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Prop. Regs Would Withdraw Onerous Covered Opinion Rules and Modify Disclaimer Rules
in Circular 230
(Parker's Federal Tax Bulletin: September 27, 2012)

Under the rules in Circular 230, which govern tax practice before the IRS, tax practitioners must meet minimum standards of conduct with respect to written tax advice, and those who do not are subject to disciplinary action, including suspension or disbarment.

Sections 10.35 and 10.37 of Circular 230 contain comprehensive rules for written tax advice. Practitioners have been complaining about the detailed rules in Section 10.35 on covered opinions since they were issued in 2004. According to practitioners, the rules are overly broad, difficult to apply, and do not necessarily produce higher quality tax advice. Practitioners have also complained that the rules unduly interfere with their client relationships and are not an ethical standard that everyone, including clients, can easily understand. Some practitioners have also opined that these rules (1) may reduce, rather than enhance, tax compliance due to the perception that a covered opinion takes more time to produce and is more expensive for the client than other tax advice; and (2) increase the likelihood that practitioners will provide oral advice to their clients when written advice is more appropriate because the covered opinion rules do not govern oral advice.

Another concern the IRS said it has been hearing from practitioners is about the unrestrained use of disclaimers on nearly every practitioner communication, regardless of whether the communication contains tax advice. Practitioners have said this practice discourages compliance with the ethical requirements because some practitioners have concluded that, if they include a disclaimer, they are free to disregard the standards in Circular 230 regarding written tax advice. The disclaimers also lead to confusion for clients because clients often do not understand why the disclaimer is present and its consequences. In addition, practitioners have complained that the disclaimer's widespread overuse causes clients to ignore the disclaimers altogether, and may render their use in some circumstances irrelevant.

As a result of these continuing complaints, the IRS has issued proposed regulations (REG-138367-06 (9/17/12)) that would eliminate the covered opinion rules in Section 10.35, expand the requirements for written advice under Section 10.37, and withdraw the proposed regulations in Section 10.39 governing requirements for state or local bond opinions. The proposed regulations would also broaden the scope of the procedures to ensure compliance (i.e., Section 10.36) by requiring that a practitioner with principal authority for overseeing a firm's federal tax practice take reasonable steps to ensure the firm has adequate procedures in place for purposes of complying with Circular 230. The proposed regulations would clarify that practitioners must exercise competence when engaged in practice before the IRS and that the prohibition on a practitioner endorsing or otherwise negotiating any check issued to a taxpayer with respect to a federal tax liability applies to government payments made by any means, electronic or otherwise. In addition, the proposed regulations would expand the categories of violations subject to the expedited proceedings in Section 10.82 to include failures to comply with a practitioner's personal tax filing obligations that demonstrate a pattern of willful disreputable conduct and also clarify the Office of Professional Responsibility's scope of responsibility.

Compliance Tip: The proposed regulations are not effective until finalized.

Elimination of Covered Opinion Rules

Currently, Circular 230, Section 10.35, provides that a covered opinion is written advice (including electronic communications) by a practitioner concerning one or more federal tax issues arising from:

(1) a transaction that is the same as or substantially similar to a transaction that, at the time the advice is rendered, the IRS has determined to be a tax avoidance transaction and identified by published guidance as a listed transaction;

(2) any partnership or other entity, any investment plan or arrangement, or any other plan or arrangement, the principal purpose of which is the avoidance or evasion of any tax imposed by the Internal Revenue Code; or

(3) any partnership or other entity, any investment plan or arrangement, or any other plan or arrangement, a significant purpose of which is the avoidance or evasion of any tax imposed by the Internal Revenue Code, if the written advice is:

(a) a reliance opinion;

(b) a marketed opinion;

(c) subject to conditions of confidentiality; or

(d) subject to contractual protection (Circular 230, Section 10.35(b)(2)(i)).

According to the IRS, significant progress has been made in combating abusive tax shelters and schemes, and preventing unscrupulous individuals from promoting those arrangements. In recent years, heightened awareness of the ethical standards governing tax advice contributed to this improved state and has benefited practitioners, taxpayers, and the government. At the same time, the IRS said there is no direct evidence to suggest that the overly technical and detailed requirements of current Section 10.35 were responsible for, or particularly effective at, curtailing the behavior of individuals attempting to profit from promoting frivolous transactions or transactions without a reasonable basis. For these reasons, the proposed regulations eliminate the covered opinion rules in Section 10.35 and instead subject all written tax advice to streamlined standards under proposed Section 10.37, as described below.

Observation: According to the IRS, the elimination of the covered opinion rules is expected to save tax practitioners approximately $5.3 million. This number, the IRS stated, does not include a number of other significant savings to both tax practitioners and taxpayers relating to the cost of obtaining a covered opinion under the current rules that would occur as a result of the proposed regulations. The IRS noted that practitioners spend many hours each year determining whether they need to prepare a covered opinion for a client or if the advice falls into one of the exceptions. This requires significant time to, among other things, research and review the complicated covered opinion rules and discuss the issue with other practitioners in the firm to determine the right course of action. If the practitioner decides, after undertaking these activities, that a covered opinion is necessary, the practitioner must discuss the covered opinion rules with the client, including how the rules affect the scope of the work that the client has asked the practitioner to perform, because the client will incur significant extra costs to obtain the written advice the client requested. These significant extra costs can, in some cases, tip the scales against obtaining written advice.

