| Home Online Publications Online Issues TTA Home Table of Contents Proposed Amendments to Circular 230 (Part I) | |
Proposed Amendments to Circular 230 (Part I) Earlier this year, Treasury issued proposed changes to Circular 230, which governs practice before the IRS. The AICPA, American Bar Association, American College of Tax Counsel and New York State Bar Association, among others, submitted comments to Treasury on the proposals. This two-part article examines the proposed revisions and these groups' comments. Susan
L. Willey, J.D. John
C. Gardner, Ph.D., CPA William
P. Cress, 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 and Benson Goldstein in reviewing this article.
Executive Summary
In January 2001, Treasury published proposed amendments1 to Circular 230,2 ranging from contingent fees to corporate tax shelters. Circular 230 governs tax practice before the IRS by enrolled agents and actuaries, attorneys and CPAs (collectively referred to as "practitioners"). Any CPA authorized to represent a taxpayer who has not been suspended or disbarred from practice before the IRS may practice before it. As defined in Section 10.2(e), practice encompasses "all matters connected with a presentation to the Internal Revenue Service or any of its officers or employees relating to a taxpayer's rights, privileges, or liabilities under laws or regulations administered by the Internal Revenue Service." Presentations to the Service include, but are not limited to, corresponding and communicating with the IRS, preparing and filing documents and representing clients at hearings, conferences and meetings. Currently, a practitioner may be privately reprimanded, suspended or disbarred from practice before the IRS. Suspension or disbarment may also produce other consequences, including increased exposure to lawsuits and actions by state boards of accountancy that may result in license revocation.3 Circular 230 was last amended in 1994. The proposed rules incorporate recent legal developments in the areas of advertising and solicitation, tax shelter opinions and other general tax practice matters. After the IRS issued advance notice of proposed rulemaking in July 2000, the AICPA Tax Division created a Circular 230 Task Force to respond to the proposed rules. The Task Force response was approved by the Tax Executive Committee and submitted to Treasury in April 2001.4 Two Task Force representatives testified at the May 2, 2001 Treasury hearing on the proposed rules. Similarly, other professional associations, such as the American Bar Association (ABA) Section of Taxation, the New York State Bar Association (NYSBA) and the American College of Tax Counsel5 (ACTC), submitted comments to the IRS6 and testified at the hearing.7 As proposed, the Circular 230 changes would have a substantial effect on all tax practitioners. Complicated and comprehensive, the proposed regulations impose new standards on tax practitioners, modify the rules that govern disciplinary proceedings and expand the sanctions available to the IRS Director of Practice (DOP). This two-part article analyzes key provisions of the proposed rules and reviews some of the problems highlighted by the AICPA, ABA, ACTC and NYSBA comments. Practitioners should begin familiarizing themselves with the proposed Circular 230 revisions, as well as the concerns raised, to facilitate their compliance with the final regulations ultimately issued.
Proposed Section 10.20—Information to Be Furnished On a lawful and proper request by the Service, proposed Section 10.20(a) requires a practitioner to promptly submit information and records on any matter before the Service. Practitioners who have "reasonable grounds" to believe in "good faith" that the requested information or records are privileged may refuse to submit such information. If neither the client nor the practitioner has custody of the requested data, the requesting officer must be notified of that fact and of "any information that either the practitioner or the practitioner's client has regarding the identity of any person who may have possession or control of the requested records or information." The IRS also proposed revisions to Section 10.20(b). Currently, this section requires practitioners to provide the DOP with information on Circular 230 violations by any person, unless the practitioner has reasonable grounds to believe in good faith either that the information is privileged or that the request itself is of "doubtful legality." On a "proper and lawful request" by the DOP, proposed Section 10.20(b) requires practitioners to provide nonprivileged information of "a violation or possible violation" of Circular 230.
Practitioner Concerns Current Section 10.20(a) requires practitioners to submit nonprivileged information and records to the IRS on a "proper and lawful request." Practitioners can refuse to comply if they believe "in good faith and on reasonable grounds" that the information or records requested are "of doubtful legality." The proposed revision to Section 10.20(a) eliminates "of doubtful legality." Assertion of privilege, however defined, would become the only justification for refusing to provide actual records or information or their location. The AICPA opposes the elimination of the "doubtful legality" language; even if an IRS summons were defective, a practitioner would be obligated to furnish the requested information. Further, the language in proposed Section 10.20(b)—requiring that a practitioner provide information about "possible violations"—"is overly broad and could force practitioners to participate in IRS 'fishing expeditions' for possible violators of Circular 230." For these reasons, the AICPA believes that the "possible violations" language should be eliminated. The NYSBA also regards proposed Section 10.20 as "vague and overbroad" in requiring practitioners to provide "any information," including information that may be in a client's possession, relating to the identity of "any person who may have" information or records requested by the Service. Noting that it may be impossible for practitioners to determine "who may have the requested records," the NYSBA believes the provision may unreasonably burden practitioners who make good-faith efforts to comply, while at the same time inappropriately turning them into "information-gatherer[s] for the Service." Furnishing requested information may also conflict with a client's best interests, particularly in the absence of client consent, as well as professional ethical standards and ABA disciplinary rules on confidentiality and the duty of client loyalty. When voluntary submission of records or information is not in a client's best interest, the NYSBA believes that practitioners should be able to advise clients to refuse such a request "without the practitioner risking discipline sanctions under Circular 230." The ABA believes that current Section 10.20(a) should remain unchanged and that the DOP should not be able to impose sanctions on practitioners who object "in good faith and on reasonable grounds" to an IRS request to produce information. Like the AICPA, the ABA objects to eliminating the exception in current Section 10.20(a) that permits practitioners to refuse IRS requests for information "of doubtful legality." The ABA believes that without this exception, proposed Section 10.20(a) would impose an "absolute obligation" on tax practitioners to submit requested information to an investigating agent, absent a "reasonable basis to assert a privilege," an obligation that not only exceeds a taxpayer's duty under current law to provide the IRS with information or records, but "is contrary to settled law." While the Code guarantees taxpayers the right to challenge the enforceability of a summons in Federal court, the ABA believes that proposed Section 10.20(a) would deny tax practitioners a similar right. The ABA asserts that requiring practitioners to identify others "who may have possession or control" of information or records requested by the Service may conflict, under some circumstances, with a taxpayer's constitutional rights. As amended, proposed Section 10.20(a) also omits an exception for privilege, and may place practitioners in the untenable choice of either remaining silent (thereby misleading the Service) or "providing a lead to potentially incriminatory information, in violation of the client's rights and privileges." Accordingly, the ABA believes that this provision should be deleted from the Circular 230 final regulations. Similarly, because proposed Section 10.20(b) deletes the "of doubtful legality" exception, the ABA believes that current Section 10.20(b) should be retained. Like the AICPA and ABA, the ACTC believes that it is inappropriate to sanction a practitioner who withholds information because he believes the request is "of doubtful legality," particularly because the IRS can initiate a proceeding to enforce a summons; such a proceeding would then determine legality. The ACTC also asserts that current Section 10.20(a)'s requirement that practitioners provide the IRS with nonprivileged information, unless the practitioner believes the request is "of doubtful legality," is broad enough to include the location of requested information not in the practitioner's or client's possession. Thus, this new "affirmative duty" in proposed Section 10.20(a) should be omitted from the Circular 230 final regulations.
