New Circular 230 regulations impose strict standards for tax practitioners.

• Author: Bailey, Arthur L.

1. Introduction

   On December 17, 2004, the U.S. Department of the Treasury published final regulations amending the tax shelter provisions of Circular 230, which imposes duties on practitioners representing taxpayers before the Internal Revenue Service. These revisions provide (1) "aspirational" practice standards for tax advisers, (2) mandatory requirements for "covered opinions," and (3) new practice standards for all other written tax advice. (1)

   These regulations are the most recent development in a continuing effort to deter abusive tax shelter opinions. As far back as 1980, the Treasury Department characterized abusive tax shelters as one of the most serious compliance problems confronting the IRS. (2) As the Treasury Department explained, the use of tax shelter schemes "undermines the public's confidence in the fairness of the tax system and may affect the level of voluntary compliance." (3)

   Professional organizations representing tax advisers generally support the concept of developing guidelines and standards applicable to formal tax shelter opinions. These groups, however, have expressed concern that such standards be limited to formal tax opinions and not carry over and apply to routine tax advice and less formal written communications. Despite these concerns, the new Circular 230 standards go well beyond formal tax opinions and tax shelter related tax advice. For this reason, all tax practitioners must be aware of the new standards and sanctions.

   This article discusses the background relating to the Treasury Department's regulation of tax shelter opinions, the final regulations, the practitioners affected by the new regulations, possible sanctions for violating the rules, and the application of the new rules in current practice.

2. Background

   The Treasury Department first proposed rules governing the standards of practice for tax shelter opinions in 1980. (4) At that time, the definition of a tax shelter opinion was limited to written advice used in the promotion of tax shelters. (5)

   In 1982, the American Bar Association's Standing Committee on Ethics and Professional Responsibility (ABA Ethics Committee) responded to the proposed rules by adopting specific tax shelter opinion guidelines in Formal Opinion 346. The guidelines, based on the Model Code of Professional Responsibility, require a practitioner who renders a tax opinion to exercise responsibility with respect to the accuracy of the relevant facts; apply the law to the facts; consider all material federal tax issues; where possible, provide an opinion on the merits of the issues; evaluate the material tax benefits; and assure that the opinion is correctly described in the offering materials. (6)

   On December 15, 1982, the Treasury Department substantially modified the proposed rules to incorporate the ABA Ethics Committee's recommendations. (7) The 1982 revisions clarified that the Treasury Department did not intend to regulate a practitioner's relationship with individual clients. (8) Rather, the definition of tax shelter opinions in the 1982 proposed regulations was limited to advice intended for taxpayers other than the practitioner's client and used in the promotion or marketing of a tax shelter. In 1984, the 1982 proposals were adopted with a few minor modifications. (9)

   In January 2001, the Treasury Department issued proposed regulations modifying the standards of practice for tax shelter opinions. (10) This proposal significantly expanded the definition of tax shelter opinions governed by Circular 230. The proposed regulations retained the tax shelter advice provisions and added a new provision governing tax shelter opinions, defined by reference to section 6662 of the Internal Revenue Code. (11)

   The Section of Taxation of the American Bar Association criticized this definition as too broad and proposed an alternative. (12) The ABA Tax Section offered a proposal that eliminated the reference to "tax shelter opinions" and proposed the substitution of a new defined term, "section 10.35 opinions." A section 10.35 opinion is written advice concerning a transaction that falls within one of the six delineated categories. (13) So-called section 10.35 opinions would have been subject to the special standards and requirements found elsewhere in the regulations. (14)

   Thereafter, the Treasury Department published new proposed regulations governing tax shelter matters on December 30, 2003. (15) The 2003 proposed regulations combined the 2001 proposed section 10.33, governing tax shelter opinions used to market tax shelters, with the 2001 proposed section 10.35, governing more-likely-than-not tax shelter opinions, into proposed section 10.35. In addition to this format change, the 2003 proposed regulations excluded "limited scope opinions" from the definition of tax shelter opinions thereby allowing a practitioner to provide an opinion that addresses some, but not all, of the relevant federal tax issues. The proposed regulations also modified the standards applicable to tax shelter opinions, and added a new section dealing with the best practices of tax advisers.

