Ethical Problems for Tax Lawyers

• Author: Michael Hatfield
• Pages: 39-55

3. Ethical Problems for Tax

Lawyers

While tax lawyers face many of the professional responsibility

problems other lawyers do, such as conflicts of interest and handling

confidential information, there are several d istinctive situations that

pose ethica l problems for tax lawyers. First are those situat ions in

which a tax la wyer provides a dvice to a cli ent in a manner expect ed

to protect the client from certa in pena lties, even if the advice turns

out to be wrong. Second are situations involving mistakes, such a s

discovering that a prior year’s ta x return is incorrect or catching the

IRS making a mistake in the clie nt’s favor. Finally are situations that

involve how private ta x lawyers interact with lawyers and other

employees at the IRS.

3.1. Tax Opinions and Tax Shelters

A ta xpayer who makes an “honest mist ake” still owes the taxes due

(and i nterest on the amount due), an audit may reveal this . Yet, the

taxpayer must pa y additional penalties only in certain situations . For

example, IRC § 6662 imposes a 20% pena lty, if the taxpayer

underpaid tax due to “negligence or disregard of the rules or

regulations,” or, regardless of negligence or disregard, if the

underpayment was “substantial ” (i.e., more than the greater of $5,000

or 1 0% of the tax owed). IRC § 666 2(b)(1 ), (b)(2) , ( d)(1).

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It i s in

seeking protection from penalties that many cli ents turn to tax

lawyers. Thus, clients w ill often seek assurances from a tax lawyer as

to a favorable position on the return since such assurances may

protect them from the penaltie s, even if the position fails to be

sustained on audit or in litigation. Tax lawyers earn significant fees in

providing such assurances (i.e., providing opinions as t o the proper

tax treatment).

In general , a t axpayer will not be subject to a § 6662 penalty if she

acted reasonably and in good faith with respect to the return position

that resulted in the underpayment of ta x. IRC § 6664(c)(1). A

taxpayer who relies on a tax la wyer’s professional advic e may cite

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doing so as evidence of acting reasonably and in good faith. Treasury

Regulations § 1.6664-4(b)(1). However, the taxpayer must have

disclosed all releva nt facts to the lawye r, and the lawyer must base the

advice on all relev ant law taki ng the facts into consideration, making

no unreasonable assumptions. Treasury Regulati ons § 1.66 64 -4(b)(1).

In short, the tax lawyer’s advice must be reasonable and in good faith

and the taxpayer’s reliance itself must be reasonable and in good

faith.

While t he taxpayer penalty regime is complex, it is important to note

that there are specific protections provided for different levels of

confidence in tax adv ice. Similar to the requirements on a tax return

preparer under § 6694, there will be no penalty premised on a tax

position for which there is “substantial authority” or a tax position

that is disclosed on Form 82 75 and for which there is a “reasonable

basis.” IRC § 666 2(d)(2 )(B). Re-read the considerati ons described

above with respect to § 6694 and the meaning of “substant ial

authority” and “reasonable basis.” Remember that a position with

substantia l authority is one for which there is about a 4 0% chance of

success, if litigated, and a position for which there is a reasonable

basis is one for which there is about a 1 0–2 0% chance of success if

litigated.

The substantial authority and reasonable basis standards are objective

standards. However, in some instances, in order to avoid a penalty,

the taxpayer must also reasonably believe that the position is “more

likely than not” to be sustained on its merits in litigation.

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The “more

likely than not” standard is greater than 50%. A taxpayer is

considered to “reasonably believe ” if the taxpayer reasonably relies in

good faith on the opinion of a professional tax advisor, if the op inion

is based on the tax advisor’s a nalysis of the pertinent facts and

authorities … and unambiguously states that the tax advisor

concludes that there is a greater than 50-percent likelihood that the

tax treatment of the item wil l be upheld if cha llenged by the Internal

Revenue Service. Treasury Regula tions §§ 1.6662-4 (g)(4)(i)(B) [non-

corporate taxpayer]; 1.6664-4(f)(2)(B)(2) [corporate taxpayer].

This special requirement applies to “tax shelters.” In common usage,

a “tax shelter” is a complicated tax scheme intended to generate