Proposed Section 10.21—Knowledge of Client's Omission Current Section 10.21 provides that practitioners must inform clients promptly of any noncompliance by the client with the revenue laws, including errors, omissions and other forms of noncompliance. The proposed change also requires practitioners to advise their clients about "corrective action" that could be taken, as well as the possible consequences of not doing so.
Practitioner Concerns The proposed revision of Section 10.21 parallels, but exceeds, the AICPA's enforceable Statements on Standards for Tax Services8 (SSTS) Nos. 6, Knowledge of Error: Return Preparation, and 7, Knowledge of Error: Administrative Proceedings, which address practitioner knowledge of error in either return preparation or before subsequent administrative proceedings. SSTS No. 6 provides CPAs with additional guidance in cases of fraud or when it may be appropriate to withdraw from representing a client in a continuing professional relationship:
Both the SSTS and Circular 230 specify that a client be apprised of the error and how to correct it. However, the AICPA objects to the proposed phrase "possible consequences of not taking corrective action." The AICPA considers this language too broad, as it suggests that practitioners must disclose to a client all conceivable (albeit remote) consequences if corrective action is not taken. The AICPA recommends "the practitioner be required to advise the client of the 'reasonably likely consequences of which the practitioner is aware.'" (Emphasis added.) The ABA supports the application of proposed Section 10.21 to all erroneous documents submitted under the revenue laws by a client, not just those required to be submitted (as under current Section 10.21). While the ABA also supports the new requirement in proposed Section 10.21 that practitioners advise clients as to the "possible consequences" of not taking corrective action, it recommends that practitioners also be required to inform clients of the possible consequences if corrective action is taken. Finally, the ABA notes that it may be more appropriate for inexperienced practitioners (or those whose interests may conflict with a client's) to advise the client to consult with a disinterested, competent practitioner as to the possible consequences of taking or not taking corrective action. Thus, it recommends that the Service incorporate such a provision into the final regulations. In its official comments, the ACTC endorses this ABA recommendation. The NYSBA agrees with the ABA that inexperienced practitioners, after detecting an error, may lack the competence to advise their clients how to correct it and the possible consequences for not doing so. The NYSBA report suggests, however, that because "the law governing the consequences of inadvertent errors...is particularly unclear," even experienced practitioners may have to conduct considerable research to identify the possible consequences of failing to take corrective action. While it recommends that Circular 230 require practitioners only to notify their clients that an error has been discovered, the NYSBA "would not object" if proposed Section 10.21 also required them to advise clients to seek advice on corrective action to "minimize any potential negative consequences."
Proposed Section 10.22—Due Diligence as to Accuracy: Reliance on Others Under proposed Section 10.22(b), the IRS presumes due diligence "if the practitioner relies on the work product of another person and the practitioner used reasonable care in engaging, supervising, training, and evaluating the person, taking proper account of the nature of the relationship between the practitioner and the person," except in tax shelter situations (Sections 10.33 and 10.35) and return position standards (Section 10.34).
Practitioner Concerns Although proposed Section 10.22(b) appears to encompass "work products that are produced within and without a practitioner's firm," the AICPA recommends that this be clarified in the final regulations. With this clarification, the AICPA supports proposed Section 10.22(b) as consistent with the SSTS. Like the AICPA, the ABA supports the addition of Section 10.22(b), which it believes clarifies the meaning of "due diligence" when practitioners rely on the work products of others. It suggests, however, that proposed Section 10.22 should be cross-referenced to proposed Section 10.34 to "clarify the meaning of due diligence when a practitioner relies on information provided by a client."
Proposed Section 10.24—Assistance from or to Disbarred or Suspended Persons and Former Internal Revenue Service Employees Proposed Section 10.24 prohibits a practitioner from accepting assistance from or assisting a person suspended or disbarred from practice before the Service "if the assistance relates to a matter or matters constituting practice before the Service." Practitioners would also not be able to accept assistance from former government employees who violated proposed Section 10.25 or Federal law. According to the IRS explanation accompanying proposed Section 10.24, however, this change "would not require practitioners to disassociate themselves from a suspended or disbarred person as long as the other proscriptions regarding disbarred or suspended persons are observed." Nor would CPA firms be required to "expel" a practitioner simply because he shared in fees "derived from services rendered by others before the Internal Revenue Service."
