Circular 230 Opinion Standards, Legal Ethics and First Amendment Limitations on the Regulation of Professional Speech by Lawyers

• Publication year: 2006

SEATTLE UNIVERSITY LAW REVIEWVolume 29, No. 4SUMMER 2006

Circular 230 Opinion Standards, Legal Ethics and First Amendment Limitations on the Regulation of Professional Speech by Lawyers

David T. Moldenhauer(fn*)

I. Introduction

The regulation of professional speech is one of the least developed areas of First Amendment doctrine. The few judicial decisions that have addressed limitations on professional speech have failed to provide a comprehensive analytical framework for defining the limits on such regulation.(fn1) Moreover, there is little consensus in the academic literature regarding the proper approach to the issue.(fn2)

This Article examines First Amendment limitations on the regulation of professional speech in the context of recent "Circular 230" regulations, which govern the content and presentation of opinions and other written tax advice ("tax opinions") concerning transactions that have a significant or principal purpose of avoiding federal taxes or are otherwise deemed to be tax avoidance transactions.(fn3) Although these regulations apply broadly to "practitioners" before the Internal Revenue Service (IRS),(fn4) this Article focuses on the application of the regulations to lawyers.

The Circular 230 regulations require a tax opinion to meet a strict set of requirements. The opinion must identify and evaluate all facts relevant to the transaction.(fn5) It must relate all applicable law to the facts.(fn6) It generally must identify and evaluate each "significant Federal tax issue," meaning a federal tax issue that meets a materiality threshold and to which the IRS has a "reasonable basis" for a successful challenge.(fn7) The opinion may not contain internally inconsistent legal analyses or conclusions,(fn8) nor may it take into account the possibility that the IRS might not audit a tax return or raise an issue on audit, or might resolve the issue by settlement if raised.(fn9) The opinion must conclude whether the overall tax treatment of the transaction is proper.(fn10) If someone other than the practitioner will use or refer to the opinion to promote, market, or recommend (collectively, "to market") a transaction (a "marketed opinion"), the opinion must conclude that the taxpayer will prevail on each significant federal tax issue affecting the transaction, and that the overall tax treatment is proper, at a confidence level of at least "more likely than not."(fn11) Any non-marketed opinion that doesn't express this level of confidence with respect to an issue must prominently disclose that the writer did not intend or write it to be used to avoid tax penalties, and that the taxpayer may not use it for this purpose (a "no reliance" legend).(fn12) A marketed opinion must prominently disclose that the opinion was written to support the promotion or marketing of the transaction and that the taxpayer should seek advice, based on the taxpayer's particular circumstances, from an independent tax advisor (a "consumer protection" legend).(fn13) The tax opinion must disclose any compensation arrangement the practitioner has with a third party for marketing the transaction, and any referral agreement with a third party who markets such a transaction.(fn14) The rules prohibit a practitioner from providing advice that is contrary to or inconsistent with a required disclosure.(fn15)

The Circular 230 regulations allow tax opinions that meet certain conditions to avoid these requirements, generally or as to specific issues, by including a "no reliance" legend.(fn16) Certain marketed opinions can avoid these requirements by including both a "no reliance" legend and a "consumer protection" legend.(fn17) However, only limited categories of tax opinions can benefit from such exceptions. A practitioner cannot use the "no reliance" legend to avoid the Circular 230 requirements if an opinion addresses a so-called "listed transaction,"(fn18) has as its principal purpose the avoidance or evasion of taxes, is a marketed opinion, or is subject to certain "conditions of confidentiality" or "contractual protection" for the taxpayer.(fn19) Opinions that are excepted from these rules still must satisfy certain requirements regarding factual due diligence, and may not take into account the possibility that the IRS will not audit a tax return or raise an issue on audit, or will resolve the issue through settlement if it is raised.(fn20)

