely than not. "Substantial authority" opinions, which state that the chance of prevailing is not more than 50 percent, however, will continue to avoid Circular 230 censure under this "covered opinion" provision.
A "marketed opinion" is any opinion to be used by a third party. If the practitioner is only preparing an opinion for his own clients, it is not a marketed opinion. Large firms here may have an advantage, since the client base of the entire firm is not considered a third party.
The difference between a plan with "the principal purpose" of tax avoidance and one with "a significant purpose" is also a finer line than some practitioners want to straddle. Nevertheless, "the principal purpose" standard is assumed to be reserved for blatant tax scams.
Catch-all categories
Avoiding the "covered opinion" provision, however, does not make a practitioner's advice immune to Circular 230. A broad category of all written advice other than covered opinions is covered in Section 10.37 of the rules:
"A practitioner must not give written advice (including electronic communications) concerning one or more federal tax issues if the practitioner bases the written advice on unreasonable factual or legal assumptions (including assumptions as to future events), unreasonably relies upon representations, statements, findings or agreements of the taxpayer or any other person, does not consider all relevant facts that the practitioner knows or should know, or, in evaluating a federal tax issue, takes into account the possibility that a tax return will not be audited, that an issue will not be raised on audit, or that an issue will be resolved through settlement if raised."
Closing the noose that allows the IRS to interpret Circular 230 aggressively, Section 10.22 requires due diligence "determining the correctness of oral or written representations made by the practitioner to clients regarding any matter administered by the IRS." On a practical level, the practitioner should keep files of all tax advice given, both oral and written.
Best practices
The final rules encourage practitioners to provide the highest quality of representation and prescribe a list of "best practices" practitioners must follow when providing advice. They also place a special burden on tax advisors with responsibility for overseeing a firm's practice before the IRS to take reasonable steps to ensure that best practices are followed throughout the firm.
So far, however, there is no safe-harbor checklist that may be used to fulfill firm-wide compliance with the revised rules of practice. The new rules give no clue as to what will be considered "reasonable" or "adequate."
The practices outlined, however, are "aspirational," and those who do not comply will not be subject to discipline, at least by the IRS. Nevertheless, use of these standards may be cited in malpractice litigation, and professional boards may take the cue to incorporate "best practices" into their rules.
Conclusions
The "best practices" section of the Circular 230 rules perhaps best sums up where the IRS eventually hopes to find resolution - within the standard imposed by the major professional groups to which tax practitioners belong.
With many of the decision makers at the IRS former practitioners themselves, with definite sympathies toward the profession, the likelihood of rigorous enforcement of the rules on behavior short of facilitating tax shelter activity is not great. While we may see stepped-up enforcement actions by the IRS Office of Professional Responsibility over the next several years, the emphasis will be on those practitioners who facilitate listed tax shelter transactions and other blatantly abusive schemes.
The real action on lesser misbehavior will remain in the preparer and accuracy-related penalties area, and to a lesser degree in the civil courts in malpractice suits brought by clients. However, the new rules do stir the pot, and perhaps will remain somewhat ambiguous to allow the IRS the added enforcement flexibility that such uncertainty may bring.
George G. Jones, JD, LL.M, is managing editor, Federal and State Tax, and Mark A. Luscombe, JD, LL.M., CPA, is principal analyst, Tax & Accounting, at CCH Inc.