Practitioner Concerns All four organizations support these changes to Section 10.24.
Proposed Section 10.25—Practice by Former Government Employees and Their Partners and Their Associates Proposed Section 10.25 updates current Section 10.26 "to reflect changes to the Federal statutes governing post-employment restrictions applicable to former government employees." As proposed, Section 10.25(b) would prohibit any former government official (as defined in the regulations) from representing "anyone in any matter administered by the Internal Revenue Service if the representation would violate 18 U.S.C. 207 or any other laws of the United States." Former government officials who participate in such a transaction can neither represent nor knowingly assist a current or previous party to it. Proposed Section 10.25(a)(8) defines "transaction" as "any decision, determination, finding, letter ruling, technical advice, Chief Counsel advice, or contract or the approval or disapproval thereof, relating to a particular factual situation or situations involving a specific party or parties" and also imposes specific time limits for transactions subject to the provision.
Practitioner Concerns The AICPA recommends that proposed Section 10.25 be "crafted more narrowly," because the proposed wording is "much stricter" than its statutory equivalent in 18 USC Section 207 and, read literally, could subject "all relatively high level IRS employees" who subsequently join firms to sanctions (even when the government is not prejudiced). According to the AICPA, "[b]anning participation by a former government employee in a tainted transaction, when the former employee does not know (and reasonably should not have known) that the transaction was under his or her official responsibility, is an excessive restriction that does not serve the purposes of the post-employment conflict rules...." Additionally, the AICPA provides an example of the problems inherent in proposed Section 10.25 and suggests language revisions.
Proposed Section 10.27—Fees Proposed Section 10.27(b) expands current Section 10.28's ban on charging a contingent fee for preparing an original return to include "any advice rendered in connection with a position taken or to be taken on an original tax return." In contrast, practitioners may charge contingent fees to prepare amended returns or refund claims (other than on an original return), as well as for advice on a return position on an amended return or refund claim (other than on an original return). At the time fees are arranged, the practitioner must reasonably anticipate that "the amended tax return or refund claim will receive a substantive review" by the Service. Under proposed Section 10.27(b), contingent fees are broadly defined to include any fee based, even partially, on whether a position taken on a return or in a refund claim is sustained by litigation or the IRS. Fees also include a guarantee, insurance, rescission right, indemnity agreement or other arrangements "under which the taxpayer or other person would be entitled to be compensated or reimbursed by the practitioner in the event a position taken on a tax return or in a refund claim is not sustained, or any other arrangement that has a similar effect."
Practitioner Concerns The AICPA supports bans on charging contingent fees on a return position "if there is no reasonable expectation that there will be a substantive review of that position by the IRS." When a return position has been substantively reviewed by the Service before return filing, however, "it should make no difference" whether the position is on an original return, refund claim or amended return. Thus, the AICPA recommends that practitioners be allowed to charge a contingent fee for advice on positions taken on any return when, prior to filing, IRS substantive review can be "reasonably anticipated." Under the AICPA's substantive-review proposal, contingent fees would be permitted when the taxpayer has received approval from the Service before return filing (e.g., a pre-filing agreement, letter ruling, application for accounting-method change, advanced pricing agreement or relief request under Regs. Sec. 301.9100). AICPA members are also bound by Code of Professional Conduct (CPC) Rule 302, Contingent Fees, and Interpretation 302-1, Contingent fees in tax matters. These rules restrict contingent fees that incorporate "the expectation of substantive review standard," and identify several instances in which contingent fees would or would not be permissible. The AICPA contends that the Section 10.27(b) proposed language needs to be clarified to permit contingent fees when practitioners represent taxpayers in IRS examinations of original returns. Further, the AICPA argues that:
Thus, this approach supports the Federal Trade Commission's (FTC's) view that broad prohibitions on contingent fees might violate the FTC Act and "reasonably undercut consumer choice." To rectify these problems, the AICPA recommends alternate language:
The NYSBA disagrees that practitioners have to reasonably anticipate that the IRS will substantively review an amended return or refund claim before being able to charge a contingent fee. Thus, it recommends that proposed Section 10.27(b) be revised to permit contingent fees on any amended return or refund claim.9 The NYSBA would add an "anti-abuse" provision to Section 10.27 to prevent practitioners from using amended returns, audits or the assertion of a deficiency to circumvent the ban on contingency fees for preparing original returns.
Proposed Section 10.28—Return of Client's Records This new section would require a practitioner to promptly return all records to a client on request, although the practitioner may retain copies of any records returned. Further, a dispute between practitioner and client over fees would not justify refusing to return client records.
Practitioner Concerns The AICPA views this new provision as "vague and open-ended," in contrast to CPC Interpretation 501-1, Acts Discreditable—Retention of Client Records. Noting that proposed Section 10.28 does not define "client's records," the AICPA recommends that the IRS add a definition based on Interpretation 501-1 that includes "any tax, accounting or other records belonging to the client that were provided to the practitioner by or on behalf of the client." Proposed Section 10.28, like Interpretation 501-1, should also provide that a practitioner's workpapers are the practitioner's property, not client records, and need not be made available to a client, except for information necessary to make the client's records complete. Further, a practitioner should need to provide requested records to a client only once, and only if they already exist in the requested medium (e.g., electronic format). Most importantly, the AICPA disagrees with the proposed limit that bars practitioners from retaining client records if there is a fee dispute. Under Interpretation 501-1, unlike proposed Section 10.28, requested records do not have to be returned until the client has paid all fees owed the practitioner. Absent a clear definition of "client records" that excludes workpapers, proposed Section 10.28 would permit a client to hire a practitioner to prepare workpapers, refuse to make pay, then demand the return of the records furnished and the prepared workpapers, all "free of charge." The ABA believes that proposed Section 10.28 should be deleted from Circular 230; requiring practitioners to return all client records, even if there is a fee dispute, "may conflict with ethical and common law rules that vary from state to state."10 If this provision is included, the ABA recommends that practitioners be obligated to return only "tax-related records," not the overly broad "any and all records of the client" (which might include client records on nontax matters). Further, because the ABA believes that a client's tax return is "created by, and reflects the work of" the preparer, it suggests that proposed Section 10.28 should clearly indicate that a tax return is not a client record. Thus, in the event of a dispute, a practitioner would be required to return only client records on which a return is based, not the return itself.