Revised Rules for Written Advice

Proposed Section 10.37 of Circular 230 would replace the covered opinion rules with basic principles to which all practitioners must adhere when rendering written advice. Specifically, the proposed regulations revise Section 10.37 to state affirmatively the standards to which a practitioner must adhere when providing written advice on a federal tax matter. It requires, among other things, that the practitioner base all written advice on reasonable factual and legal assumptions, exercise reasonable reliance, and consider all relevant facts that the practitioner knows or should know. A practitioner must also use reasonable efforts to identify and ascertain the facts relevant to written advice on a federal tax matter under the proposed regulations. Consistent with current Section 10.37, the proposed regulations provide that a practitioner must not, in evaluating a federal tax matter, take into account the possibility that a tax return will not be audited or that an issue will not be raised on audit.

The proposed regulations would eliminate the provision in the current regulations that prohibits a practitioner from taking into account the possibility that an issue will be resolved through settlement if raised when giving written advice evaluating a federal tax matter. According to the IRS, the current rule may unduly restrict the ability of a practitioner to provide comprehensive written advice because the existence or nonexistence of legitimate hazards that may make settlement more or less likely may be a material issue for which the practitioner has an obligation to inform the client. The proposed regulations provide that the IRS will continue to apply a heightened standard of review to determine whether a practitioner has satisfied the written advice standards when the practitioner knows or has reason to know that the written advice will be used in promoting, marketing, or recommending an investment plan or arrangement a significant purpose of which is the avoidance or evasion of any tax imposed by the Internal Revenue Code.

The proposed regulations would also provide that a practitioner may rely on the advice of another practitioner only if the reliance on that advice is reasonable and in good faith considering the facts and circumstances. The reliance is not considered reasonable when the practitioner knows or should know that the opinion of the other practitioner should not be relied on, the other practitioner is not competent to provide the advice, or the other practitioner has a conflict of interest.

Unlike current covered opinion rules, the proposed regulations do not require that the practitioner describe in the written advice the relevant facts (including assumptions and representations), the application of the law to those facts, and the practitioner's conclusion with respect to the law and the facts. Rather, the scope of the engagement and the type and specificity of the advice sought by the client, in addition to all other appropriate facts and circumstances, are factors in determining the extent that the relevant facts, application of the law to those facts, and the practitioner's conclusion with respect to the law and the facts must be set forth in the written advice. Also, unlike the current covered opinion rules, the proposed regulations provide that the practitioner may consider these factors in determining the scope of the written advice. Further, the determination of whether a practitioner has failed to comply with the requirements of the proposed rules under Section 10.37 would be based on all facts and circumstances, not on whether each requirement is addressed in the written advice.

IRS Aims to Eliminate Overuse of Disclaimers

Currently, many practitioners use a Circular 230 disclaimer at the conclusion of every email or other writing as a measure to remove the advice from the covered opinion rules. In the preamble to the proposed regulations, the IRS notes that in many instances, these disclaimers are frequently inserted without regard to whether the disclaimer is necessary or appropriate. These types of disclaimers are routinely inserted in any written transmission, the IRS noted, including writings that do not contain any tax advice. The proposed removal of the covered opinion rules, the IRS stated, eliminates the detailed provisions concerning covered opinions and disclosures in written opinions. Proposed Section 10.37 on written advice does not include the disclosure provisions in the current covered opinion rules. As a result, the IRS expects that these proposed regulations, if adopted, would eliminate the use of a Circular 230 disclaimer in email and other writings.

IRS Clarifies General Standard of Practitioner Competence

Although a practitioner can be sanctioned for incompetent conduct under Section 10.51 of Circular 230, no provision of Circular 230 specifically requires a practitioner to exercise competence when engaged in practice before the IRS. Under the proposed regulations, Section 10.35 would be revised to clarify that a practitioner must possess the necessary competence when engaged in practice before the IRS. Proposed Section 10.35 specifies that competent practice requires the knowledge, skill, thoroughness, and preparation necessary for the matter for which the practitioner is engaged.

Electronic Negotiation of Taxpayer Refunds Prohibited

Under proposed Section 10.31 of Circular 230, a practitioner may not endorse or otherwise negotiate any check (including directing or accepting payment by any means, electronic or otherwise, into an account owned or controlled by the practitioner or any firm or other entity with whom the practitioner is associated) issued to a client by the government in respect of a federal tax liability. The revision is meant to clarify that the prohibition on practitioner negotiation of taxpayer refunds applies in the modern-day electronic environment in which the IRS and practitioners operate. The proposed regulations would also expand Section 10.31 to apply to all individuals who practice before the IRS, not just those practitioners who are tax return preparers.

Observation: According to the IRS, there are a small number of unscrupulous preparers and practitioners who attempt to manipulate the electronic refund process with the intent to defraud their clients and the IRS. The proposed regulations would clarify that it constitutes disreputable conduct for a practitioner to direct the payment (or accept payment) of any monies issued to a client by the government in respect of a federal tax liability to the practitioner or any firm or entity with which the practitioner is associated and that such conduct is subject to sanction.

Parker Tax Publishing

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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