Circular 230: is the hysteria over?

• Author: Bailey, Arthur L.

1. Introduction

   On December 20, 2004, the U.S. Department of Treasury published amendments to Circular 230 (hereinafter referred to as "final regulations"), which generally governs practice before the Internal Revenue Service by attorneys, accountants, and other tax consultants and practitioners. (1) The December 2004 amendments relate to the limitations on "written advice" provided by those professionals deemed to practice before the IRS. During the six months leading up to the June 21, 2005, effective date of the regulations, those affected (or potentially affected) by the new rules engaged in what was from time to time referred to as "Circular 230 hysteria."

   Lawyers and accountants howled as their tax partners pleaded to have a Circular 230 disclosure statement (cautioning that any advice contained in the message could not be relied on to avoid penalties) appended to every email emanating from the firm. Some firms adopted such a rule, so that everything from a legal opinion to a luncheon invitation became "stickered" with the now familiar Circular 230 disclosure. Grown men and women debated whether the Circular 230 disclosure should be above or below the email signature line and whether placing the disclosure in its own paragraph in the same font as the email text was sufficient to make the disclosure "prominent." Hours were spent analyzing and drafting the specific language of the Circular 230 disclosure--should the term "advice" be qualified by a parenthetical, "(if any)," in case the email does not contain "advice"?

   Looking back, some of the consternation may have been unnecessary and some of the debates even silly. But the reality is that practitioners have taken seriously their obligations under these regulations to comply with the standards of practice for written tax advice. This is evident from the numerous communications between practitioners and representatives of Treasury and the IRS's Office of Professional Responsibility (OPR), which identify the practical problems involved in applying the final regulations to everyday tax advice.

   In response to some of the concerns from tax practitioners, Treasury responded with important clarifications. Specifically, in May 2005, Treasury modified the final Circular 230 regulations governing written tax advice. (2) The May modifications provide significant guidance in areas relating to post-return advice, in-house tax advice, negative advice, the definition of "prominently disclosed," and the definition of "the principal purpose."

   While important clarifications have been made, the core question remains whether the end justifies the means. The regulations were developed to curb abusive tax shelter opinions. But do they? Instead of outlawing abusive tax shelter opinions, the regulations provide a road map on how to write a tax shelter opinion that will be "blessed" as Circular 230 compliant. Tax practitioners providing tax shelter opinions may charge higher fees since compliance with Circular 230 requires such opinions to be more complete. But nothing in the regulations prohibits the use of tax opinions in tax shelter transactions. Thus, the "cost" of dealing with abusive tax shelter opinions is being borne daily by taxpayers seeking routine and benign tax advice on non-tax shelter questions. Indeed, given the cost of obtaining written tax advice that is compliant with the covered opinion requirements of Circular 230, an argument can be made that one consequence of the regulations is to discourage taxpayers from seeking tax advice in writing. If true, this is truly unfortunate.

   Clearly, a case can be made for taking a fresh look at the basic structure of Circular 230 and the effect of the regulations, which undeniably adds another unnecessary layer of complexity to the task of providing written tax advice. This article, however, sidesteps that question and instead undertakes to summarize and comment on Circular 230 developments since the final regulations were issued in December 2004. This article thus updates an article published in the January-February 2005 edition of The Tax Executive. (3) That article provided an overview of the recently promulgated regulations governing written tax advice, the background relating to the Treasury's regulation of tax shelter opinions, and commentary on the application of the new rules in current practice. This article discusses the regulation modifications published in May 2005, outlines the topics and questions described in letters to OPR, and reviews the other written recommendations to OPR. The article concludes with suggestions for improving the Circular 230 regulations governing written tax advice.

2. The May Modifications to Circular 230

   The May modifications to Circular 230 focus on five specific issues about which practitioners had expressed concern: post-return advice, in-house advice, negative advice, the definition of "prominently disclose," and the definition of "the principal purpose." Even though these modifications make important steps toward easing the burden on every day written tax advice, they fall short of curing the fundamental problems with the regulations--their scope and complexity.

   1. Post-Return Advice

      Practitioners expressed concern that a memorandum (i.e., something short of a full-blown opinion) expressing post-return advice, such as a conclusion about the hazards of litigation was subject to the Circular 230 regulations. Treasury and the IRS agreed that such written advice should not be subject to the stringent "covered opinion" requirements of Circular 230. Thus, the May modifications exclude from the definition of "covered opinion," written advice prepared or issued after the taxpayer has filed a tax return reflecting the benefits of the transaction. (4) This exclusion, however, does not include advice if the practitioner knows or has reason to know the taxpayer will rely upon such advice to take a position on a tax return, including an amended return that claims tax benefits not reported on a previously filed return.

      The post-return advice exception is an important exclusion for practitioners providing advice in the context of an IRS examination or litigation. Absent this modification, the regulations would literally have subjected most advice regarding the merits of an issue in controversy to the covered opinion rules. Obviously, written advice regarding a transaction under audit or in litigation should not be burdened with the application of rules designed to discourage tax practitioners from providing abusive tax shelter opinions for penalty avoidance purposes.

      Nevertheless, the language of the exclusion causes confusion in the context of transactions that have tax effects over multiple years, some of which are under audit and some of which lie in the future. In this situation, the taxpayer has filed a tax return reflecting some, but not all, of the tax benefits of the transaction. Thus, the question arises whether the language of the regulations, which generally refers to "the tax benefits of the transaction," includes such advice. It seems logical that if the taxpayer has already taken a position on a tax return reflecting the benefits of the transaction--and the practitioner reasonably concludes that the advice will not be relied upon to take a different position in future years--the exception should apply. The answer, however, is not clear.

   2. In-House Advice

      The exclusion for in-house advice applies to most, but not all, of the advice provided by in-house tax advisers. This exception is limited to advice provided by employee-advisers to their employers with respect to the employer's tax liability. (5) It is widely accepted that this definition does not, on its face, include advice to someone other than the employer (e.g., company executives, employees, or customers). On the other hand, there is some uncertainty and confusion because the regulations fail to provide a definition of the term "employer."

      In-house practitioners should be concerned with...