Proposed Section 10.29—Conflicting Interests While current Section 10.29 prohibits a practitioner from representing conflicting interests before the IRS unless the parties consent after full disclosure, proposed Section 10.29(a) extends this ban to "potential conflicting interests" before the IRS unless the practitioner reasonably believes that none of the represented parties will be adversely affected, fully discloses the potential conflict to all represented parties and obtains their written consent. Proposed Section 10.29(b) requires a practitioner to retain copies of the written consents for 36 months and provide them to any IRS employee on request. Proposed Section 10.29(c) prevents a practitioner from representing a party before the IRS if the party's interests would be materially limited by the practitioner's own interests. An exception applies if the practitioner believes that the client would not be adversely affected and the client consents after being informed of the potential conflict and associated risks.
Practitioner Concerns All four professional groups expressed concern about the proposed changes to Section 10.29. The AICPA believes that the addition of "potential" to "conflicting interests" in Section 10.29(a) creates a vague standard for determining when a practitioner is required to take action. For example, when a practitioner provides advice on partnership return elections that will affect the partners' tax reporting, a "potential" conflict-of-interests exists that would require full disclosure and written consent under the proposed rule. The AICPA believes that consent should not be required until conflicting interests actually exist; further, whether a client's consent needs to be in writing is for the practitioner and client to decide. Additionally, the AICPA contends that providing such documents to the IRS could not only violate professional ethical standards of confidentiality, but also Sec. 7216 restrictions on disclosure of return information. Accordingly, the AICPA calls for proposed Section 10.29(a)(2) and (b) to be withdrawn. The AICPA also argues that "the condition proscribed" by proposed Section 10.29(c), "in which a practitioner's 'representation of the party may be materially limited by the practitioner's own interests,' is a condition that actually can be created by an IRS official's assertion or threatened assertion of Circular 230 sanctions or other penalties against the practitioner." Accordingly, the AICPA believes that Circular 230 should not contain provisions that "could transform assertions of Circular 230 sanctions or other penalties into mandates that may disrupt a taxpayer's existing representation" or that "unduly undermine confidence in a practitioner's representation of a taxpayer." Thus, the AICPA recommends that proposed Section 10.29(c) be withdrawn or, if adopted, limited to "situations in which a practitioner is manifestly taking positions or representing a taxpayer in a manner that is contrary to the taxpayer's best interests." The ABA "applauds the substance of Section 10.29," with two exceptions. First, it recommends that proposed Section 10.29(a)(2) and (c) be amended to permit oral (and written) waivers of a potential conflict-of-interest. Because ABA Model Rule of Professional Conduct (ABA Model Rule) 1.7(a) does not require written waivers in such situations, the ABA is concerned that there may be "a substantial degree of inadvertent non-compliance" with the written consent requirement in proposed Section 10.29(a)(2), which "only appears to apply to potential conflicts of interest between multiple parties who are represented by the practitioner." In contrast, proposed Section 10.29(c) refers only to "client consents" when the potential conflict is between the client's and practitioner's interests. The ABA recommends that this consent may be verbal or written. Second, the ABA is concerned that "potential conflict-of-interest" is undefined in proposed Section 10.29(a) and may be "substantially more inclusive" than "conflicting interests" as used in both current Section 10.29 and the preamble to the Circular 230 proposed amendments. The ABA recommends that the term either be changed to "conflicting interests" or be explicitly limited "to situations in which the objectives of the practitioner's representation of one party before the Internal Revenue Service would be directly adverse to the interests of the other party." The ABA believes that a "directly adverse" standard is appropriate for determining when conflicts-of-interest are "significant enough" to require a waiver, which would also parallel ABA Model Rule 1.7(a). Because proposed Section 10.79(c) includes an example of censure based on conflicts-of-interest, the ACTC anticipates that the Service may be contemplating a "substantial initiative" in this area. Like the ABA, moreover, the ACTC believes that the final Section 10.29 regulation should not require conflict-of-interest waivers to be in writing, consistent with ABA Model Rule 1.7(a). Requiring written waivers would impose an "unreasonable burden" on practitioner-client relationships not currently present. Like the AICPA, the ACTC also objects to extending Section 10.29's waiver requirement to "potential" conflicts-of-interest, because it is uncertain when the requirement would apply. The NYSBA believes that proposed Section 10.29 should limit a "potential conflict" to situations in which a practitioner knows (or has reason to know) that the parties' economic interests either currently diverge or are "more likely than not" to diverge in the near future. In addition, the NYSBA recommends that the Service provide additional guidance regarding conflicts between two clients—specifically, how such conflicts should be disclosed, as well as the form and content of waivers. Finally, the NYSBA provides two examples to illustrate when a practitioner's own interests may limit client representation and advocates their inclusion in the final Section 10.29 regulation.
