Attorneys Seek Revisions to Circular 230 Based on Practical Problems

Dear Sirs:

We understand that the Treasury Department and the IRS, in adopting the recent amendments to Circular 230, made a serious effort to balance the needs of the government with the burdens that would be imposed on tax advisors. In addition, we believe that many of the amendments to Circular 230 were justified and will improve the standards of tax practice. However, we believe that in some respects, the amendments made in Section 10.35 of Circular 230 create unnecessary difficulties for tax advisors. Consequently, this letter makes recommendations for changes to Section 10.35. It is based on practical problems that we and many others have encountered in seeking to comply with that Section in its current form.¹

We believe that all of our suggestions are fully consistent with the purpose of the regulations. We respectfully request the Treasury Department and the IRS to incorporate our suggestions into revised regulations or other guidance. We also recommend that regulations or other guidance incorporate the positions taken in the letters to Cono R. Namorato and Stephen A. Whitlock, from Leslie B. Samuels and Diana L. Wollman, dated July 1, 2005, and August 4, 2005 (the "July 1 Letter" and the "August 4 Letter", respectively).

Our recommendations fall into five categories:

• Recommendations concerning marketed opinions;

• Recommendations concerning the definition of advice;

• Recommendations concerning exclusions from covered opinion status;

• Recommendations concerning principal purpose transactions; and

• Recommendations concerning written advice contained in emails.

Section 10.35 defines "marketed opinion" to mean written advice "if the practitioner knows or has reason to know that the written advice will be used or referred to by a person other than the practitioner (or a person who is a member of, associated with, or employed by the practitioner's firm) in promoting, marketing or recommending a partnership or other entity, investment plan or arrangement to one or more taxpayer(s)."

If written advice falls within this definition, it must comply with the requirements for covered opinions unless it contains the three disclosures set forth in Section 10.35(b)(5)(ii) (described in Part I.A. below). Without these disclosures, the advice is a covered opinion and must reach a conclusion of at least "more likely than not" that the taxpayer will prevail on the merits with respect to each significant federal tax issue, and the advice cannot be a limited scope opinion.

Furthermore, in specific types of corporate transactions, such as self-tenders and consent solicitations, the phrase "promotion or marketing" itself raises concerns under the securities laws. In self-tender offers and consent solicitations, issuers specifically state that they are not promoting or recommending the transaction, because any such promotion or recommendation could raise liability concerns under the Securities Act of 1933 and other securities laws. The marketing legend is inconsistent with this specific statement by issuers and could inhibit the willingness of issuers to engage in these transactions. Additionally, in equity self-tender offers, the use of "promotion or marketing" may raise fiduciary concerns under state law. It was obviously not the intention of Circular 230 to subject issuers to potential securities and/or corporate law liability merely by complying with Circular 230. Accordingly, we recommend that it be permissible for "prong B" to state that tax advice was written "in connection with" a particular transaction, without the reference to promotion or marketing, in cases where (1) the advice is provided only to pre-existing holders of debt and/or equity (and not to any third parties) and (2) the transaction documents contain an explicit statement that the issuer is not promoting or recommending the transaction.

We believe that these proposed modifications to "prong B" of the marketing legend -- both replacing the words "to support" with the words "in connection with" and eliminating the words "promotion or marketing" in cases where the specific requirements described above are satisfied -- provide a workable alternative to the current language. Moreover, in all cases, the statement in "prong A" that taxpayers may not rely on the advice for penalty protection will remain, as will the statement in "prong C" that taxpayers should consult independent tax advisors.

• Example 1 (husband-wife): Husband hires a lawyer to advise him with respect to charitable planning alternatives. The lawyer prepares a memorandum for husband, describing charitable remainder trusts, charitable lead trusts, private foundations and donor advised funds. Husband discusses the memorandum with his wife, with whom he files joint tax return.

• Example 2 (accountant): Same facts as example 1. Lawyer sends copy of memo to husband's accountant, in preparation for a telephone call with the accountant to discuss which alternative might make most sense in view of husband's assets.

• Example 3 (negotiations): Lawyer sends an e-mail summarizing the tax consequences of a Section 338(h)(10) election to her client containing the standard "non-reliance" legend. Lawyer has reason to know that the client might refer to the email in negotiations with the other side of the transaction.

• Example 4 (intermediary): The general partner of a partnership hires a lawyer to provide advice regarding the tax consequences of the partnership's making a particular investment. The general partner refers to the opinion in a conference call with its partners with respect to the potential investment.

First, the word "recommend" results in the definition sweeping in advice even if it is used only by the principals to a transaction or their tax advisors, with no "marketer" involved.³ For instance, as shown in Example 2, if one practitioner advising a taxpayer provides a copy of his written advice to another practitioner who is advising the same taxpayer, the advice seems to be a marketed opinion.

