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Circular 230 Final Regs. (Part I) In July 2002, Treasury published final regulations amending most of the existing Circular 230 rules governing practice before the IRS. This two-part article reviews selected final regulations that most affect practitioners. Part I examines IRS requests for client information, practitioner knowledge of client errors, diligence as to accuracy, fee arrangements and return of client records.
John C. Gardner, Ph.D.,
CPA
Editor’s note: Dr. Gardner chaired the AICPA Tax Division’s Circular 230 Task Force. Authors’ note: The authors wish to acknowledge the assistance of Dan Mendelson, Benson Goldstein and Jim Emillian in reviewing this article. For more information about this article, contact Dr. Eide at eide.barb@uwlax.edu.
Executive Summary
In July 2002, the IRS published final Circular 2301 regulations2 governing practice before the IRS by enrolled agents and actuaries, attorneys and CPAs (collectively referred to as practitioners). These final regulations amend most of the existing Circular 230 rules, except for tax shelter matters (Section 10.33), which Treasury plans to replace in the near future. For tax-shelter practice rules, practitioners continue to be governed by current Section 10.33 (issued in 1984 and last amended in 1994). The IRS also intends to issue another advance notice of proposed rulemaking to revisit contingent fees and other IRS practice matters. The IRS had published proposed Circular 230 regulations in January 2001,3 that were commented on by professional organizations such as the AICPA and the American Bar Association (ABA).4 The AICPA Tax Executive Committee's Circular 230 Task Force submitted written comments and testified; the AICPA Tax Division submitted comments, primarily on the proposed tax-shelter-opinion provisions. After a brief introduction to Circular 230, this article reviews selected final regulations that most affect practitioners.5 Part I, below, covers IRS requests for client information, practitioner knowledge of client errors and omissions, diligence as to accuracy, assistance from disbarred and suspended persons, fee arrangements and return of client records. Part II, in the next issue, will examine conflicts of interest, solicitation, sanctions and disciplinary procedures.
Circular 230 Circular 230 regulates practice before the IRS by attorneys, CPAs, enrolled agents and actuaries. Subpart A of Circular 230 governs authority to practice before the IRS. Section 10.3(b) requires a CPA who is not currently under suspension or disbarment from such practice to file a written declaration that he or she is currently qualified as a CPA and authorized to represent the designated party or parties. Section 10.2(d) defines “practice” broadly as all matters connected with a presentation to the IRS, its officers or employees, relating to a taxpayer's rights, privileges or liabilities under laws or regulations administered by the IRS. These presentations include corresponding and communicating with the IRS; representing a client at hearings, conferences and meetings; and preparing and filing documents (including tax returns), even though individuals not subject to Circular 230 can also prepare returns.6 Subpart B sets out the duties and restrictions of practice before the IRS, including the regulations examined below. Subpart C specifies the sanctions for violating Circular 230; Subpart D explains the rules that apply in disciplinary hearings. Circular 230 is a potent weapon in the IRS arsenal of potential sanctions against tax practitioners. The recent amendments to Circular 230 contain both favorable and adverse changes. It is essential for CPAs in tax practice to be aware of the Circular's content and to formulate detailed procedures ensuring that they (or their firms) are not sanctioned.7 Amendments Section 10.20—Information to be Furnished On a proper and lawful request from an IRS officer or employee, revised Section 10.20(a)(1) requires a practitioner to promptly submit information or records in any matter before the IRS, unless the practitioner has reasonable grounds for believing in good faith that the requested material is privileged. If neither the practitioner nor the client has possession or control of such requested information or records, Section 10.20(a)(2) mandates the practitioner to (1) promptly notify the IRS of that fact and (2) identify the person who the practitioner believes may have possession or control of the requested records or information. A practitioner is required to make a reasonable inquiry of the client about any such person. However, he or she does not have to independently verify client information or ask anyone other than the client. The final Circular 230 regulations eliminate the phrase “of doubtful legality” from prior Section 10.20(a) and (b). According to TD 9011, this deletion does not effectuate a substantive change in a practitioner’s ability to resist government efforts to obtain documents or information irrelevant to an inquiry, confidential, privileged or otherwise immune from compulsion. Rather, it merely eliminates the redundancy in Section 10.20, because that provision already requires that IRS requests be proper and lawful. Unfortunately, practitioners lack explicit guidance as to how the IRS will determine whether requested records or information are confidential or privileged, because neither TD 9011 nor the final regulations define "confidential" or “privileged,” nor include references to Code sections or other laws that define these or similar terms. Section 10.20(b) also requires practitioners to furnish the IRS Director of Practice (DOP), on a proper and lawful request, with any information they have concerning a DOP inquiry into an alleged Circular 230 violation by any person, and testify about such information in any proceeding instituted under the regulations. Also, under Section 10.20(c), practitioners cannot interfere (or attempt to interfere) with a proper and lawful IRS effort to obtain any information or record. Practitioners may, of course, resist requests under Section 10.20(b) and (c) if they believe in good faith and on reasonable grounds that the record or information is privileged. In clarifying the final Circular 230 provisions, TD 9011 states that “alleged violations” are not limited to violations actually the subject of a Subpart D disciplinary proceeding, because the DOP should be able to obtain evidence about alleged violations to determine whether they merit formal charges. To comply with Section 10.20, practitioners should maintain records of any oral or written client contact to obtain information requested under Section 10.20, as well as copies of any contact with IRS personnel.
