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Final Circular 230 Written Tax Advice Regulations

Posted on June 18, 2014

Michael Desmond is the author of today’s guest post on the recently finalized Circular 230 Regulations. Mike is a sole practitioner in California with deep private and public sector experience, including a stint as Tax Legislative Counsel at Treasury and partner with McKee Nelson LLP and Bingham McCutchen LLP. He has spoken and written extensively on issues relating to tax compliance and ethics, and is widely regarded as one of the top tax controversy attorneys in the country.

As readers know, Circular 230 contains the rules that govern practice before IRS. The new regulations mostly concern efforts to regulate written tax advice. In addition to discussing the practical changes, including the removal of the annoying Circular 230 legends, Mike notes that with these rules  IRS has abandoned the efforts to detail standards directed at potentially abusive transactions and has opted for a more flexible principles based approach. Mike’s post highlights the history of the issue and the practical benefits of the change. He also raises questions about what will prevent the inevitable next round of aggressive tax planning. Les

          On June 12, 2014, long-awaited final regulations were published in the Federal Register under Treasury Department Circular 230 addressing standards applicable to written tax advice. The final regulations are, for the most part, consistent with proposed regulations published in September 2012.

Most notably, the final regulations eliminate from Circular 230 the “covered opinion” standards in prior section 10.35 that were applicable to defined sets of transactions thought to present a heightened risk of tax abuse. Under the prior regulations, the threshold question of what constituted a “covered opinion” involved a complex and uncertain inquiry that was criticized as being both over and under inclusive. Assuming that a covered opinion was involved, prior section 10.35 mandated that any written advice follow a cumbersome, prescribed form. To avoid the resulting cost and to address the threshold uncertainty as to what constituted a covered opinion, most practitioners adopted a boilerplate “legend” for their written advice that was thought to exempt that advice from the covered opinion rules entirely. Since their adoption in late 2004, the complex and cumbersome covered opinion rules in former section 10.35 of Circular 230 have been vocally criticized and the IRS has made little secret of the fact that it has been unable or unwilling to enforce them.

In repealing the covered opinion rules in former section 10.35, the Treasury Department and IRS replaced them in the final regulations with a strengthened, “principles based” rule in section 10.37 applicable to all written tax advice. While the principles-based approach eliminates much of the uncertainly and complexity associated with the former covered opinion rules, it also eliminates the benefit of a targeted rule that was intended to apply to a fairly circumscribed set of potentially abusive transactions. Under the principles-based approach, practitioners now have far more discretion to determine the form and content of their written tax advice and to tailor that advice to the particular circumstances of an engagement and to the factual and legal complexity of the underlying issues. That discretion (or, more specifically, abuse of that discretion) was the reason for first imposing targeted written advice rules in Circular 230 in 1984, when Circular 230 was amended to include heightened standards applicable to written advice rendered with respect to “tax shelters.”   While there is little question that repeal of the covered opinion standards in favor of a principles-based approach was the right thing to do, two aspects of the final regulations should be highlighted.

First, the final regulations are noteworthy in that they mark a sea change in the use of Circular 230 as a tool for targeting and, if possible, preventing the use of written tax advice to facilitate potentially abusive transactions. For 30 years, Circular 230 has included a rule targeted at “tax shelters” or some iteration thereof.   While there is little record of enforcement proceedings having been prosecuted by the IRS’s Office of Professional Responsibility under these targeted rules, they have been viewed by most practitioners as an effective deterrent, preventing at least some aggressive written advice from being issued and, in turn, preventing at least some taxpayers from entering into potentially abusive transactions. Since the covered opinion standards were promulgated in 2004, it has been widely believed, however, that any deterrent effect that those standards had was outweighed by the burden imposed. With the passage of time, that balance has continued to shift toward burden and away from deterrent.

Looking at the covered opinion rules (and their “tax shelter” forerunners) against the current compliance landscape, the wisdom of the decision to repeal those rules seems clear. While largely driven by factors independent of Circular 230 (e.g., the government’s criminal prosecution of practitioners and firms and taxpayer malpractice claims), imposing only a “principles-based” standard for written tax advice under Circular 230 raises a concern as to what will prevent the next round of aggressive tax planning. The short answer is robust enforcement of both the principles-based approach in new section 10.37 and the general due diligence standards in section 10.22, together with robust enforcement of parallel rules under the preparer penalty provisions of Code sections 6694 and 6695, among others.   However, the groundwork for problems with that approach is being laid already with recent cutbacks in the IRS’s enforcement budget. While repeal of the covered opinion rules was unquestionably the right thing to do, history will tell what the cost might be for abandoning the 30-year effort to adopt workable standards targeted at potentially abusive transactions.

The second aspect of the final regulations to highlight has to do with the ubiquitous “legend” that most practitioners have adopted in an effort to remove written tax advice from the old covered opinion rules. The legend originated from language in former section 10.35 that seemed to permit written advice to be carved out of the covered opinion rules if it included language that “prominently disclosed” that it could not be relied upon for penalty protection purposes. While the efficacy of the legend can be debated, in the preamble to the final regulations Treasury and the IRS recognized that its use might be “misleading.”

While not detailed in the preamble, use of the legend to escape from the covered opinion rules might have been misleading in the context of listed or principle purpose transactions or in the context of marketed opinions, none of which were subject to a “prominent disclosure” carve out. Use of the legend might also have been misleading in the context of tax issues other than income tax, where the applicable penalty rules are not always linked to the “more likely than not” standard that former section 10.35 was built around. More significantly, use of the legend was problematic and possibly misleading because it purported to act as a rule of evidence, making irrelevant advice and other communications from a practitioner that might otherwise be an important part of an “all facts and circumstances” defense to penalties under the reasonable cause rules of Code section 6694.   See Treas. Reg. § 1.6694-4(b)(1) (“The determination of whether a taxpayer acted with reasonable cause and in good faith is made on a case-by-case basis, taking into account all pertinent facts and circumstances.”).   Circular 230 is, and properly should be focused on practitioners. If a practitioner fails to meet any standard imposed by Circular 230, the consequence should be on the practitioner in the form of a disciplinary proceeding and, if appropriate, a sanction, not on the taxpayer who reasonably relied on the practitioner irrespective of boilerplate legends and caveats. Because the covered opinion rules that gave rise to the “legend” have now been repealed, this problem and the legend that gave rise to it should disappear as well. In the preamble to the final regulations the Treasury Department and IRS say specifically that they “expect these amendments will eliminate the use of a Circular 230 disclaimer in email and other writings.”

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