Lawyers, CPAs Urge Treasury, IRS to Revisit Circular 230 Rules

We are writing in our capacity as individual members of the National Conference of Lawyers and Certified Public Accountants (the "National Conference"), an organization cosponsored by the American Bar Association ("ABA") and the American Institute of Certified Public Accountants ("AICPA"). The National Conference includes 18 attorneys and CPAs drawn from various Sections of the ABA (Tax, Business Law, Litigation and Real Property, Trusts and Probate), and the AICPA Relations with the Bar Committee. Most of our members practice (or have practiced) in large or smaller-sized law and accounting firms; some work in corporate settings. The group meets twice each year to discuss tax and non-tax issues of common interest to the legal and accounting professions and, as appropriate, provides assistance to our respective parent organizations in connection with their consideration of and formulation of positions on such issues.

For the past several years, the subject of abusive tax shelters has been a consistent agenda item at National Conference meetings. We have focused in particular upon the recent governmental initiatives in this area, including the revisions to the Treasury regulations under Circular 230 regarding practitioner diligence standards for providing written tax advice. Several of our members participated substantially in the development and preparation of comments that were submitted by the ABA Tax Section and the AICPA Tax Executive Committee with respect to the various proposed and final versions of these regulations. A number of us also have been involved in efforts within our respective firms to formulate internal protocols and procedures for complying with the new Circular 230 rules.

As noted at the outset, the views expressed in this letter, are offered solely in our individual capacities. They are not intended, and should not be construed as representing, with respect to any of the matters addressed, the position of the ABA, the AICPA, any of their constituent entities or any of the firms or other organizations with which the undersigned are associated.

The Circular 230 revisions have, as you well know, generated a fair amount of criticism and anxiety in the practitioner community. The purpose of this letter is to set forth what we perceive to be the core concerns that have emerged, and to urge that Treasury and IRS respond to these concerns through further modification of these rules. Please understand that we neither intend nor desire to leave any impression that we generally oppose efforts to tighten practitioner standards in this area or to subject those who fail to abide by such standards to serious sanctions. Quite to the contrary, we believe that such efforts are very important; and we genuinely appreciate and applaud the enormous amount of time and energy that government personnel have devoted to what we all know to be an extremely difficult exercise. With all due respect, however, we think it fair to say that, having now lived with the new Circular 230 rules for six months, tax practitioners are becoming more and more concerned that they are too broadly targeted and unnecessarily intrude upon the ways in which professional relationships between taxpayers and their advisers are normally conducted.

Tax opinion letters prepared without sufficient factual or legal diligence have no doubt played a major role in the promotion and proliferation of abusive tax shelter transactions and products. However, as a result of important administrative and legislative actions in recent years, many of these are now considered "reportable transactions" which taxpayers and their "material advisors" must disclose or face substantial monetary penalties for failing to do so. Moreover, in light of the "disqualified opinion" and "disqualified tax advisor" rules enacted in 2004 as part of the JOBS Act anti-tax shelter package, it is now more difficult to rely upon outside tax opinions where reportable transactions are successfully challenged by the Service and accuracy penalties are asserted. Together with Sarbanes-Oxley and the PCAOB "auditor independence" rules in the public company sphere, certain highly publicized Justice Department criminal enforcement action against tax professionals and noticeably increased IRS audit and enforcement activity, we believe that these measures have substantially reduced the incidence of tax-abusive transactions and the willingness of outside tax advisers to bless such transactions with unsupportable opinions or advice.

The impetus for the Circular 230 amendments also stems from the desire to curb abusive tax shelters. Consistent with this objective, new § 10.35 does target as "covered opinions" a number of transactions that have characteristics commonly thought to be indicative of tax abuse, namely: (i) listed transactions; (ii) transactions having a "principal purpose" of tax avoidance (unless the desired favorable tax result is consistent with the Code and the underlying legislative purpose); and (iii) marketed, confidential or contractually protected transactions that have a "significant purpose" of tax avoidance. But the purpose, administrability and ultimate usefulness of the Circular 230 amendments is blurred considerably, we believe, by the inclusion of "significant purpose"/"reliance opinions" as covered opinions, and by the addition of new § 10.37 to deal with written advice not covered by § 10.35. These latter features of the new rules extend their reach well beyond the world of abusive tax shelters and products, and into the realm of everyday tax advice.