Section 10.21—Knowledge of Client's Omission Section 10.21 requires practitioners who know that a client has (1) not complied with the U.S. revenue laws or (2) made an error in (or omission from) any document, return, affidavit or other paper executed or submitted under the U.S. tax laws, to notify the client of the error, omission or noncompliance, as well as the consequences (but not how to correct the error or omission, as had originally been proposed).8 Unfortunately, Circular 230 does not define an error, omission or noncompliance with the Code or regulations. The AICPA's Statements on Standards for Tax Services (SSTSs) No. 6 (Knowledge of Error: Return Preparation) and No. 7 (Knowledge of Error: Administrative Proceedings) may provide some assistance to AICPA members who are subject to these statements.9 SSTSs Nos. 6 and 7 both define “error” (which becomes operative only when there is more than an insignificant effect on a taxpayer’s liability) as any position, omission or accounting method that, at the time the return is filed, fails to meet the standards in SSTS No. 1, Tax Return Positions. An error also involves any position taken on a prior-year return that no longer meets the “realistic possibility” standard articulated in SSTS No. 1 due to judicial decisions, legislation or administrative pronouncements that have a retroactive effect. Practitioners subject to SSTS No. 6 should not only inform the taxpayer about an error, but also recommend corrective actions. If the taxpayer has not taken appropriate steps to correct an error on an earlier return, SSTS No. 6 states that any AICPA member requested to work on the taxpayer’s current return should consider whether to withdraw from preparing the return and whether to continue a professional or employment relationship with the taxpayer. Members who decide to prepare the current return should take reasonable steps to ensure that the error is not repeated. SSTS No. 7 outlines similar steps that the member should take on discovering an error during an administrative hearing. Both SSTS Nos. 6 and 7 state that members should consider consulting with an attorney before deciding what to recommend to the taxpayer and whether to continue a professional or employment relationship because a potential violation of Rule 301 of the AICPA’s Code of Professional Conduct, privileged communications laws, IRS regulations or the Code itself, and other considerations, may create a conflict of interest between the member and the taxpayer-client. During a tax preparation engagement or an administrative hearing, however, AICPA members are not obligated to inform the taxing authority about the error, nor allowed to do so without the taxpayer's permission (except when required by law).
Section 10.22—Diligence as to Accuracy Section 10.22(b), Reliance on Others, states that practitioners are presumed to have exercised due diligence when they rely on another person's work product and use reasonable care in engaging, supervising, training and evaluating that person (taking proper account of the nature of the relationship between the practitioner and the person). As TD 9011 stresses, this subsection applies to reliance on others, whether within or outside of a firm. In hiring outside specialists, the practitioner’s duty would center on the use of reasonable care in engaging a specialist, because the relationship would not involve training or supervision. Section 10.22(b)’s presumption of due diligence does not apply to Sections 10.3310 (tax shelter opinions) and 10.34 (the realistic possibility standard for practitioners who give advice on return positions or prepare and sign a return), because these sections have their own due diligence rules. Section 10.24—Assistance From or to Disbarred or Suspended Persons Revised Section 10.24(a) states in part that a practitioner cannot (knowingly and directly or indirectly) accept assistance from or assist any person under disbarment or suspension from IRS practice in a matter constituting practice before the IRS. Prior Section 10.24(a) was much broader than the revised provision—all employment or assistance from such practitioners was prohibited, even if their assistance was not related to practice before the IRS. Similarly, prior Section 10.24(b) prohibited practitioners from accepting employment as an associate, correspondent or subagent from any suspended or disbarred person or sharing fees with any such person. The preamble to the Circular 230 proposed regulations stated that practitioners would not be required to disassociate themselves from a suspended or disbarred person as long as they observed the other proscriptions regarding disbarred or suspended persons. For example, practitioners who are partners of a law or accounting partnership would not be required to expel another partner subject to discipline simply because the disciplined partner might otherwise share in fees derived from services by others before the IRS. This major change in rules for suspended or disbarred practitioners leaves any employment or partnership decisions to the business entity.