The Circular 230 requirements are intended to address the significant policy and budgetary issue of practitioners' involvement in the development, marketing and encouragement of abusive tax shelters.(fn21) Professionals connected with these abusive shelters certainly have acted inappropriately in some cases,(fn22) but the Circular 230 requirements are in many respects an inappropriate response to these problems. The framework and prohibitions they impose prevent a lawyer from giving taxpayers a complete, informed assessment of their rights. In certain circumstances, the rules create significant ethical conflicts and deny the public legal advice. In general, they distort the lawyer's role and erode the principles underlying legal ethics rules. The restriction of information and distortion of a lawyer's role make the rules vulnerable to a First Amendment challenge under the doctrines of professional speech and, in the case of opinions used to market tax shelters to third parties, under a general "hearer-centered" First Amendment theory.

Part II of this Article discusses the background, scope, and requirements of the Circular 230 rules. Part III discusses the ethical rules applicable to tax opinions, compares these rules to the Circular 230 opinion standards, and concludes that the Circular 230 standards impose substantially greater requirements on practitioners than, and in certain respects conflict with, the ethical rules. Part IV discusses First Amendment case law and commentary regarding professional speech, and proposes that professional speech regulations be analyzed by a model that defines permissible regulation of professional speech by reference to the role of the profession in society and accepted professional norms. Part IV also discusses the professional speech doctrine in the context of a more general "hearer-centered" First Amendment theory, which is relevant in evaluating the restrictions on professional opinions used to market tax shelters to third parties. Part V applies the professional speech model and the "hearer-centered" theory to the Circular 230 tax opinion requirements, and concludes that the "viewpoint-neutral" standards imposed by Circular 230, while perhaps furthering the legitimate government purpose of ensuring that taxpayers not enter into tax-motivated transactions without a full understanding of the risks, are not narrowly tailored to their purpose and distort the normal functioning of the profession based on accepted usage. Part V also concludes that the "viewpoint-based" standards imposed by Circular 230 are even less justified in terms of furthering a legitimate government purpose, and more seriously distort the role of a lawyer and interfere with the exercise of professional judgment. Finally, Part V considers what requirements the government could legitimately impose on tax opinions under the "professional speech" model and, in the case of opinions used to market tax shelters, under the "hearer-centered" theory.

II. Circular 230 Opinion Rules

A. History of the Circular 230 Opinion Standards

The Treasury Department (Treasury) has regulated lawyers and others practicing before the Department and its bureaus since before the modern income tax.(fn23) Although Circular 230 regulated aspects of tax advice for many years, Treasury's authority to regulate the content of tax advice had been questioned.(fn24) That question was addressed, however, by the American Jobs Creation Act of 2004,(fn25) which amended the current authorizing statute, 31 U.S.C. Section 330, to specifically authorize Treasury to impose standards for written advice with respect to entities, plans or arrangements having a potential for tax avoidance or evasion.(fn26)

Treasury first adopted rules regulating the content and presentation of tax shelter opinions in 1984, in former Section 10.33 of Circular 230.(fn27) Former Section 10.33 was directed primarily to the problem of heavily qualified, hypothetical, inconclusive or incorrect opinions which promoters used to market tax shelters.(fn28) The preamble to the 1984 rules described the problem as follows:The theory of the tax shelter promoter appears to be that the tax opinion, even if qualified or simply incorrect, may provided [sic] the investor with assurance that penalties will not be assessed ... Moreover, promoters also appear to hope that investors will view the practitioner's willingness to provide an opinion, even when the opinion is frankly pessimistic ... or simply does not purport to address key tax aspects, as an endorsement of the tax shelter.(fn29)

The 1984 rules generally defined a "tax shelter" as an investment having specific federal income or excise tax savings attributes as a significant and intended feature.(fn30) A "tax shelter opinion" was defined as "advice by a practitioner concerning the Federal tax aspects of a tax shelter either appearing or referred to in the offering materials, or used or referred to in connection with sales promotion efforts, and directed to persons other than...