Menu
Tax Notes logo

CPA Criticizes Circular 230 Rules

MAY 9, 2005

CPA Criticizes Circular 230 Rules

DATED MAY 9, 2005
DOCUMENT ATTRIBUTES
May 9, 2005

 

Mr. Eric Solomon

 

Acting Deputy Assistant Secretary (Tax Policy)

 

Department of the Treasury

 

Room 3104 MT

 

1500 Pennsylvania Avenue, N.W.

 

Washington, D.C. 20220

 

 

The Honorable Mark W. Everson

 

Commissioner

 

Internal Revenue Service

 

Room 3000 IR

 

1111 Constitution Avenue, N.W.

 

Washington, D.C. 20224

 

 

Dear Acting Assistant Secretary Solomon and Commissioner Everson:

 

 

I am writing to submit comments with respect to a particular aspect of the amendments to regulations governing practice before the Internal Revenue Service that were published in December 2004 (the "New Regulations").

I am the author of the Federal Tax Practice Standards volume of the CCH Tax Practice and Procedure Commentaries Library; in addition, I have spoken to a significant number of local and regional CPA practitioners (as well as to attorneys) on Circular 230, the New Regulations, and other professional standards (e.g. the AICPA Statements on Standards for Tax Services) at various conferences, committee meetings and discussion groups sponsored by the California CPA Society and it's companion Education Foundation. While I serve on various AICPA and California committees in the tax arena and Chair the California CPA Society's Los Angeles Tax Committee, my comments are my own; at the same time, however, the comments do represent concerns -- or more properly, confusion -- that I have heard voiced by local firm and sole practitioners in the CPA profession.

Background

The historical background and evolution of the administrative need for these revised regulations under Circular 230 governing tax advice opinions has been summarized by other authors (collectively in some cases); for example, these matters are covered thoroughly and superbly in comments of the New York Bar Association Tax Section (Report No. 1081 submitted March 3, 2005) and the comments of the American College of Trust and Estate Counsel (submitted April 6, 2005).

More likely than not v. Substantial authority opinions

My concern is with the relationship of the "more likely than not" requirement of Section 10.35(e) with respect to taxpayer/client penalty protection and the "Reliance opinion" requirements at Section 10.35(b)(4) as they conflict with the taxpayer/client "substantial authority" standard which is still the legal threshold for non-tax shelter items on a tax return under Internal Revenue Code of 1986, as amended, Section 6662(d)(2)(B)(i).

The New Regulations provide that unless a Reliance Opinion reaches a "more likely than not" conclusion, the opinion must clearly state that it may not be relied upon for penalty protection. Written advice from a tax professional pertaining to an item on a return becomes subject to the Covered Opinion standards (which includes a "Reliance opinion" within its definition) if it is "Any partnership or other entity, any investment plan or arrangement, or any other plan or arrangement, a significant purpose of which is the avoidance or evasion of any tax imposed by the Internal Revenue Code. . . " (emphasis supplied).

The Impact on the "Larger" Tax Practitioner Community: Local and Regional Practitioners

While it appears to the larger practitioner community that the New Regulations target those tax professionals that provide transactional tax advice (primarily tax lawyers and members of the tax practices of only the very largest CPA firms), the fact is that Circular 230 (which encompasses the New Regulations) apply to every person authorized to "practice before the Internal Revenue Service." In this respect, I would suggest that the overwhelming amount of formal and informal (including email) written advice that is given to clients/taxpayers in this country is given by CPAs in sole practice or as members of local or regional CPA firms.

And I would suggest that the authors of the New Regulations did not take this fully into account in the drafting process, perhaps because they really did not intend that the New Regulations would apply to such advice. Nonetheless, the language is sufficiently unclear as to be interpreted to reach this advice.

Coupled with the rather expansive (as well as ambiguous) definition of "significant purpose of which is the avoidance. . . of any tax", the Reliance Opinion standard -- if not clarified -- could have far reaching impact on thousands of CPAs in their everyday tax practice. While all indications are that the Treasury is (in this writer's opinion, quite justifiably) concerned with tax shelter and similar tax "arrangements" and these types of transactions and the limited practitioner community involved in providing opinions on such arrangements, a broad interpretation the "significant purpose" definition could place an unfair, unnecessary and unjustified (in fact in conflict with the stature) burden on the greater tax practitioner community; alternatively, it could result in countless violations of the "Reliance opinion" standard due to a simple lack of awareness of the applicability of the standard in the tax practitioner community. Finally, it could result in unfairly and improperly impinging on the larger tax practitioner community's relationship with its clients (taxpayers). The imposition of a constraint with respect to scope of tax advice -- assurance that a penalty will not apply -- that can be given where the statute does not call for it is not helpful or useful for the taxpayer, the tax professional or the Treasury/Internal Revenue Service.

