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In the last few weeks, you may have noticed strange language in e-mails you receive from your tax colleagues or from other tax lawyers or accountants. The strange language may read something like this: IRS Circular 230 Disclosure: To ensure compliance with requirements imposed by the U.S. Internal Revenue Service, we inform you that any tax advice contained in this communication (including any attachments) was not intended or written to be used, and cannot be used, by any taxpayer for the purpose of (1) avoiding tax-related penalties under the U.S. Internal Revenue Code or (2) promoting, marketing, or recommending to another party any tax-related matters addressed herein. It turns out that this “disclosure” is really a disclaimer, informing the recipient of the e-mail (or any other document with the disclosure) that he can’t rely on any tax advice contained in the e-mail � at least for purposes of avoiding federal “tax-related penalties.” In other words, if the recipient acts on any tax advice or recommendations contained in the e-mail (by, for example, filing a federal income tax return in reliance on those recommendations) and the IRS then audits that tax return and the return proves wrong, the recipient can’t avoid penalties by saying that he relied in good faith on the advice of a tax practitioner when he filed the return. That’s not to say the e-mail recipient won’t be able to rely on the authorities underlying the conclusion in the practitioner’s message, but that’s an entirely different topic. The recipient can’t rely on the e-mail advice itself because of the disclaimer, and as a result, the recipient could be subject to penalties � typically 20 percent of the additional tax owed. TAX SHELTERS Will clients complain about this disclaimer? After all, they are paying for tax advice that they are now being told they cannot rely on in a very fundamental way. Since the new Circular 230 rules only became effective on June 21 (see 31 CFR Part 10, �10.35(g)), it may be too soon to speak confidently about client reaction to this new regime. In our experience (however brief that may be), clients are willing to tolerate this disclaimer once the tax lawyer explains that the only other alternative (which would allow the disclaimer to be eliminated) is to provide a lengthy and extensive tax opinion that complies with the new Circular 230 rules for tax lawyers and accountants. Such a tax opinion would be very expensive to write because of the new minimum standards that the IRS has imposed on such opinions. Once clients understand that point, then the disclaimer becomes acceptable. Nonetheless, the IRS has made it very difficult for clients to receive tax advice that will protect them from penalties � even in situations that don’t seem to present any potential for abuse whatsoever. Why has the IRS done this? The answer is: tax shelters. The new Circular 230 rules are part of the government’s war against tax shelters. The entire tax community and its clients are being punished for the alleged misdeeds of those few practitioners who marketed abusive tax shelters by providing tax opinions for investors. In the government’s view, certain accounting firms and law firms marketed abusive tax shelters to taxpayers by producing opinions that the tax shelters “worked,” with the opinions stating that it was “more likely than not” that the shelters actually delivered the anticipated tax benefits. Under previous as well as current law, a taxpayer who relied on such an opinion in good faith could not be penalized for taking a particular position on his tax return, even if the position was ultimately rejected by the IRS and more tax was owed. This was the business model underlying the proliferation of abusive tax shelters � taxpayers were given penalty protection by essentially buying tax opinions concluding that the shelter worked. At least that is the government’s position. With penalties supposedly off the table, tax shelters were easier to market. Taxpayers were told that if the shelter was unwound, all they would owe would be the tax they would have paid anyway if they hadn’t invested in the shelter, along with interest on that tax (computed at a rate presumably lower than what investors could earn on their money elsewhere). STRINGENT REQUIREMENTS The government believes that too many of the resulting tax opinions were deficient � seriously deficient � and so has issued the new rules mandating minimum requirements for tax opinions that are much more stringent than in the past. The new rules amend the existing Circular 230 (which contains Treasury Department regulations governing activities of lawyers and accountants who practice before the IRS). The rules impose tough new standards on “covered opinions,” which are tax opinions issued for certain types of transactions that the government thinks may be tax shelters. A tax practitioner writing a covered opinion must comply with the stringent new requirements. A covered opinion that does not comply is considered deficient, and a lawyer or accountant who writes such a noncompliant opinion can be severely sanctioned by the IRS � including being fined and penalized, “disbarred” from practicing before the IRS, and publicly stigmatized by appearance in an IRS list of offenders released to the public. The government has made these penalties for noncompliance quite severe, and yet it seems to be puzzled at the response of the tax community, which has reacted to the rules by adding these Circular 230 disclaimers to almost all correspondence. The new rules make it much tougher, in terms of the analysis that such covered opinions must contain, for practitioners to provide opinions that give penalty protection to taxpayers. For example, the government believes that tax shelter opinions in the past were professionally inadequate because the opinions relied on unreasonable factual assumptions in support of their conclusions. Tax shelter opinions frequently assumed that the transactions had a “business purpose” or were accompanied by a “profit motive,” whereas (at least in the government’s view) the transactions were completely devoid of business purpose. In the government’s view, tax practitioners were deliberately making these unrealistic assumptions (or demanding that clients make unrealistic representations) in order to be able to provide