Second, the phrase "used or referred to" in the definition of marketed opinion results in the application of the marketing legend to written advice that is never seen by anyone other than the original recipient. For instance, in Example 3, the adverse party never sees the lawyer's advice, but the client "uses" the advice in negotiations, apparently causing it to be a marketed opinion.⁴ Similarly, the advice in Example 4 seems to be a marketed opinion because it is referred to by the client during a conference call. We do not believe these results were intended. Circular 230 applies only to written advice, presumably because it would be difficult for taxpayers to claim that they relied on oral advice for penalty protection. Yet, the language "used or referred to" suggests that the marketing legend might be required on written advice even if the person receiving the advice merely referred to the advice orally in discussions with another taxpayer. Where that taxpayer never sees the written advice, "the opt-out legends would serve no purpose and make no sense."⁵

To solve the two problems described above, we believe that the definition of marketed opinion should be limited to the case where the written advice itself is expected to be shown or delivered to third parties in order to promote or market (but not merely to "recommend") a transaction to such persons. As modified, the definition would read:

• a disclosure document containing a description of the tax consequences of investing in a simple debt instrument; and

• a brochure prepared by a practitioner, for distribution by a public charity, explaining the deductibility of a cash contribution to the charity.

II. Recommendations Concerning the Definition of Advice

The rules of Section 10.35 only apply to written advice. The regulations, however, do not provide a definition of the word "advice". As a result, it is not clear whether certain written documents fall within the ambit of Section 10.35. For example:

• Example 1 (outlines/articles): A practitioner prepares an outline for a bar association discussion. The outline includes a summary of the tax consequences of a transactional structure. The practitioner is aware that it is possible that any person may refer to the outline in support of certain tax results.

• Example 2 (email "list-serve"): A group of practitioners from various firms are part of an email group in which members post questions. Many of these questions reflect specific client situations, but no client is ever identified. Group participants know that their responses to a question may be used by the attorney who posed the question in advising a client.

Accordingly, we recommend that the term "advice" be defined as writings prepared for the benefit of a practitioner's client, whether or not the client is the taxpayer whose tax treatment is addressed.

III. Recommendations Concerning Exclusions from "Covered Opinion" Status

We assume that one reason for the exclusion is that if tax advice is publicly filed with the SEC, the transaction is not a tax shelter that is being hidden from the IRS. Moreover, a tax statement that satisfies the SEC's requirements for fair and accurate disclosure should be sufficient for purposes of Circular 230 (although Section 10.37 clearly still applies to these tax statements). These observations apply equally, of course, regardless of whether the SEC filing was in fact required. In addition, it would put an enormous burden on taxpayers to determine, in each case of a filed SEC document containing tax advice, whether the filing of that particular document was required under the SEC rules. Consequently, this language should be clarified to state that if a document is filed with the SEC, including as an exhibit, it is automatically excluded from Section 10.35.

We recognize that there are differences between SEC filings and Bankruptcy Court filing in terms of both public availability and review. For example, not all Bankruptcy Courts are part of the PACER system. Documents that are available on PACER may not be as easily searchable as documents available on EDGAR, and PACER charges a nominal fee. Moreover, the "adequate information" standard applicable to disclosures filed with the Bankruptcy Court is not the same as the "fair and accurate" standard applicable to SEC filings.

We believe, however, that the general public accessibility of the documents and their review by the Bankruptcy Court support an exclusion for at least some tax disclosure filed in Bankruptcy Court. The exclusion could apply to all such filings. Alternatively, a more narrow exclusion could be provided for disclosure contained in Bankruptcy Court filings that are available on PACER or on the bankrupt corporation's website.

At a minimum, the preliminary advice exclusion should apply if the practitioner reasonably expects that the subsequent advice either will satisfy all the requirements for a covered opinion or will fall within one of the other categories of excluded advice enumerated in Section 10.35(b)(2)(ii). It is not clear, however, whether the preliminary advice exclusion also applies if the subsequent advice will contain the appropriate legend and therefore will not be a covered opinion. We urge clarification of the scope of this exclusion.

It is also not clear whether the subsequent advice must be rendered by the same practitioner as the one giving the preliminary advice. The regulations require a reasonable expectation that a practitioner will render subsequent advice satisfying the requirements of Section 10.35. The preamble to the regulations, however, refers to a reasonable expectation that the practitioner will render such subsequent advice. We believe that the goals of Section 10.35 are met as long as the taxpayer ultimately receives written advice complying with Section 10.35 from any practitioner. Therefore, a practitioner should be entitled to rely on the preliminary advice exclusion if he or she reasonably expects another practitioner to render the required advice.

