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On Dec. 29, 2003, the Internal Revenue Service issued proposed modifications of the regulations governing practice before it. The proposed regulations set forth best practices for tax practitioners and modify rules relating to marketed opinions, more likely than not opinions, and limited scope tax opinions. In early 2003, the service announced the creation of the Office of Professional Responsibility to further its continuing commitment to ensure the integrity of the American tax system. Recognizing that tax professionals are an integral part of the voluntary compliance system, the service formed the office to investigate allegations of misconduct and negligence by professionals practicing before the service (i.e., attorneys, accountants, and actuaries). With the proposed modifications of the regulations, the service has again taken steps to promote ethical practices through its issuance of guidance addressing several areas: practitioner “best practices;” the parameters of and reliance on tax shelter opinion letters; and the required disclosure of reportable transactions, as defined in Treasury Regulations under section 6011 of the Internal Revenue Code of 1986, as amended. See Circular 230, 31 CFR Part 10. The service’s guidance serves two purposes: (1) to strengthen the tax system through heightened standards governing tax practitioners; and (2) to increase the disclosure of information to the service. Notably, the service is following the lead of other governmental agencies that have issued guidance in recent months on ethical administrative practices, including the Securities and Exchange Commission. The “best practices” delineated include: �communicating clearly with clients regarding the terms of engagement (e.g. the practitioner should determine a client’s expected purpose for and use of the advice and should ensure that all parties have a clear understanding of the form and scope of the advice or assistance to be rendered); �establishing the facts, determining which facts are relevant, and evaluating the reasonableness of any assumptions or representations made; �relating applicable law, including potentially applicable judicial doctrines, to the relevant facts; �arriving at conclusions supported by the law and facts; �advising the client of the import of the conclusions reached, including, for example, whether a taxpayer may avoid penalties for a substantial understatement of income tax (i.e. an accuracy-related penalty) if the taxpayer relies on the advice rendered; and �acting fairly and with integrity in practice before the service. Not only has the service stated that tax professionals should adhere to the “best practices,” but it mandated in section 10.36 of the proposed regulations that tax practitioners with the responsibility for overseeing a firm’s IRS practice should take “reasonable steps to ensure that the firm’s procedures for all members, associates, and employees are consistent with the[se] best practices.” The service provided no examples, however, of procedures that are consistent with the best practices described therein. Tax Shelters The service also issued significant guidance on tax shelter opinions and their effectiveness in the marketplace. While a taxpayer could have relied in many instances on a tax shelter opinion as reasonable cause for the avoidance of accuracy-related penalties prior to the new proposed regulations, the relief offered by such opinions has now been called into question. A marketed tax shelter opinion is an opinion addressing all material federal tax issues (generally of a particular tax shelter transaction), including a more likely than not opinion, that a practitioner knows, or has reason to know, will be used in promoting, marketing or recommending a tax shelter to one or more taxpayers. In contrast, a limited scope opinion is an opinion addressing a tax shelter that is limited to some, but not all, material federal tax issues that may be relevant to the service’s treatment of a tax shelter. An opinion is limited only if the taxpayer and the practitioner agree to limit the scope of the opinion. Significantly, the service remarked that a limited scope opinion will not be treated as a marketed tax shelter opinion. The proposed requirements for practitioners in preparing more likely than not and marketed tax shelter opinions include: (1) using reasonable efforts to identify and ascertain the facts surrounding the transaction and determining which facts are relevant; (2) identifying and considering all relevant facts; (3) not basing the opinion on any unreasonable factual assumptions, representations, statements or findings of the taxpayer or other persons; (4) relating applicable law or judicial doctrines to the relevant facts; (5) not basing the opinion on unreasonable legal assumptions, representations or conclusions; (6) providing an overall conclusion of the federal tax treatment of the tax shelter and the reasons for that conclusion; and (7) considering all material federal tax issues in reaching a conclusion that is supported by the facts and law with respect to each material federal tax issue, including the likelihood that the taxpayer will prevail on the merits with respect to each material federal tax issue, unless such opinion is limited in scope or is otherwise not a marketed tax shelter opinion, as defined by the proposed regulations. In reference to (1), note that the IRS acknowledges that in the case of a marketed tax shelter opinion, the practitioner is not expected to identify or ascertain facts peculiar to a taxpayer to whom the transaction may be marketed. See Prop. Regulation section 10.35(a)(ii). Disclosures Additionally, the proposed regulations set forth certain required disclosures that an opinion must contain. The service was particularly concerned with financially interested practitioners that have arrangements with promoters (compensatory, referral based or fee-sharing), and the proposed regulations require such practitioners to disclose the existence of any such arrangement. The service has stated that it will question the reasonableness and good faith of taxpayers who know or have reason to know that the practitioner is not financially independent when making a determination of whether accuracy-related penalties may be avoided for reasonable cause. A marketed tax opinion must disclose any material federal tax issues for which the practitioner could not reach a conclusion at a confidence level of at least more likely than not, and that since the opinion is a marketed opinion, taxpayers should seek advice from their personal tax advisors regarding any “excluded” material tax issues. It appears that a taxpayer cannot rely on a marketed opinion of a tax practitioner including issues for which a more likely than not conclusion could not be made to avoid accuracy-related penalties on positions taken with respect to such issues. Like a marketed tax shelter opinion, the limited scope opinion must make specific disclosures when a practitioner is unable to conclude with a confidence level of at least more likely than not on one or more material federal tax issues addressed by the opinion. The proposed regulations require a professional to disclose at the commencement of a limited scope opinion that: (1) the opinion is limited to one or more federal tax issues as agreed upon by the taxpayer and the practitioner; (2) additional issues may exist that could affect the federal tax treatment of the tax shelter by the service; (3) the opinion does not provide an opinion with respect to those issues; and (4) with respect to federal tax issues outside the scope of the opinion, the opinion cannot be relied upon by the taxpayer for the purpose of avoiding accuracy-related penalties. Defenses The service has also issued Final Treasury Regulations that affect the defenses available for penalties assessed when a taxpayer has failed to disclose certain matters on its tax return. Again, the service is attempting to ensure transparency by taxpayers. For returns filed after Dec. 31, 2002, and with respect to transactions entered into after Jan. 1, 2003, a taxpayer may not rely on tax advice to establish reasonable cause and a good-faith defense to accuracy-related penalties if the taxpayer fails to disclose a reportable transaction, as defined in Treasury Regulations under code section 6011. The final regulations also mandate that a taxpayer may not rely on an opinion that a regulation is invalid to establish that the taxpayer acted with reasonable cause and in good faith, if the taxpayer has failed to disclose its position that the regulation is invalid. Since the American tax system is built on voluntary compliance, without adequate disclosure, the service’s enforcement capability is severely limited. Together, these items of published guidance will likely further the service’s mission to make the American tax system more transparent, and taxpayers more forthcoming. The best practices should strengthen the service’s and the American taxpayers’ opinions of tax professionals by requiring higher standards for practice before the service. Nevertheless, it appears that practitioners and taxpayers must be more mindful in rendering, and relying on, opinions. Ferszt is a tax and ERISA partner at Wolff & Samson of West Orange and Lilling is an associate in the firm’s tax and ERISA practices.

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