favorable conclusions so that taxpayers would purchase their shelters. The government’s intentions are obvious: By beefing up the requirements that tax practitioners must meet, the government hopes that practitioners will issue fewer covered opinions to potential tax shelter investors. As a result, the number of marketed tax shelters will go down. At the same time, the new rules allow tax practitioners to avoid the burdensome procedures required for covered opinions if the practitioner provides the new disclaimer in the text of the tax opinion itself. The disclaimer must be prominently disclosed (in typeface at least as large as the other typeface in the document), and the disclaimer must provide that the opinion cannot be relied upon for penalty protection. In other words, the disclaimer allows practitioners to provide normal tax advice without having to go through the requirements of the new rules at the cost of clients being unable to rely on this advice for a principal reason that they usually seek it (i.e., to protect them against penalties in the event that the IRS disagrees with the advice). BROAD LANGUAGE But what does this have to do with e-mails, you may ask? How many marketed tax shelters relied on tax opinions sent in the form of e-mails? The answer is “none,” based on everything we know. The problem is that the government’s definition of a covered opinion for purposes of Circular 230 is very broad and arguably applies to many situations that don’t resemble tax shelters in any realistic manner. Although the government has narrowed the language of the new rules in response to numerous complaints from practitioners, the language has not been narrowed enough. So there is a real risk that much of the normal, day-to-day written advice provided by tax practitioners (the new rules do not, generally, apply to oral advice) comes under the definition of a covered opinion. Therefore, a practitioner providing such written advice could get into trouble with the IRS for not following the new guidelines for covered opinions. IRS officials have made comforting remarks about their intention to interpret the rules reasonably, while at the same time not changing the written text of the regulations to ensure that this interpretation prevails. In response to this uncertainty, virtually every major law firm and accounting firm in the country, to our knowledge, has inserted these disclaimers in its e-mails and other correspondence. You will likely discover that every kind of tax disclosure in private transactions (tax opinions and disclosure required by the Securities and Exchange Commission are not covered by the new rules), as well as virtually every piece of correspondence from a lawyer containing tax-related language, will include this disclaimer unless the lawyer goes to the trouble of meeting the new standards for a covered opinion (and unless the user of that opinion is willing to pay the extra costs that such a commitment entails). THE GOLDEN VERSION What if a client wants to be able to rely on a tax opinion? What are the new Circular 230 standards governing covered opinions that will provide that client with penalty protection? The new standards prohibit a tax practitioner from basing an opinion on unreasonable factual assumptions that the practitioner knows (or should know) are incorrect. In practice, they impose significant and burdensome due diligence requirements to check out projections, financial forecasts, and appraisals upon which the tax practitioner would otherwise rely. The opinion must consider all significant federal tax issues and generally must provide a conclusion as to every “significant” tax issue. In other words, the opinion typically cannot just focus on one or two main issues and specifically provide that it is not addressing others. Therefore, a covered opinion that is Circular 230-compliant will inevitably be a lengthy document analyzing multiple tax issues based on only those assumptions (or client representations) that the tax practitioner has determined are reasonable. A short conclusory opinion will not work. Certainly, practitioners in the future will write tax opinions that are Circular 230-compliant � they will just be much more expensive than in the past. Many firms, for example, have established special committees to review tax opinions to make sure they comply with these new rules, and the additional time and attention spent under the new regime will be reflected in a higher price charged to the client. The troublesome effect of the new Circular 230 is compounded by the fact that the broad definition of a covered tax opinion includes opinions on any transaction that has a “significant” purpose (not necessarily the main purpose) of “avoidance or evasion” of federal tax (not just income tax, but estate tax, gift tax, or any other federal tax). What constitutes a transaction with a “significant” purpose of tax avoidance? That definition is very expansive, and could include all kinds of mundane and everyday transactions. So, welcome to the brave new world of tax advice under revised Circular 230. Corporate and securities lawyers have been suffering under the new Sarbanes-Oxley rules for some time now � rules that were enacted in response to corporate wrongdoers, but which apply to all public companies and make life much more difficult for everyone involved. The new Circular 230 rules are the tax lawyers’ equivalent of Sarbanes-Oxley � they punish everyone to make it more difficult for those who market tax shelter opinions, and they change the rules considerably even for those who have never been involved with a tax shelter. How these rules will evolve is, at this time, uncertain. But one thing is clear: Get used to seeing Circular 230 disclaimers in almost everything tax lawyers write. Unless the IRS narrows the regulations to make them more reasonable, the tax community has concluded that every doubt should be resolved in favor of adding a disclaimer to every written document or correspondence a tax lawyer produces, unless the intention is to write an elaborate Circular 230-compliant opinion. There is simply too much risk in not adopting such a strategy.
Steven E. Clemens and Thomas L. Evans are partners in the New York and D.C. offices, respectively, of Kirkland & Ellis. They can be reached at [email protected] and [email protected].

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