Proposed Section 10.30—Solicitation The proposed revisions to Section 10.30 streamline the restrictions on practitioner advertising and solicitation of employment to bring Circular 230 into compliance with court decisions11 and comments received. As revised, Section 10.30(a)(1) extends the existing ban on "false, fraudulent, or coercive statement[s] or claim[s]" and "misleading or deceptive statement[s] or claim[s]" in public communication to include private solicitations, while notably removing the broader restrictions against "unfair" and "unduly influencing" statements or claims. In addition, by providing examples of unacceptable descriptions that could mislead the public, including the use of the term "licensed," proposed Section 10.30(a)(1) also expands and clarifies the ways enrolled agents may describe their professional designation. Current Section 10.30(a)(2), while prohibiting "uninvited solicitations" that result from personal contact or phone communications, explicitly exempts five activities from this restriction, including mailed solicitations and those seeking new business from existing clients. Proposed Section 10.30(a)(2) replaces this list; it makes clear that any uninvited oral or written solicitation that violates Federal or state law or "applicable rule" (such as state bar rules) is prohibited. While practitioners still must clearly identify lawful solicitations as such (as well as the information source used to target recipients of direct-mail solicitations), practitioners are no longer required to mark solicitations in capital letters on either the envelope or first page of the mailing. The IRS is not proposing any substantive change to Section 10.30(b), which authorizes practitioners to publish and disseminate fee information. Proposed Section 10.30(c), however, expands the permissible means of communicating fee information to include e-mail, facsimiles and hand-delivered circulars, as well as the previously recognized methods of communication: "professional lists, telephone directories, print media, mailings...radio, television, and any other method" that does not render the communication of fee information false or deceptive. In addition to retaining a list of recipients of direct and e-mail solicitations, practitioners must retain copies of the actual written, electronic and broadcast solicitations for at least three years after they were last used. Unlike prior Section 10.30(c), however, the proposed revisions do not require practitioners to prerecord broadcast solicitations. The proposed revisions to Section 10.30(d) simplify the language that restricts practitioners from associating with individuals or entities that improperly publish or disseminate fee information or solicit employment in IRS matters.
Practitioner Concerns The AICPA recommends that proposed Section 10.30 be limited to Section 10.30(a)(1), which both prohibits false or misleading communications in practitioner solicitations and identifies permissible professional designations for enrolled agents. Proposed Section 10.30(a)(1) prohibits deceptive practices in both "public communications" and "private solicitations." The ABA questions whether the IRS intends to create a distinction between communications and solicitations and, if not, suggests that the proposed regulation refer simply to "public or private communication." If the IRS intends such a distinction, the ABA suggests that the rule be clarified. Proposed Section 10.30(a)(1) also prohibits enrolled agents from describing themselves as "licensed." Because the ABA believes that the process to become an enrolled agent is analogous to a licensing procedure, it objects to this ban. Because proposed Section 10.30(a)(2) essentially bars solicitation that violates existing law or professional ethics rules, the AICPA regards it as redundant and recommends that it be deleted from the final regulation. Because the FTC, AICPA and ABA can handle solicitation and advertising concerns that arise in IRS matters,12 additional provisions in Circular 230 are unnecessary. Accordingly, the AICPA recommends that Sections 10.30(b), (c) and (d) be eliminated from the final version of Circular 230. Proposed Section 10.30(c) regulates practitioner communication of fee information and lists permissible communication methods. The AICPA believes that attempts by Circular 230 to regulate the publication and dissemination of fee schedules and professional fees of tax practitioners could lead to "market distortions." It also questions the wisdom of permitting the dissemination of only the four types of fees listed in Section 10.30(b)(1)(i), as well as the ban on charging a higher fee within 30 days of the last publication of the practitioner's fee schedule. The AICPA also regards the ban on false and deceptive communications in Section 10.30(c) as duplicative of Section 10.30(a) and, hence, unnecessary. In addition, it considers the requirement that practitioners retain copies of all direct mail and e-mail solicitations for three years, along with a list or description of recipients, to be overbroad and burdensome. Unlike the AICPA, which believes that the entire subsection should be deleted from the final version of Circular 230, the ABA would not only retain proposed Section 10.30(c), but would also expand the list of acceptable communication methods (as well as the manner in which communications could be retained) to include communications "in any available medium" (including those not yet developed). Proposed Section 10.30(d) attempts to ban practitioners from associating with individuals or entities that they know have violated Section 10.30, even nonpractitioners not subject to Circular 230. As worded, this provision would restrict practitioners from associating with nonpractitioners not required to identify solicitations as such or who could permissibly charge higher fees within 30 days of publishing a fee schedule. Because Section 10.30(a) already prohibits practitioners from using (or participating in the use of) false, deceptive or coercive claims in either public communications or private solicitations, the AICPA regards proposed Section 10.30(d) as unnecessary.
Proposed Sections 10.33 and 10.35—Tax Shelter Opinions Current Section 10.33 was added to Circular 230 in 1982 to regulate corporate tax shelter opinions and offering materials. The passive-loss rules subsequently adopted in the Tax Reform Act of 1986 drastically reduced the marketing of shelters to individuals, but resulted in more tax practitioners promoting and drafting shelter opinions. Of the numerous legislative attempts to limit shelters, two bear directly on Treasury's proposed shelter-opinion regulations in proposed new Section 10.35.13 In 1994, Congress amended Sec. 6662, automatically subjecting corporate taxpayers to the substantial-underpayment penalty unless the taxpayer acted with "reasonable cause" and "in good faith" as provided in Regs. Sec. 1.6664-4. Reliance on a shelter opinion may demonstrate the requisite reasonable cause and good faith. The Taxpayer Relief Act of 1997 revised the definition of a tax shelter in Sec. 6662(d)(2)(C)(iii). Previously, tax avoidance had to be a "principal" purpose of a shelter; after the 1997 changes, however, tax avoidance or evasion must only be a "significant purpose." The term "tax shelter" includes "a partnership or other entity, any investment plan or arrangement, or any other plan or arrangement, if a significant purpose of such partnership, entity, plan, or arrangement is the avoidance or evasion of Federal income tax." Treasury explicitly incorporated the Sec. 6662(d)(2)(C)(iii) definition into proposed Sections 10.33(c)(2) and 10.35(c)(2), which represents a major substantive change in the application of Circular 230 to shelter opinions.