First, the reference to advice given "for purposes of determining the tax liability of the employer" creates uncertainty because there is an implication that the advice must be limited to the calculation of the dollar amount of the tax liability arising from a particular transaction. For example, it is not clear whether this language covers the case where an in-house practitioner writes a memorandum to officers of her employer (a) describing the tax consequences arising from alternative investment structures, where the purpose of the memorandum is to advise on structuring the investment in a tax efficient manner or (b) describing possible IRS challenges to a tax position so that the officers can consider whether to establish an accounting reserve or whether to include a risk factor in related disclosure. Accordingly, we recommend that the phrase "determining the tax liability" be changed to "addressing a tax issue."

In addition, the in-house exclusion does not appear to apply if the written advice addresses the tax consequences to a wholly-owned subsidiary or other affiliate of the practitioner's employer. To deal with this problem, we suggest that the in-house exclusion apply if it addresses a tax issue of a corporate employer or any related person within the meaning of Section 267(b).

It is also not clear whether the word "solely" operates to exclude advice in which an in-house practitioner addresses the tax issues relevant to the employer as well as other taxpayers in a transaction involving the employer (even if the advice will not be shown to the other taxpayers). To address this concern, we suggest that the in-house exception apply in these cases as long as the practitioner providing the advice does not know or have reason to know that the advice will be used to promote or market the transaction to other participants in the transaction and neither the employer nor any related entity derives any fee or other economic benefit for promoting or marketing the transaction.

Partnerships raise additional issues. It is not clear if the in-house exclusion applies where the practitioner is (1) an employee of the partnership, because the tax issues will generally be relevant not only to the partnership but also to the partners of the partnership, (2) an employee of a corporate partner, because the advice does not relate to the tax liability of the employer, or (3) a partner of the partnership. We acknowledge that the in-house exclusion should not be drafted in way that would allow tax shelter promoters to become employees or partners in a partnership and then give advice on the tax shelter to the other partners. Nevertheless, there are commonplace circumstances for which an exception for employees or partners of partnerships is appropriate. For example, a partner in a law firm providing written tax advice to the law firm should be entitled to the in-house exception. If a widget manufacturer is organized as a partnership, then written tax advice provided by an employee or partner regarding the operations of the partnership should also be entitled to the exception. With these examples in mind, we recommend that further consideration be given to expanding the in-house exclusion in a manner that includes the commonplace partnership situations, but does not thwart the goals of Circular 230.

IV. Recommendations Concerning "Principal Purpose" Transactions

Under Section 10.35, any written advice related to a "principal purpose" transaction must comply with all the covered opinion requirements. In particular, as to such a transaction (in contrast to a "significant purpose" transaction), a legend does not exempt the advice from satisfying the requirements for a covered opinion, and a limited scope opinion is not permissible.

This rule ensures that taxpayers have a full analysis of the tax law and the attendant risks before proceeding with what might be characterized as an aggressive transaction. Except in the context of marketed opinions, however, we believe that the same rules that apply to "significant purpose" transactions should apply to "principal purpose" transactions.

We have two reasons for this conclusion. First, it is often extremely difficult to determine the dividing line between a "principal purpose" transaction and a "significant purpose" transaction. Outside the context of an opinion distributed to taxpayers (other than the original recipient) to promote or market a transaction, we do not believe that such a subtle dividing line should be the basis for causing fundamentally different rules to apply under Section 10.35.

Second, while many taxpayers participating, or contemplating participation, in "principal purpose" transactions will be satisfied with advice that cannot be relied on for penalty protection, few if any will be willing to pay the costs to obtain a covered opinion that does provide penalty protection. As a result, the existing rule will result most commonly in no written advice being provided at all in a transaction that might be a "principal purpose" transaction.

For example, assume a client were to send a practitioner an e-mail asking whether it would make sense for profits from a foreign subsidiary to be distributed to a U.S. parent corporation. Assume that neither the foreign subsidiary nor the U.S. parent currently needs the cash, and the only reason for the transaction would be to take advantage of a favorable foreign tax credit position that might not exist in the future. Unless the practitioner were able to conclude that the tax benefit resulting from the proposed transaction was clearly contemplated by the Code or Congressional intent, the only available alternatives would be to provide the client with a full covered opinion, oral advice or no advice at all. We believe that in almost all cases, the result will be oral advice. Both the practitioner and the client will probably write their own memos to the file describing the oral advice, but neither will send its own memo to the other.

