Trust and Estate Counsel Suggest Revisions to Circular 230 Regs

We submit these comments to supplement our comments dated April 6, 2005, and to share with you certain observations about the changes effected to Circular 230 (the "Circular") as of June 21, 2005. As a result of these observations and our experience studying and applying the changes to the Circular for the past year, this report recommends further changes to the Circular. Our new recommendations, if adopted, would change certain of the recent amendments to the Circular significantly.¹

Many practitioners feel compelled to include such a statement in written communications, despite its inaccuracy, in order to ensure that they will not be subject to discipline under the Circular in the event that the intended recipient of the written advice shares it with a third party. The result is that many taxpayers are now aware that a statement that tax advice was written to promote, market or recommend a transaction usually is false and believe that it is recited either to protect the tax practitioner or to create more work for the practitioner, and not for the benefit of the client. We believe that this has eroded rather than increased the confidence of the public in tax practitioners.

We understand, for example, that many practitioners are now providing oral advice rather than written advice even with respect to what they regard as routine questions. Oral advice escapes coverage under section 10.35 (as well as section 10.37). Yet that oral advice, if proven to have been given, may provide the same penalty protection for clients receiving it as would written advice. A serious problem with substituting oral advice for written advice is the risk of misunderstanding by clients. Our collective experience is that clients more often misunderstand oral advice than written advice. Although some IRS personnel have advised unofficially that routine advice is not covered by section 10.35, few practitioners are willing to accept the risk that the IRS will conclude that the written advice is not routine and should have complied with section 10.35. The penalties for violation are just too severe. Therefore, many practitioners are now providing oral rather than written advice. The failure to provide written advice serves neither the IRS nor taxpayers.

We believe there is a reasonable chance that a court would disregard the presence of a Circular 230 "you cannot rely on this written communication for tax penalty protection" disclaimer in determining whether the client reasonably relied on the written communication, because the disclaimer has become meaningless. A court likely would understand that everyone ignores the Circular 230 disclaimers and jumps directly to the specific message contained in the written communication. The Circular 230 disclaimers have become the equivalent of the boy who "cried wolf."

One approach to accomplishing this result would be to provide that an arrangement that seeks a tax benefit that is consistent with the Code and Congressional purpose has no "Significant Federal Tax Issue" within the meaning of section 10.35 of the Circular.³ If this provision were added, a determination that the tax benefit sought by a particular arrangement is consistent with the Code and Congressional purpose would have at least two consequences. First, as section 10.35 now provides, tax avoidance would be deemed not to be the Principal Purpose of the arrangement. Second, the written advice given with respect to the arrangement would not be a Reliance Opinion because it would not involve a Significant Federal Tax Issue. Because it would not be a Reliance Opinion, it would not have to satisfy the Covered Opinion requirements unless it were a Marketed Opinion or an opinion subject to Conditions of Confidentiality or Contractual Protection.

We believe taxpayers are poorly served when their tax advisors are forced to weigh (1) the potential imposition of the extraordinary costs of complying with the section 10.35 rules for a Covered Opinion against (2) giving the client a more cost-efficient tax penalty protection letter (i.e., at a reasonable basis level) that needlessly understates the practitioner's views of the strengths of the tax arrangement.⁶

A similar problem arises in the context of written advice concerning a Significant Purpose Transaction where (1) more than one Significant Federal Tax Issue is addressed and (2) a confidence level of more likely than not or higher is reached with respect to some issues but not others. In this case, a practitioner who includes a Circular 230 disclaimer warns his or her client that the advice cannot be relied upon for penalty protection with respect to each issue discussed in the advice. The result would appear to be different if the practitioner instead provided his client with two pieces of written advice, one addressing those issues for which a more likely than not or higher conclusion had been reached and a second addressing those issues for which a lower level of confidence had been reached. In such a case, there would have been no reason for the practitioner to include a Circular 230 disclaimer on the second piece of advice.

Our government should not force practitioners to make these misrepresentations. We urge you to change the Circular to provide that written advice that reaches a conclusion at a confidence level of at least "more likely than not" as to a particular arrangement will not cause the advice to be treated as a Reliance Opinion if the taxpayer does not need a "more likely than not" opinion for penalty protection. This change would permit practitioners to express their true conclusions as to the merits of such arrangements without including the Circular 230 disclaimer.

We recommend that the Circular be changed to make it clear that either (1) a prohibition on sharing or duplicating a written communication coupled with an authorization to disclose the tax treatment or tax structure of the relevant transaction or (2) a prominently disclosed statement in the written communication that it cannot be used to promote, market or recommend any transaction or matter addressed in the communication protects the communication from Marketed Opinion status but does not itself cause the communication to be treated as issued under Conditions of Confidentiality.

We think that section 10.35 should be clarified to provide that a prominently displayed statement in any written communication that the communication is intended to be a general explanation of the subject discussed and does not constitute legal or tax advice upon which anyone may rely should be sufficient to remove the communication from the scope of that section. Such statements have long been used by banks, insurance companies and others when providing what certainly is intended to be written educational materials. We are unaware of situations where taxpayers have claimed successfully that relying on such written materials constitutes grounds to avoid penalties. Accordingly, we also recommend that the Circular be amended to provide that such statements remove any written communication from the scope of section 10.35.

² Neither that regulation nor the rule in the Circular provides any guidance as to how to determine what is consistent with the statute and Congressional purpose. The examples contained in Reg. § 1.6662-4(g)(2)(ii) are so "plain vanilla" (e.g., buying a municipal bond is consistent with the Code and Congressional purpose) to suggest that, perhaps, the scope of such consistency is limited to tax benefits that are self-evidently consistent. Additional examples would be helpful.

³ A Federal Tax Issue will be considered "significant" in situations where the IRS has "a reasonable basis to challenge a taxpayer's treatment of an item . . . [if] its resolution could have a significant impact, whether beneficial or adverse, under any reasonably foreseeable circumstance on the overall Federal tax treatment of the transaction(s) or the matter(s) addressed in the opinion" (emphasis added). We think it is unwise for the definition of "significant" to include cases where it is reasonably foreseeable that an IRS challenge would be beneficial to a taxpayer. Changing the definition of "significant" to exclude such cases would be consistent, in our view, with providing the "negative" advice exclusion that was added in May 2005.

⁴See Code Sec. 6664.

⁵See Treas. Reg. § 1.6664-4.

⁶ It has been suggested by commentators that practitioners should consider providing their clients with two opinion letters -- one that would reach a reasonable basis conclusion and would state expressly that the letter may be relied upon for tax penalty protection and a second letter that would express the practitioner's actual higher level of confidence but would state expressly that the letter may not be relied upon for penalty protection. Although such a double opinion letter approach may comply fully with Circular 230, it would be expensive, confusing and unsettling for clients to receive two such letters. See Jonathan G. Blattmachr, Mitchell M. Gans & Tracy L. Bentley, The Application of Circular 230 in Estate Planning, Tax Notes 61 (April 4, 2005).