The treatment of "significant purpose" transactions as "covered opinions" is viewed by many practitioners as especially problematic, because (i) achieving favorable tax treatment is commonly an important factor in a wide array of legitimate business transactions; (ii) no definitional parameters for the vague "significant purpose" standard are provided; and (iii) the heightened diligence requirements of § 10.35 potentially can apply to virtually any type of written client communication, no matter how informal or routine it may be. Concerns also exist regarding the intended lines of demarcation between "principal purpose" and "significant purpose" transactions, as well as the degree of diligence required in determining, for the former, whether the "consistent with the Code and legislative purpose" exception applies.

In light of such problems, trying to determine whether the advice being given rises to the level of a "covered opinion" can truly be a more difficult, more time-consuming and less certain exercise than formulating a position on the proper tax treatment of the underlying matter. Most firms have sought to avoid these burdens by simply adding permitted disclaimer legends to virtually every outgoing e-mail or other informal written communication (even those containing no reference to tax matters). That practice has the effect of discouraging rather than encouraging adherence to the heightened diligence standards of § 10.35. The blanket disclaimers have also caused much confusion and unhappiness on the part of clients who fail to understand why they are paying outside professionals for advice they can't rely upon if a penalty is asserted.

We recognize that "covered opinion" status may not attach in many instances, and that some type of "backstop" is necessary to assure that practitioners also exercise appropriate diligence in giving written advice on non-"covered opinions." We note in this regard that the prior version of Circular 230, through §§ 10.22 and 10.34, already required a reasonable degree of diligence in these typically less formalized advice-giving settings. While those provisions may well be in need of greater specificity or other strengthening, the "catch-all" approach of § 10.37 frankly does not adequately accomplish that task; and the intended interface of that provision with §§ 10.22 and 10.34 (which continue to apply) is unclear. Given these uncertainties (with respect to both §§ 10.35 and 10.37), it is quite possible that, in time, the current rules will lead to a marked escalation in the practice of providing tax advice orally as opposed to in writing. That likely will have the unfortunate effect of raising the incidence of miscommunication and misunderstanding on the part of clients with respect to the proper tax treatment of transactions on which they seek outside advice.

In the final analysis, we genuinely believe that the new Circular 230 rules are not working well because they try to do too much. The primary focus should be upon curbing irresponsible practitioner behavior in connection with transactions that are clearly tax-abusive. That is not to say that practitioners should be given a free pass in all other advice-giving contexts; but we and our clients really do need to have a better sense of when more stringent diligence requirements will apply. Given especially the current emphasis upon stronger enforcement of the tax laws, practitioner concerns in this sensitive area are not alleviated by unofficial remarks by government speakers at tax conferences, or by press reports of practitioner letters that purport to confirm views expressed during informal discussions with government officials. The stakes are simply too high for practitioners to assume that everything will be fine so long as they act in ways that comport with "common sense" and "reasonableness."

While we recognize that striking the right balance in these rules is by no means an easy task, we do believe that significant clarification and improvement is possible and worth pursuing. In that regard, we think it would be useful to revisit some of the previously suggested approaches to formulating the basic structure of the Circular 230 revisions, including, for example: (i) an "opt-in" approach for opinions intended to provide penalty protection; (ii) limiting heightened diligence requirements to "formal", as opposed to "informal", written advice; (iii) providing appropriate definitional exceptions to the "significant purpose" trigger (as was done in Treas. Reg. § 301.6111-2(b)(4), concerning "confidential corporate tax shelters" under old-section 6111(d)); and (iv) implementing a relatively simple administrative mechanism for responding, via regular published guidance, to specific practitioner inquiries regarding application of the regulations.

A delegation from the signatories to this letter would welcome an opportunity to meet with Treasury, IRS and/or OPR officials to discuss this important subject in further detail. Please contact either Herbert N. Beller (at 202/383-0120) or Harvey L. Coustan (at 312/634-4771) if that might be helpful.