Tax opinion confidence levels.

• Author: Smith, Annette B.

When a professional tax adviser provides a formal opinion on the merits of a taxpayer's return position, the adviser usually expresses it in terms of where the position falls along a hierarchical spectrum of "tax opinion confidence levels."

In the most basic iteration of the hierarchy, the meaningful confidence levels range upward from:

1. Not frivolous;

2. Reasonable basis;

3. Realistic possibility of success;

4. Substantial authority;

5. More likely than not; and

6. Should.

   Although the "should" standard is not directly related to the Code or the regulations, it is not coincidental that the other five standards correspond with particular statutory or regulatory safe harbors from penalties.

   Protection from Penalties

   Adequately disclosing a return position generally affords protection against (1) a return-preparer penalty under Sec. 6694 (as long as the position is not frivolous) and (2) the Sec. 6662 substantial-understatement and intentional-disregard accuracy-related penalty (as long as a reasonable basis exists for a position that is not a tax shelter).

   Even without adequate disclosure, if a realistic possibility of success (defined by the regulations as at least a one-in-three chance) exists that the return position will be sustained on its merits if challenged, neither (1) the return-preparer penalty nor (2) the accuracy-related penalty imposed for taking a position contrary to a revenue ruling or a notice (but not a regulation) will be applied. The substantial-understatement component of the Sec. 6662 accuracy-related penalty also does not apply to an undisclosed-return position for which there is substantial authority, provided that the position is not a tax shelter.

   When there is substantial authority for a return position that is not a tax shelter, the taxpayer's reasonable belief that its treatment of the item is more likely than not the proper treatment will bring a noncorporate taxpayer within the statutory safe harbor of Sec. 6662(d)(2)(C). This will also satisfy the "authority" and "belief" requirements imposed on corporate taxpayers seeking to avoid the substantial-understatement penalty on a reasonable-cause basis. Satisfying these requirements, however, is not dispositive of reasonable cause for this purpose. Moreover, the Service and Treasury have proposed to make the reasonable-cause provisions inapplicable to undisclosed transactions reportable under Sec. 6011.

   Other Confidence Levels

   Whether in response to client requests or...