Definition of "Tax Shelter Opinion" One objective of the proposed changes to Circular 230 is to regulate opinions on corporate tax shelters. Current Section 10.33(c)(3) defines a tax shelter opinion as "advice by a practitioner concerning the Federal tax aspects of a tax shelter either appearing or referred to in the offering materials, or used or referred to in connection with sales promotion efforts, and directed at persons other than the client who engaged the practitioner, to give the advice." Section 10.33 does not apply to a shelter opinion offered directly to a corporate client-participant by a practitioner. Proposed Section 10.35(c)(4) defines a tax shelter opinion as "written advice by a practitioner concerning the Federal tax aspect of a tax shelter item or items."14 This new definition would encompass both corporate tax shelter opinions and opinions used to promote shelters to third parties. The Circular 230 proposal splits the guidelines for shelter opinions into two parts. According to proposed Section 10.35(a), new Section 10.35 would govern all shelter opinions that conclude "that the Federal tax treatment of a tax shelter item or items is more likely than not (or at a higher level of confidence) the proper treatment," regardless of whether they were provided directly to a potential investor or used in conjunction with third-party promotional efforts. Proposed Section 10.33 would strictly govern a shelter opinion that (as defined in proposed Section 10.33(c)(4)) does not conclude that the Federal tax treatment of a tax shelter item or items is more likely than not the proper treatment, but that "a practitioner knows or has reason to believe will be used...in promoting...the tax shelter to one or more taxpayers..." Proposed Section 10.33 may not be relevant to corporate tax shelter opinions, because a "more likely than not" conclusion must be reached before a corporate client potentially can rely on the opinion to avoid the substantial-understatement penalty. In fact, proposed Section 10.33(a)(5)(iii)(B) requires clear and prominent disclosure on the first page of the opinion that it was not written to establish that a corporate taxpayer had acted with reasonable cause and in good faith as to a shelter item. Similarly, proposed Section 10.33(a)(5)(iii)(A) attempts to protect third-party individual investors, by requiring clear and prominent disclosure on the first page of the opinion that the opinion was not written to establish "that a taxpayer other than a corporation reasonably believed at the time a tax return was filed that the tax treatment of a tax shelter item was more likely than not the proper treatment of that item...." It is difficult to envision the circumstances under which a practitioner would issue a shelter opinion under proposed Section 10.33.
Practitioner Concerns Section 10.35 was added to provide due-diligence standards for shelter opinions to be used for penalty-abatement purposes. Accordingly, practitioners should be subject to these standards only if they know or should know that the opinion will be used for such purposes. Thus, the AICPA recommends that the due-diligence standards in Section 10.35 should not apply to a shelter opinion if the opinion expressly states that it is not to be relied on for penalty-abatement purposes. This exception would cover situations in which a taxpayer desires an opinion but is unwilling to bear the cost of the due diligence required by Circular 230 for penalty-abatement purposes. The phrase "Federal tax treatment" is used throughout proposed Sections 10.33 and 10.35, yet those standards apply only to opinions regarding Federal income tax treatment of tax shelters. Thus, the AICPA recommends that this phrase be replaced by "Federal income tax treatment" whenever the phrase is used. If tax consequences other than income tax are intended, the IRS needs to clarify that in proposed revisions to Circular 230.
Definition of "Tax Shelter" The proposed revision of the tax shelter definition is important in two respects. First, it replaces the current definition of a tax shelter with the controversial definition in Section 6662(d)(2)(C)(iii) that applies to the substantial-underpayment penalty.15 Under that definition, a shelter means "a partnership or other entity, any investment plan or arrangement, or any other plan or arrangement, if a significant purpose of such partnership, entity, plan, or arrangement is the avoidance or evasion of Federal income tax." Second, while the current Section 10.33(c)(2) definition specifically excludes nine transactions from the requirements for tax shelter opinions, Treasury's proposal retains only two: municipal bonds and qualified retirement plans. Treasury and the IRS did request comments, however, on other types of transactions that should be exempted.
Practitioner Concerns The AICPA opposes a standard of conduct
based on the definition The definition of tax shelter in proposed Sections 10.33(c)(2) and 10.35(c)(2) is accompanied by a list of transactions specifically excluded. The AICPA does not regard the exclusion of specific transactions sufficient to compensate for a vague and overbroad definition. Although the IRS proposal requests additional comments as to whether other transactions should be exempt from the definition of a tax shelter opinion, it provides no criteria to be used in making such recommendations. In addition, the IRS did not explain why seven of the nine transactions exempted from the current tax shelter definition are not excluded in the proposed revision to Section 10.33 and new Section 10.35.17 The AICPA believes that "the standard for designating transactions as tax shelters for purposes of Sections 10.33 and 10.35 should be determined by reference to 'the principal purpose' definition prescribed under the predecessor to section 6662(d)(2)(C)(iii)." It further states that such a narrower, ascertainable standard would focus enforcement on clear violations and minimize inappropriate use. If the "significant purpose" definition is retained, then in lieu of a long list of excluded transactions, the AICPA suggests that three categories of transactions should not, under any circumstances, be considered a shelter under proposed Sections 10.33 and 10.35 entered into for the purpose of tax evasion: 1. Transactions germane to the taxpayer's business. 2. Transactions expected to produce a reasonable economic return consistent with the taxpayer's investment and risk (taking into account all costs, including professional fees). 