We see no logical reason to force the practitioner to provide oral advice (or no advice) in this situation. We acknowledge that in the context of a marketed opinion on a "principal purpose" transaction, the existing rules might be appropriate to prevent improper promotion of tax shelters. Outside that context, we believe that taxpayers should be able to ask for advice short of a covered opinion, and practitioners should be able to provide such advice so long as the advice contains the legend that it cannot be relied on for penalty protection.

As discussed in Part I.B. of this letter, the definition of marketed opinion goes beyond opinions distributed to taxpayers (other than the original recipient) to promote or market a transaction. The scope of the definition of marketed opinion causes our concerns regarding the principal purpose test to apply even in the context of certain marketed opinions. In the examples set forth in Part I.B, none of the written advice is an opinion distributed to taxpayers (other than the original recipient) to promote or market a transaction. Yet, if the advice in any of those examples addressed a principal purpose transaction, the client would have to decide between incurring the costs of a covered opinion or not receiving written advice. We do not believe this is an appropriate result. As another example, assume that a bank asks a practitioner for advice regarding a financial product that might be considered a principal purpose transaction. The bank has not determined whether it will market this product and, if it does, it will not deliver the practitioner's advice to potential investors. Instead, investors will be urged to seek their own tax advice. If the bank wants written advice, the practitioner will be required to deliver a full covered opinion even though the taxpayers whose tax treatment is addressed will never see that opinion. Again, we believe that this is an inappropriate result. These concerns can be addressed by narrowing the definition of marketed opinion and applying the principal purpose test solely to that more limited set of cases.

V. Recommendations Concerning Written Advice Contained in Emails

Written advice contained in emails presents a separate set of practical concerns due to the frequency and fast pace at which emails are sent and the ease with which they can be forwarded. As a result, virtually every firm of which we are aware has adopted the practical solution of requiring a legend on every email that provides tax advice. Many firms are providing "automatic" legends for some or all of their lawyers to avoid unintentional violations.

Because of the nature of email communication, a practitioner may not be in a position to determine whether a particular email contains advice that is a reliance opinion or a marketed opinion. In addition, if a firm automatically inserts a legend in all emails, the lawyer must manually replace the standard non-reliance legend with the marketing legend in appropriate circumstances. The implementation of legending emails would be greatly simplified if a single legend could be used for all messages, combining the two existing legends. Tracking the language of the existing regulations, with modifications reflecting the recommendations set forth in Part I.A. above, a single legend might read as follows:

These differences in interpretation are quite fundamental, especially because lawyers' ability to comply with some interpretations may be limited by available technology. We recommend that guidance clarify how the prominent disclosure requirement is to be satisfied in emails. Another alternative would be to eliminate the prominent disclosure requirement for emails altogether. The legend would still appear somewhere in the email and would notify the recipient that the email cannot be relied upon for penalty protection.

VI. Conclusion

We, our firms, and the firms with which we have worked over the past several months have spent considerable amounts of time educating our colleagues, including those in our non-U.S. offices, about Circular 230 and enabling our firms to comply with the regulations. Through this process, we have seen the need for regulatory guidance to address ambiguities, inconsistencies and other issues presented by the current version of Section 10.35.

We believe that the issues we have raised herein can be addressed by modifying the regulations along the lines that we have suggested, without undercutting the purpose of the regulations.

Thank you for your consideration of these matters.

² Under Section 10.35(e)(2), "prong B" and "prong C" of the marketing legend are also required disclosures in "marketed opinions" that satisfy the covered opinion requirements.

³ This paragraph and the next assume that the practitioner providing the written advice knows or has reason to know that the advice will be used or referred to by the original recipient in communications with another taxpayer.

⁴ The advice in Example 3 also would seem to be a marketed opinion because it is being used by one party to "recommend" the transaction to the other party.

⁵See the July 1 Letter.

⁶ Section 10.35(c)(3)(v) provides that a practitioner may provide a limited scope opinion if, among other things, the opinion is not described in Section 10.35(b)(5). Section 10.35(b)(5)(i) sets forth the definition of marketed opinion and Section 10.35(b)(5)(ii) provides the exception for legended opinions. The practitioners' concern is that, even with the legend, the opinion is "described" in Section 10.35(b)(5).

The authors of this letter believe that the sole purpose of Section 10.35(c)(3)(v) is the pro-taxpayer purpose of authorizing penalty protection for certain opinions that do not cover all significant federal tax issues. However, this authorization is not provided for marketed opinions. Thus, if a marketed opinion does not cover all significant federal tax issues, it cannot provide penalty protection. However, we do not believe the Section states, or was intended to state, the further point that such a marketing opinion is flatly prohibited, even if legended.

⁷ As noted in the August 4 Letter, articles, training outlines, presentations and books "are clearly intended to be educational, not to transmit advice."

⁸ See http://pacer.psc.uscourts.gov/.