A literal reading of the New Regulations would seem to indicate that in some, if not many instances, a tax professional would not be permitted to advise his or her client in writing that substantial authority exists for the client's treatment of an item on a tax return (or prospectively an item that will be placed -- or perhaps not placed -- on a return) and affirmatively state that, having met the substantial authority threshold, the client will not be subject to an understatement penalty. If this is the case, it would appear to be overreaching on the part of Treasury and an attempt to rewrite Code Section 66662(d)(2)(b)(1) to incorporate a "more likely than not" standard where Congress has clearly rejected that higher standard with respect to non-tax shelter items (the higher standard having been included in early drafts of the legislation and later removed). One could also interpret the Treasury position as saying to taxpayers "you can still argue substantial authority to avoid a non- tax shelter understatement penalty under Section 6662, but you can't rely on the advice of a tax professional in making the argument." This is surely not what is intended in the Regulations -- at least one would hope.

Example

To present one example of the kind of issue that might arise under the New Regulations as presently drafted, let suppose a client receives a significant settlement in an employment related lawsuit. Under the Supreme Court's recent decision that rejected the "netting of settlement proceeds and legal fees" the settlement proceeds are fully includible in the calculation of adjusted gross income and legal fees are treated as an itemized deduction. This may subject the gross settlement proceeds to alternative minimum tax significantly in excess of the regular income tax.

The American Jobs Creation Act of 2004 provided relief in some employment litigation situations for civil rights claims; the AJCA also included a somewhat broader "netting" provision for legal fees that arise from common law claims under State or local law "regulating any aspect of the employment relationship . . . . prohibiting the discharge of an employee [as] retaliation or reprisal against an employee for asserting rights, or taking other actions permitted by law." Clearly, the scope of this provision is yet untested in either administrative or judicial proceedings.

It is entirely possible that a tax professional might be asked to provide an opinion concerning the tax treatment of this type of item (prospectively in anticipation of settlement or after settlement) by an employment attorney in her context of representing her client.

In this situation, the tax adviser may conclude that there is insufficient development of the tax law in this area to comfortably conclude that it is "more likely than not" that netting would by sustained in an administrative or judicial proceeding.

However, the tax adviser may well conclude that -- based on prior tax law, legislative history and statutory intent, there is "substantial authority" for netting of the legal fees. And, clearly, this should be the standard the taxpayer must meet to avoid imposition of the substantial understatement penalty; just as clearly, the tax adviser should be permitted to issue a substantial authority opinion which the client may rely upon with respect to avoiding a penalty assessment (New Regulations Section 10.37 should govern an opinion issued in this situation).

Nonetheless, it is not entirely clear that this type of penalty protection opinion may be issued under the New Regulations. If under Section 10.35(b)(2)(C) an opinion concerning the settlement-legal fees is construed to be "any other. . . arrangement, a significant purpose of which is the avoidance. . . of any tax", then the adviser must basically refuse to provide penalty protection (pursuant to Section 10.35(e)(4)(ii).

This would clearly go beyond the statutory requirement under Section 6662(d)(2)(B)(i), yet it is not clear that this would not be the result.

Numerous similar examples faced by thousands of tax professionals in the everyday course of their tax practices could be cited where a similar quandary might arise. While representatives of the Internal Revenue Service have often advised tax professionals to take a common sense approach to the following the intent of the regulations, it would appear that the New Regulations are sufficiently unclear that they should be revised. The revision is necessary to provide additional guidance in this area and to ensure that the New Regulations do not, effectively, go well beyond what is required by the statute to protect taxpayers from the substantial understatement penalty and to permit the taxpayer's tax professional to provide assurance that the penalty protection standard is met.

Solving the Problem (revising the New Regulations)

There are essentially two ways to solve this problem. One is to narrow the definition of "plans or arrangements" contained in Section 10.35((b)(2)(C) to exclude from the "Reliance opinion" definition any plan, arrangement or item for which substantial authority would be sufficient to avoid a substantial understatement penalty. The other approach is to modify Section 10.35(b)(4) in such a way as to provide that the opinion may affirmatively state that the penalties should not apply in situations (or to items on, or not on as the case may be, the return) where the penalty insulation standard is "substantial authority."

I appreciate your consideration of my comments.

Respectfully submitted,

 

 

Kip Dellinger, CPA

 

c.c.

 

 

Cono Namorato, Director, Office of Professional Responsibility

 

Internal Revenue Service
DOCUMENT ATTRIBUTES
Copy RID