With the tax law becoming increasingly complex, it is no surprise that there often can be several well-intentioned interpretations of a particular provision. Also no surprise is the expectation of many clients that a fee for planning advice should almost always result in an exponential decrease in overall tax liability.
Add to this mix an Internal Revenue Service commissioner who is very vocal about the need for direct enforcement efforts against practitioners who facilitate overly aggressive tax planning, and sparks begin to fly. There is much room for misinterpretation among IRS personnel and practitioners as to what goals legitimate tax planning can embody without sparking litigation.
Environment of enforcement
Commissioner Mark W. Everson has been in office for just over 18 months. It didn't take him long, however, to turn "enforcement" into a battle cry that calls some practitioners unprincipled facilitators of fraud, especially in the tax shelter arena. He believes that the need for greater enforcement is largely attributable to three trends: the increased complexity of our tax laws, the increased role of international transactions, and a deterioration of ethical standards in law and accounting.
Speaking to the third trend this past November, Everson directly criticized attorneys and CPAs for promoting abusive tax shelters and for distorting the attorney-client privilege to hide investors' identities. Instead of ensuring tax compliance and providing better service, law and accounting firms compete for business by selling abusive tax shelters and treating fines for tax law violations as a cost of doing business, Everson said. Citing the revitalized IRS Office of Professional Responsibility, Everson added, "If people don't get the message, we will help them get the message."
Given this atmosphere at the IRS "from the top down," the fear among "ordinary" tax practitioners is that they will be caught in the crossfire. Assertive tax planning will be viewed as contributing to a climate of abuse. Especially in the field offices, practitioners worry that aggressive tax planning will be misinterpreted as abusive and examinations will more routinely look for signs of "abuse."
Worse than simply being blamed and penalized with clients for overly aggressive tax planning, practitioners now must worry about whether they will be accused of being a "material advisor," a label that opens up substantially increased liability for disclosure, reporting and penalties.
The IRS recently issued its first wave of guidance dealing with the new requirements imposed on investors and material advisors under the 2004 Jobs Act. While that series of revenue procedures provided good news in the form of limits placed on the types of transactions subject to disclosure, it has not brought much solace to tax practitioners. The question of the hour remains what level of tax planning activity will define who is a material advisor.
On a positive note, certain parameters to the definition are beginning to be developed. They give some hope that the definition will not be used to attack strategies not specifically related to listed or significantly related tax shelter transactions.
Material advisors
A material advisor is required, with respect to any reportable transaction, to make a return setting forth information that identifies and describes the transaction and any potential tax benefits expected to result from the transaction. According to Notice 2004-80, the definition of "reportable transaction" for this purpose is contained in Reg. §1.6011-4(b).
The IRS is keeping an open mind for the moment, and has requested comments on the definition of material advisor as well as ways to reduce taxpayer burden and to improve disclosure. In Notice 2004-80, the IRS announced that, for the present time, the definition of "material advisor" in Reg. §301.6112-1(c)(2) would apply. Existing rules under §301.6112-1(c)(2), (c)(3) and (d) will also apply, including the minimum fee amounts for listed transactions.
Under the code, a material advisor is any person who provides any material aid, assistance or advice with respect to organizing, managing, promoting, selling, implementing, insuring or carrying out any reportable transaction; and who directly or indirectly derives gross income for the advice or assistance in excess of an established threshold amount (or other amount that may be provided by the IRS). The threshold amount is $50,000 in the case of a reportable transaction where substantially all of the tax benefits are provided to natural persons, and $250,000 in any other case.
Beyond listed transactions
Staff attorneys for the IRS chief counsel recently have been advised to assign Uniform Issue List codes to their shelter, abusive transaction and scam cases. The UIL codes enable the chief counsel to track work items. The codes also facilitate the chief counsel's reporting of its anti-shelter activities and provide information about the progress of the IRS's anti-shelter activities. One troubling development in this regard is that UIL codes have been assigned not only to "listed transactions," but also to a long list of "other abusive transactions."
This list includes: abusive trusts, home-based businesses, Americans with Disabilities Act credit abuses, U.S. possessions residency and sourcing IMT4, frivolous filer (including reparations), corporation sole, offshore credit card project, family limited partnerships, FBAR penalty, consumer credit counseling, donor-advised funds and supporting organizations. Identifying these issues as potentially "abusive" likely will pull in a good many transactions that may be the result of "ordinary" tax planning, especially in the case of home-based businesses, family limited partnerships and donor-advised funds.
Rules of practice
Cono Namarato, head of the IRS Office of Professional Responsibility, summed it up at a recent tax-exempt conference in Washington. He described the OPR as "reinvigorated" by efforts to ensure that practitioners comply with Circular 230 and other standards for representing taxpayers before the IRS.
He reported that the OPR today operates quite differently from before he took over as head nearly a year ago. During his tenure, the OPR has doubled in size to its current level of 50 employees. His immediate plan is to pursue a number of high-impact tax cases that he hopes will lead to a change in overall practitioner behavior.
The ability of the OPR to enforce the tax code was dramatically increased by the 2004 Jobs Act. Under the new legislation, the OPR now has authority to impose civil money judgments against both entities and individuals that knew or should have known of a violation. The civil money judgments can be as large as the amount of gross income that was earned on a violation. The OPR will also have jurisdiction over tax shelter opinion writers as soon as supporting regulations are implemented.
Namarato foresees that Circular 230 will be changed in certain areas. He is expecting that regulations clarifying the definition of a tax shelter under Circular 230 will be issued relatively soon.
Conclusions
Hopefully, the IRS will clearly define the role of material advisors in 2005. The agency has asked for comments and the definition may not be as extensive as many practitioners expect. The 2004 Jobs Act has added a lot of fuel to the anti-shelter campaign, and the long-term impact will be significant. A reinvigorated OPR may be at the forefront of using the tools in the 2004 Jobs Act.
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.