Section 10.27—Fees Section 10.27(b)(2) prohibits practitioners from charging contingent fees for preparing original returns or rendering advice in connection with a position taken (or to be taken) on an original return. The AICPA’s Tax Division agrees with the prohibition in Section 10.27(b) that specifically bars tax planning for positions taken (or to be taken) on an original return when the IRS did not have the opportunity to review the positions except through the normal audit process.11 In contrast, Section 10.27(b)(3) allows contingent fees to be charged for preparing or providing advice in connection with an amended return or refund claim (other than one made on an original return), but only if the practitioner reasonably anticipates at the time the fee arrangement is entered into that the amended return or refund claim will be substantively reviewed by the IRS. Under Section 10.27(b)(1), a contingent fee is any fee based (in whole or in part) on whether a position taken on a return (or other filing) avoids an IRS challenge or is sustained by the IRS or in litigation. Contingent fees would also include any arrangement under which the practitioner reimburses the client for some (or all) of the fee if the return position is challenged by the IRS or is not sustained. A fee arrangement is a guarantee, indemnity agreement, rescission right or any arrangement with a similar effect. TD 9011 states that the IRS and Treasury remain concerned about the use of contingent fees and will request further public comments in an upcoming advance notice of proposed rulemaking. The AICPA Tax Division’s submission to Treasury articulates public policy reasons for allowing contingent fees12 and calls for the adoption of the following amendment to Circular 230: Based on a reasonable expectation of substantive review by the IRS or consideration by the courts, percentage of results fees and success fees are permitted for representation of taxpayers in non-criminal adversarial proceedings, administrative or judicial, and for tax services involving private letter ruling requests, pre-filling agreements, advanced pricing agreements, applications for changes in accounting method (requiring advance approval of the IRS National Office), requests for relief under Treasury Reg. Section 301.9100, and similar submissions.13 CPAs may find it useful to review Federal Trade Commission Order 69814 and the AICPA’s 1991 rule on contingent fees (Rule 302 and Interpretation 302-1) for additional guidance.
Section 10.28—Return of Client’s Records When so requested by their clients, practitioners are required under Section 10.28(a) to promptly return all of a client’s records necessary for the client to comply with his or her Federal tax obligations (the practitioner is expressly permitted to retain copies). Practitioners generally are not relieved of their Section 10.28 responsibilities simply because of a fee dispute. However, if state law permits the practitioner to retain client records in a fee dispute, the practitioner would need return only those records that must be attached to the taxpayer’s return. In this circumstance, the practitioner must provide the client with reasonable access to review and copy any additional records retained under state law and needed to comply with Federal tax obligations. Under Section 10.28(b), client records include all documents or written or electronic materials provided to a practitioner or obtained by the practitioner in the course of client representation that preexisted the client’s retention of the practitioner. Client records also include materials prepared at any time and provided to the practitioner by the client or a third party, if the records are furnished “with respect to the subject matter of the representation.” Schedules, refund claims, returns, appraisals or other documents that practitioners (or their agents) prepare and present “to the client with respect to a prior representation” are client records if necessary for the taxpayer to comply with his or her current Federal tax obligations. However, Section 10.28 expressly excludes these documents from the definition of client records when the practitioner withholds them pending the client’s performance of a contractual obligation to pay fees for the documents. According to TD 9011, Section 10.28 is designed to protect practitioners from being disadvantaged or compromised by clients seeking to obtain an unfair advantage. A practitioner should check with his or her attorney as to state laws on fee disputes in his or her practice jurisdiction(s) or in the client’s domicile. To protect against potential fee disputes, practitioners should document (in an engagement letter) all contractual obligations to be undertaken for the client.
Conclusion To ensure continued compliance with Circular 230, practitioners and their staffs should become familiar with the final regulations (and review the SSTSs). Firms should also review their current policies and procedures, and incorporate any Circular 230 revisions that affect their tax practice. Next month, the second part of this article will examine the final Circular 230 regulations on conflicts of interest, solicitation, sanctions and disciplinary procedures. |
