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November 1, 2007

New IRS Rules on Tax Advice

 
Revised Circular 230, the rules of practice before the IRS that each tax practitioner must follow, requires tax advice for "covered opinions" to follow one of two paths: (1) to be accompanied by exhaustive analysis that usually well exceeds the expectation (and fee range) for routine tax advice; or (2) to be accompanied by a disclaimer that the advice cannot be relied on to avoid penalties. Given a broad possible interpretation of "covered opinions" to include informal tax advice, many practitioners have decided that the only safe way out under the revised rules is to include a disclaimer on all written advice to clients.  

The IRS issued rules that will affect how we, tax professionals, communicate with you, our client. The rules, which took effect June 20, 2005, apply whenever a practitioner provides written advice, including e-mails, faxes, and letters, on tax issues. While the rules are motivated by the government's well-founded concern with abusive tax shelters, they will apply to advice given on many common and accepted transactions.  

The rules grew out of the government's decision to attack the mechanisms used by tax shelter promoters to sell abusive tax shelters. The new rules address the practice of promoters to obtain boiler-plate opinions for tax shelters. Taxpayers engaging in abusive transactions use these types of opinions to escape tax penalties of 20 percent or more, on top of what they owe in taxes, by claiming they "reasonably" and "in good faith" relied on the tax opinion for their belief that the transaction was permissible.  

In the new IRS rules, clients cannot rely on a tax opinion for protection from penalties unless the practitioner provides a comprehensive opinion that considers and discusses:  

1.    All relevant facts and applicable law,
2.    The relationship between the facts and the law,
3.    A conclusion as to the legal consequences of each tax issue, and
4.    The likelihood that the taxpayer will prevail if the IRS challenges the transaction.
 

The new rules apply to tax advice for transactions that have a "significant purpose" of tax avoidance. This standard is vague and uncertain, in large part because the IRS did not want to create any loopholes. Consequently, the new rules may sweep in many routine, non-abusive transactions. The penalties to practitioners can be severe for providing written advice that does not meet these requirements, including disbarment from practice before the IRS.  

Because of the new rules, the cost of securing a comprehensive opinion will be higher. An alternative to writing an expensive opinion is to include a disclaimer on written advice furnished to the client. This disclaimer will state that the client cannot rely on the opinion for protection from tax penalties. Accordingly, this firm will routinely include the following language in written communications:  

"This written advice is not intended or written to be used, and it cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed on the taxpayer."  

Even with this legend, there are other defenses to penalties. You will not automatically be penalized if the IRS challenges a transaction.  

Please be assured that we will continue to act diligently to meet your needs. The use of this legend does not change the quality of our service and the advice you have come to expect from us. In appropriate cases, after consultation with you, we will provide a comprehensive opinion that meets the new rules.  

If you have any questions about this important development, please contact us.