   The final regulations released by the Treasury Department on December 17, 2004, are effective for advice issued 180 days after the adoption of the final regulations, i.e., June 20, 2005. (16) The new rules make substantial changes in the structure and scope of the practice standards, most significantly the final regulations do not exempt routine tax advice but attempt to strike a balance with a two-tier structure that permits practitioners to "opt-out" of the heightened covered opinion standards. Practitioners opting out of the stringent standards applicable to covered opinions are nevertheless subject to the standards applicable to other written advice.

3. Overview of the New Circular 230 Regulations

   The new regulations govern three aspects of tax advice. First, the regulations provide "best practices" for tax advisers. The preamble to the new regulations, as recommended by the ABA Tax Section, describes the best practices guidelines as "aspirational," meaning that the regulations merely provide that the best practices constitute a standard that tax practitioners should seek to achieve as a goal. The preamble to the regulations makes clear that these provisions are aspirational and not practice standards that will give rise to sanctions for a practitioner's conduct that falls short of the best practices standards. (17)

   Second, the regulations set forth mandatory requirements for "covered opinions." A covered opinion is written advice that concerns one or more federal tax issues arising from (1) a listed transaction, (2) a plan or arrangement, the principal purpose of which is the avoidance or evasion of any tax, or (3) any plan or arrangement, a significant purpose of which is avoidance or evasion of tax if the written advice is (a) a reliance opinion (i.e., concludes with at least a more-likely-than-not standard), (b) a marketed opinion, (c) subject to conditions of confidentiality, or (d) subject to contractual protection. (18) A practitioner giving advice in a covered opinion must consider all relevant facts, relate applicable law to relevant facts, evaluate the significant federal tax issues, and provide an overall conclusion. (19)

   Third, the regulations provide rules for practitioners giving written advice that is not a covered opinion ("other written advice"). The rules applicable to other written advice set forth a list of prohibitions, for example, written advice shall not be based on unreasonable factual or legal assumptions. These provisions are subjective and depend on the facts and circumstances surrounding the advice, including the scope of engagement. (20)

   Practitioners whose conduct falls short of the mandatory tax practice standards set forth in the regulations (i.e., those applicable to "covered opinions" and "other written advice") are subject to sanctions, including sanctions that would bar a practitioner from practicing before the IRS. (21) At this time, the sanctions do not include monetary penalties, but monetary penalties against a practitioner who violates Circular 230 were authorized under the American Jobs Creation Act of 2004. (22) The new Circular 230 regulations do not reflect the changes made by the American Jobs Creation Act. (23)

4. Detailed Description of New Rules

   1. Best Practices

      The best practices provision states that tax advisers "should provide clients with the highest quality representation." (24) Best practices include (1) communicating clearly with the client regarding the terms of engagement; (2) establishing the facts, determining which facts are relevant, evaluating the reasonableness of assumptions or representations, relating applicable law to relevant facts, and arriving at a conclusion supported by the facts and law; (3) advising clients regarding the significance of the conclusion; and (4) acting fairly and with integrity in practice before the IRS. (25) These standards generally parallel the ABA Model Rules for Professional Conduct. (26)

      A tax adviser should take steps to ensure these guidelines are followed by other practitioners that the adviser is responsible for overseeing. In addition, tax advisers with overseeing responsibilities are expected to take steps to ensure that the firm's procedures are consistent with these standards. (27)

      As previously stated, the best practices standard is described in the regulations as "aspirational." The guidelines describe a standard that practitioners should attempt to reach when giving tax advice. A practitioner is not subject to sanctions for failure to achieve these aspirational goals. (28)

      The best practices standards in the final regulations are essentially the same as the standards in the proposed regulations. The final regulations clarify in the preamble that these provisions are not mandatory standards of behavior.

   2. Covered Opinions

      One source of significant controversy...