3. Transactions reasonably consistent with the purpose and intent of the tax law that the practitioner believes applies to the transaction.18 The ABA believes that the definition of a tax shelter in proposed Section 10.35(c)(2) should apply only to transactions in which a client's "principal purpose" is to avoid or evade Federal income tax, not merely a "significant purpose." If the proposed definitions of tax shelter and tax shelter opinion in proposed Section 10.35(c)(4) are adopted in new Section 10.35, the list of routine business transactions subject to this rule would be "virtually endless," necessitating a lengthy list of excluded transactions. Consequently, the ABA views the proposed "significant purpose" definition of tax shelter as "inappropriately broad" and suggests that the "principal purpose" definition be adopted instead. If the definition of tax shelter were appropriately limited, the proposed definition of tax shelter opinion would be acceptable. Conversely, if the tax shelter definition is not limited, the ABA recommends that the definition of tax shelter opinion be limited to opinions used for marketing shelters or for penalty-abatement purposes. After indicating general agreement with the ABA's comments, the ACTC expressed grave concerns with the "proliferation" of "artificially contrived tax-reduction schemes" it believes "demeans the entire tax practitioner community." The ACTC also emphasized the need for clear and even "stringent" rules articulating due diligence and ethical principles to govern "responsible tax professionals" when the "business purpose" of a transaction is "secondary to the tax plan." Acknowledging that imposing "special duties" on tax professionals to examine the facts may increase "the cost of the tax opinion in 'borderline' transactions," the ACTC concludes that this would not be "too high a price to pay to bring ethical sanity back to the [legal] profession in its pivotal role of applying the tax rules to complex transactions." The NYSBA believes that Circular 230 should explicitly articulate proposed Sections 10.33's and 10.35's goals. In addition, the IRS should provide more examples for both sections, clarify the effective date and require shelter opinions under either section to "briefly describe the tax shelter disclosure and list-keeping requirements under the Code Section 6011, 6111, and 6112 regulations and to discuss whether those requirements apply to the transaction[.]"19
Proposed Section 10.35—More Likely Than Not Tax Shelter Opinions: Expanded Due Diligence on Factual Matters Under both current law and proposed Section 10.35, practitioners who provide shelter opinions are required to inquire as to all relevant facts. In the opinion, the practitioner must relate the applicable law to these facts, analyze and evaluate all material Federal tax issues and reach an overall conclusion. While these general requirements have not changed from current Section 10.33, extensive changes in the language and detail of proposed Section 10.35 will create greater practitioner responsibility for due diligence on factual matters and representations, as well as provide greater specificity as to the opinion's contents.
Factual Matters Proposed Section 10.35(a)(1) re-quires that a practitioner be satisfied that the "material facts" are accurately and completely described in both the opinion and any related promotional materials. While "material facts" is not explicitly defined, parenthetical explanations in Sections 10.35(a)(1)(i) and (ii) suggest that material facts include "factual assumptions and representations" and "assumptions as to future events." Essentially, any factual assumption that a practitioner makes about a shelter transaction will be a "material fact." Proposed Section 10.35(a)(1)(ii) further provides that tax shelter opinions "must not be based, directly or indirectly, on any unreasonable factual assumptions (including assumptions as to future events)." It then provides several examples of unreasonable factual assumptions, including those that a practitioner either knows or has "reason to believe" are "incorrect, incomplete, inconsistent...or implausible in any material respect." Also unreasonable are factual assumptions "regarding a fact or facts that the practitioner could reasonably request to be provided or to be represented." Finally, unreasonable factual assumptions include, under proposed Section 10.35(a)(1)(iii)(C), a factual assumption that a transaction has a "business reason," that a transaction is "potentially profitable apart from tax benefits" or with respect to a material valuation issue. In effect, a practitioner must identify all material and relevant assumptions based on both currently known facts and future events, then justify that the factual assumptions are not unreasonable. Thus, for example, an opinion, based even indirectly on the inherently "unreasonable" assumption that the transaction has a business reason apart from its tax benefits (unless "adequate factual support" accompanies the opinion), would not help a client avoid a Sec. 6662 substantial-understatement penalty. Under proposed Section 10.35, moreover, a practitioner must not just ensure that all relevant facts are reasonable, but there must be no inconsistency within the body of facts (including factual assumptions). As under current Section 10.33, proposed Section 10.35(a)(1)(iii) allows a practitioner to rely on factual representations of the taxpayer and other persons (e.g., an appraiser), when it would be reasonable to do so. Specifically, a practitioner can rely on "representations describing the specific business reasons for the transaction, the potential profitability of the transaction apart from tax benefits, or a valuation prepared by an independent third party." However, the practitioner must determine whether the person making the representation is knowledgeable and the appropriate person. Although practitioners are not required to perform an independent verification of a factual representation, they still have the unstated responsibility to review it. Under current Section 10.33(a)(1)(ii), practitioners are prohibited from relying on a representation if they have "reason to believe that any relevant facts" asserted by others are "untrue." Under proposed Section 10.35(a)(1)(iii), practitioners are prohibited from relying on a representation if they know or have reason to believe, based on their own background and knowledge, that "the relevant information is, or otherwise appears to be, unreasonable, incorrect, incomplete, inconsistent...or implausible in any material respect." For example, a factual representation that there are business reasons for a transaction, without providing those reasons, is incomplete (and, thus, unreasonable).
Proposed Section 10.35—More Likely than Not Tax Shelter Opinions: The Opinion Unlike current Section 10.33 on tax shelter opinions, proposed Section 10.35 expressly states what is to be included in an opinion. For example, while current Section 10.33(a)(2) states that practitioners must relate the law to the actual facts, the analysis is not required to be included in the opinion. In contrast, proposed Section 10.35(a)(2) states that the opinion must relate the applicable law to the relevant facts, then specifies the inclusion of certain information items (discussed below) not previously required.
Relate Law to Facts Under proposed Section 10.35(a)(2), practitioners must "relate the applicable law" to the clearly identified facts on which the opinion's conclusions are based. In addition, the opinion must include "a reasoned analysis" of both the pertinent facts and the "legal authorities" that support any conclusions expressed in the opinion. Proposed Section 10.35(a)(2)(iv) further cautions practitioners that opinions "must not contain legal analysis or conclusions with respect to Federal tax issues that are inconsistent with each other." Thus, practitioners who provide opinions with such inconsistencies could be subject to sanctions for noncompliance.
