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The Internal Revenue Service proposed new regulations last week that would tighten the reins on lawyers who vouch for tax shelters and could force law firms to rethink how they supervise their tax departments. The proposal is part of an IRS crackdown on abuses in the use of opinion letters in tax practice. Opinion letters are documents lawyers prepare vouching that a tax shelter is likely to satisfy the IRS and the courts if challenged. It can be lucrative work — with some lawyers earning fees as high as $1 million for a single letter. But federal officials in recent months have started more aggresively targeting what they say are fraudulent shelter schemes. The IRS is also sharpening its oversight of lawyers and other professionals who represent clients before the agency. Late last month, the IRS announced it would beef up its Office of Professional Responsibility, vowing to double its staff size and appointing Cono Namorato, a D.C. partner at Caplin & Drysdale and one of the District’s top tax attorneys, as its director. The changes are welcome by many in the tax bar. “The tax shelter industry has changed dramatically in the last 20 years,” says Richard Shaw, a lawyer in San Diego who chairs the American Bar Association’s Section of Taxation. “Given the state of play, we desperately needed to make sure the rules were upgraded.” Shaw says the ABA has had some input on the formation of the rules, meeting with top agency officials to discuss the changes. The IRS has scheduled a Feb. 18 hearing to solicit public comment. For law firms, the IRS initiative could have its broadest impact by bringing new governance considerations to bear on how opinion letters are issued. The rules would put the heads of tax practices on the hook for violations of IRS requirements committed by lawyers under their direction. This means a practice group leader could face disciplinary action — including banishment from representing clients before the IRS — even if that lawyer did not directly commit an infraction, says Gregory Jenner, deputy assistant secretary for tax policy at the Department of the Treasury. At many law firms, the partners who head practice groups have business development or administrative responsibility, but don’t take on the role of supervising the work of the other partners. Some firms may feel the need to rethink such arrangements. “This will have a significant impact on the way tax practices are structured,” says David Blair, a partner at Miller & Chevalier, a D.C. firm known for its tax work. According to Blair, the current internal procedure at Miller & Chevalier is to have the partner who is writing the opinion ask two other partners to read it over before it’s finalized. Now, because of the IRS proposal, the firm is considering having the head of its tax practice, Thomas Johnston, monitor each opinion the firm writes and appoint a partner not involved in the matter to conduct a “cold read” of the opinion to ensure that it is appropriate, Blair says. Having the head of the group directly involved in that process would be further insurance against sending out any opinions that even “skate close to the edge,” says Blair. While the IRS is moving on the regulatory front, Congress is looking at possible legislation aimed at the tax shelter business. A bill introduced on Nov. 24 by Sens. Max Baucus (D-Mont.) and Charles Grassley (R-Iowa), among others, would impose monetary penalties on any firm that “knew or reasonably should have known” that one of its partners was violating IRS rules. In whole, the effort represents a kind of beefed up government oversight of tax lawyers, similar to how congressional enactments and regulatory pronouncements have turned up the heat on securities lawyers in the past few years. Lawyers frequently write opinion letters as backup on all kinds of deals. Preparing opinions for clients’ corporate and personal tax shelters is routine work at most big law firms. A tax shelter can be as simple as a real estate deal that allows an owner to take significant tax deductions on paper while still generating real cash flow. But over the last decade or so, a sophisticated market for tax shelter plans has evolved. By the mid-1990s, major accounting firms had begun to market highly complex shelters to corporations. And lawyers weren’t absent from those deals, writing opinion letters and, in some cases, actually helping to design the shelters themselves. “Law firms that years earlier would have looked at that work and said it was too greasy took it because they could get rich,” says one D.C. tax lawyer. Indeed, says IRS official Jenner, the profitability of opinion letters is key to the growth of their appeal to law firms. Jenner says that during the mid-1990s, law firms and accounting firms moved away from billing by the hour or charging flat fees for opinion letters and started to bill on a value basis. In other words, law firms were paid a percentage of the amount the client saved on its taxes thanks to the shelter the law firm had blessed. “The practitioner then, to a certain extent, had a stake in the conclusions,” Jenner says. “Whereas previously the practitioner tended to be more independent.” A Senate report issued in November outlined the emergence of the industry: “Dubious tax shelter sales are no longer the province of shady, fly-by-night companies with limited resources. They are now big business, assigned to talented professionals at the top of their fields and able to draw upon the vast resources and reputations of the country’s largest accounting firms, law firms, investment advisory firms, and banks.” Lawyers who promote shelters or issue opinion letters have recently come under heightened scrutiny by the IRS and legislators. Some have even been sued by clients claiming legal malpractice after the IRS questioned or disallowed a tax shelter scheme. ‘THE LURE OF BIG DOLLARS’ The Senate Permanent Subcommittee on Investigations held a hearing Nov. 20 that explored the role lawyers play in tax shelter opinion letters. Lawmakers put their focus on one firm, Sidley Austin Brown & Wood, which they said had issued more than 250 opinion letters alone for tax shelters sold by KPMG. The senators said that Sidley was paid at least $50,000 per boilerplate letter and made more than $12 million. Sen. Norm Coleman (R-Minn.) said lawyers were “gagged and blindfolded by the lure of big dollars.” Sidley partner Thomas Smith Jr. said at the hearing that one of the firm’s lawyers, without the firm’s knowledge, had issued hundreds of favorable opinion letters as part of an agreement with KPMG for tax shelters the IRS subsequently disallowed. Smith headed Brown & Wood from 1996 until it merged with Sidley & Austin in 2001. Sidley Austin fired the partner in October for accepting undisclosed compensation and refusing to explain his conduct to the firm, Smith told the Senate. Sidley Austin and Dallas-based Jenkens & Gilchrist are co-defendants in a suit brought by a tax shelter buyer who alleges that the firms should have known the shelters they signed off on would not satisfy the IRS. The IRS has issued summonses to both Sidley and Jenkens & Gilchrist seeking the names of clients who used potentially illegal shelters in which firm lawyers were involved. Both firms are fighting the summonses. A Sidley spokeswoman says the firm does not comment on pending litigation. Jenkens & Gilchrist maintains that the information the government is seeking is protected by attorney-client privilege and says the firm is “morally and legally bound to utilize every resource available” to protect the identities of its clients. In interviews last week, tax lawyers said the IRS’s proposed rules could help some firms draw distinctions between individualized tax counsel and lawyers who aggressively market opinion letters in conjunction with accountants. At the least, says Miller & Chevalier’s Blair, this would require more disclosure — thus codifying “best practices” for tax lawyers. “It requires lawyers to be completely upfront about the implications and effect of the opinion,” he says. The appointment of Namorato, a former federal prosecutor, is expected to reinvigorate the Office of Professional Responsibility, which is charged with investigating allegations of misconduct and negligence against agents, attorneys, and accountants representing taxpayers before the IRS. Namorato is expected to start his new position within the month. On Dec. 31, he left Caplin & Drysdale, where he worked for 25 years, according to the firm. Namorato declined to comment about his new role. Tax lawyers in Washington say the IRS office has traditionally had a low profile. Howard Jacobson, a senior Akin Gump Strauss Hauer & Feld tax partner who practiced at Caplin & Drysdale early in his career, calls the IRS’s appointment of the 61-year-old Namorato “a tremendous coup.” “He comes with a good understanding of what the government is up against and what practitioners are dealing with,” Jacobson says. “It’s my hope that the commissioner [Mark Everson] will really listen to him and give him the freedom to move forward.”

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