The move by the Internal Revenue Service to further limit contingent fees for Circular 230 tax practitioners has drawn opposition from virtually every group of tax professionals.Representatives from the American Institute of CPAs, the American Bar Association Tax Section, the American Association of Attorney-CPAs, the National Association of Enrolled Agents and the National Association of Tax Professionals, along with others, opposed the change at recent IRS hearings.

Section 10.27 of Circular 230 defines a contingent fee as any fee that is based, in whole or in part, on whether or not a position taken on a tax return or other filing avoids challenge by the IRS or is sustained either by the IRS or in litigation. It includes any fee arrangement in which the practitioner will reimburse the client for all or a portion of the client's fee in the event that a position taken on a tax return or other filing is challenged by the IRS or is not sustained.

Current rules prohibit a practitioner from charging a contingent fee for preparing an original tax return or for any advice rendered in connection with a position taken on an original tax return, noted Bob D. Scharin, senior tax analyst at Thomson RIA.

However, a contingent fee may be charged for preparation of, or advice in connection with, an amended tax return or a claim for refund other than a claim made on an original tax return. But that's only if the practitioner reasonably anticipates at the time that the fee arrangement is entered into that the amended tax return or refund claim will receive substantive review by the IRS.

"The new rules permit a contingent fee only in connection with an IRS examination or the challenge of an original return," Scharin said.

"We believe that Section 10.27 of Circular 230 should not be changed," said Martin Davidoff, CPA, of Dayton, N.J.-based E. Martin Davidoff & Associates. Davidoff, testifying on behalf of the American Association of Attorney-CPAs, told an IRS panel that the current standards are fair and reasonable.

"The assumption [under the current rules] is that contingent fees will be permissible if not specifically prohibited," he said. "The proposed changes to Section 10.27 turn this approach on its head by generally prohibiting all contingent fee arrangements and then carving out specific exceptions."

The rules aim to clamp down on the "audit lottery" by discouraging the taking of return positions that exploit the audit selection process, according to the preamble.

"They think that my judgment as to whether a case should be brought will be impaired by the fact that I'm getting a contingent fee," said Davidoff. "Frankly, that's just not true. Good practitioners do the right thing, and bad practitioners will be bad whether it's contingent or not. Prohibiting contingent fees will not make them less bad. They need to find the people who are doing the wrong thing and go after them."

The American Institute of CPAs did not permit contingent fees at all prior to 1989, noted Tom Ochsenschlager, vice president for taxation at the AICPA.

"The Federal Trade Commission said our prohibition of contingent fees was in restraint of trade. We started permitting contingent fees not because we wanted to, but because we were forced into it at gunpoint," he said. "If the IRS goes ahead with the rules, eventually the FTC will have to weigh in on it."

He added, "The standard for years was that you could not charge an attest client a contingent fee unless there was a reasonable expectation that the position would be reviewed by a competent authority. Now the IRS says to forget about whether it's reviewed, they'll only allow the fee in cases of examinations. In effect, you can only charge a contingent fee if the client is under examination."

"There are lots of areas where contingent fees should be permitted," he continued. "For example, why shouldn't it be approved for a private letter ruling? It's arguably a better case than if the client were under examination."

"It also raises issues for the client who is under continuous examination," he said. "Does that mean he can file an original return subject to a contingency fee, while the client not under continuous examination could not? There are a lot of little angles that need to be worked on before the rules become final."

Mark Ely, who heads the Tax Account Analysis Review Program, said that the proposal to limit contingent fees doesn't make any distinction in the type of services that the IRS wants to restrict.

"What we do doesn't meet any of the articulated objections to limit fees," he said.

The group specializes in interest and penalty reviews made after an IRS examination. Ely, formerly KPMG's national partner-in-charge of practice, procedure and administration in its Washington National Tax Practice, noted that KPMG no longer does this type of service.

"It involves a very complex review of transcripts. Once you find something, it can take over a year to produce results. If you have global interest netting, it's a long time from when you file a claim to when you get cash, so clients prefer a contingent fee for budget purposes. Without it, we could give a client a $100,000 bill and find nothing," he said.

"It seems overly harsh if you do not allow taxpayers to try to correct a charge for interest that they're entitled to as a result of an IRS determination," he said.

Discouraging taxpayers?

The National Association of Enrolled Agents expressed a concern that further limiting contingent fees may become a disincentive for a taxpayer and a practitioner to arrive at the correct tax. For example, it said, while a taxpayer may not want to attempt to correct a return that is in the government's favor because of the professional fee involved, "She would be willing to apply for what she was entitled to if she could assure the fees to obtain that correction would not exceed the potential benefit to be gained."

The National Association of Tax Professionals noted that although contingent fee arrangements have a propensity to encourage questionable return positions, it is the one safeguard available to taxpayers to ensure that they have access to legal and accounting resources that put them on a reasonable par with the resources available to the government.

"The new rules would reduce the number of amended returns that would be filed, because people could not do it under a contingent fee arrangement," said Scharin.

"From the IRS perspective, if the number of amended returns goes down, while the IRS continues to audit the same number of returns, in fact the audit rate would go up. But some of the bogus amended returns filed under a contingent fee arrangement are done by people who are not licensed to practice before the IRS, and they are not currently covered by Circular 230," he said.

The ABA Tax Section stated that the current rule meets the concern that practitioners not assist taxpayers in exploiting the audit selection process. Further limitation would prohibit contingent fees in cases in which the taxpayer cannot exploit the audit process.

"Proposed Section 10.27(b) expands the prohibition of contingent fees to include any services rendered in connection with any matter before the IRS," it stated. "This broad-brush prohibition is, on the one hand, duplicative of the current rule (which effectively addresses 'playing the audit lottery' concerns) and, on the other hand, over-inclusive insofar as it extends to tax services provided under circumstances that have no relationship to this perceived abuse."

In fact, the ABA urged, the regulation should be eased, rather than tightened: "To the contrary, the current regulation should be expanded to permit contingent fees in any situation in which IRS review of the taxpayer's position is probable."

At any rate, the ABA said, attorney or auditor independence, while important issues, are not issues that should directly concern the Office of Professional Responsibility.

Davidoff agreed: "Absent a connection with the exploitation of the audit process, the regulation of contingent fees by OPR is simply not appropriate. The proposed changes allow for contingent fees in an examination environment. Frankly, I would have no idea how to write an engagement letter with respect to such a fee. I have never entered, and suspect I will never enter, into a contingent arrangement on an examination."

"Contingent fees serve an important purpose to the public in balancing the scales between a formidable IRS and the average taxpayer," he said.

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