Analysis of Material Federal Tax Issues Like its predecessor, Section 10.33(a)(3), proposed Section 10.35(a)(3) requires practitioners to ensure that all material Federal tax issues have been considered and that any issues that have a "reasonable possibility" of being challenged by the Service are "fully and fairly addressed." This provision also requires that an opinion include a statement that "the practitioner has considered the possible application to the facts of all potentially relevant judicial doctrines, including the step transaction, business purpose, economic substance, substance over form, and sham transaction doctrines, as well as potentially relevant statutory and regulatory anti-abuse rules." In analyzing relevant legal authorities, this section further requires that practitioners consider "the taxpayer's non-tax and tax purposes (and the relative weight of such purposes) for entering into a transaction and for structuring a transaction in a particular manner."
Practitioner Concerns Requiring practitioners to state that they have considered the "possible application" of "potentially relevant" judicial doctrines, statutes and anti-abuse authorities achieves no useful purpose and holds practitioners to the highest possible compliance standards. The AICPA believes that sanctions should be imposed only when a practitioner does not meet ascertainable minimum standards. If the IRS retains the standard in proposed Section 10.35(a)(3), it should require practitioners to consider only anti-abuse rules "clearly relevant," rather than "potentially relevant." In addition, requiring practitioners to analyze the applicability of anti-abuse doctrines and rules duplicates the factual and legal analysis requirement in proposed Section 10.35(a)(2)(iii). Finally, the AICPA contends that the more stringent analysis required by proposed Section 10.35(a)(3) "would extend beyond standards currently prescribed by anti-abuse authorities, by requiring evaluations of the relative weight of non-tax and tax purposes for the transaction."
Evaluation of Material Federal Tax Issues In regulating all shelter opinions, current Section 10.33(a)(4) allows two possible outcomes. When possible, a practitioner is required to provide an opinion as to whether it is more likely than not that an investor will prevail with respect to each material Federal tax issue that faces a reasonable possibility of IRS challenge. When the practitioner is unable to furnish such an opinion, the opinion provided must state that fact and explain why. Proposed Section 10.35(a) addresses only one subset of shelter opinions, i.e., those concluding "that the Federal tax treatment of a tax shelter item or items is more likely than not...the proper treatment." In contrast to the current standard, proposed Section 10.35(a)(4)(i) requires a practitioner to reach a conclusion on each material Federal tax issue; the inability to provide an opinion on an issue is unacceptable.
"Overall Conclusion" Under current Section 10.33(a)(5), when possible, a practitioner must provide an overall conclusion as to "whether the material tax benefits in the aggregate more likely than not will be realized." A favorable overall conclusion is warranted if "substantially more than half of the material tax benefits...more likely than not will be realized if challenged by the Internal Revenue Service." Proposed Section 10.35(a)(4)(ii) changes the criterion for issuance of a "more likely than not" opinion. The opinion must "unambiguously conclude" that the Federal tax treatment of a shelter item or items is more likely than not (or at a higher level of confidence) the proper tax treatment. Further, a "favorable overall conclusion may not be based solely on the conclusion that the taxpayer more likely than not will prevail on the merits of each material Federal tax issue."
Practitioner Concerns If a favorable overall conclusion may not be based solely on the conclusion that a taxpayer is more likely than not to prevail on the merits of each material Federal tax issue, the AICPA believes that proposed Section 10.35(a)(4)(ii) should identify other factors that should be taken into account.
Description of Opinion As proposed in Section 10.35(a)(5), a practitioner must take reasonable steps to ensure that the nature and extent of the opinion is correctly reflected or referred to in any written materials or in any other efforts to promote the tax shelter. This reflects no substantive change from the current standard.
Reliance on Opinion of Others Current Section 10.33(b)(1) permits a practitioner to rely on the opinion of another "competent practitioner" with respect to material tax issues and provide a shelter opinion on less than all such issues, if the following conditions are met. First, the other practitioner must provide an opinion that both assesses all material tax issues that have a reasonable possibility of IRS challenge and evaluates "whether the material tax benefits in the aggregate more likely than not will be realized." After reviewing the other practitioner's opinion and any promotional materials for the tax shelter, the practitioner must have "no reason to believe" that the opinion and offering materials do not comply with Section 10.33(a). In contrast, proposed Section 10.35(b)(1) specifies that practitioners who provide shelter opinions must be "knowledgeable in all of the aspects of Federal tax law relevant to the opinion being rendered." Practitioners lacking such knowledge may rely on the opinions of other practitioners who are not merely competent, but are "sufficiently knowledgeable regarding such issues" and the practitioner has no reason to believe their opinions would not meet Section 10.35. According to proposed Section 10.35(b)(2), a practitioner's opinion must also identify any other practitioner on whom he is relying, state the conclusions reached in the other practitioner's opinion and indicate its date. Additionally, the practitioner must be satisfied that the combined analysis satisfies Section 10.35.
Financial Forecasts and Projections Consistent with current Section 10.33(b)(2), under proposed Section 10.35(b)(4), a shelter opinion exists even in the absence of a separate opinion letter and regardless of whether the practitioner's name is referred to in promotional materials. The IRS deems a financial forecast or projection a shelter opinion under proposed Section 10.35(c)(4) if it includes written advice concerning the Federal tax aspects of a shelter item and "is predicated on assumptions regarding Federal tax aspects of the investment."
Conclusion The second part of this article, in the December 2001 issue, will address proposed Circular 230 Section 10.36 (procedures to ensure compliance) and proposed Subparts C, D and E, addressing sanctions, disciplinary proceedings and general provisions. |
