Mainly as a result of the actions of the IRS against a number of large CPA and law firms regarding tax shelters, Circular 230 was most recently amended, effective June 21, 2005, to cover the issuance of tax opinions and to establish an “aspirational” set of “best practices.”

The IRS became concerned with tax opinions since clients used them to justify aggressive tax positions in order to pay the least tax possible. The concern was that many of these tax opinions did not arrive at logical conclusions based upon the fact situation, law, regulations, rulings and case law. In what has been described as “overkill,” the IRS reaction was to impose standards on all written communications.

Circular 230 is the set of regulations governing how CPAs, attorneys, enrolled agents and others practice before the Internal Revenue Service. A portion of the Circular 230 rules parallel to a great extent the AICPA Code of Professional Conduct and the Standards of Tax Practice.

Written Communications
If the newly written communication rules were only restricted to the tax opinion letter or memorandum, they might only affect CPAs who issue tax opinions. However, the newly written communication rules impose restrictions on tax opinions as well as other written communications.

The definition is expansive. It covers any communication in writing, including letters, memos, e-mails and faxes. Whenever a client has requested that the CPA notify him in writing about a tax matter, this writing is potentially a covered written communication unless there is a specific exception. A simple letter discussing whether or not a client should file a joint return or file as married filing separate becomes a written communication subject to the new Circular 230 rules. The new requirements can also cover comments on the tax consequences of estate planning, partnership, LLC or S corporations and other routine communications.

Written communications are divided into three classifications: a covered opinion; a limited scope opinion; and other written advice.

A covered opinion includes any written advice on a transaction identified by the IRS as a listed transaction that the IRS has determined is a tax avoidance transaction. These so-called listed transactions are identified under Reg. Sec. 1.6011-4(b)(2). A covered opinion also includes any written advice concerning any entity, plan or arrangement in which the principal purpose is the avoidance or evasion of tax. In addition, if the opinion is a reliance opinion, marketed opinion, subject to a condition of confidentiality or subject to contractual protection, rather than a principal purpose, it is sufficient if there is a significant purpose to avoid or evade tax. A covered opinion can fall within more than one of these classifications.

A principal purpose is one that is more significant than any other purpose. Circular 230 does not provide guidance on what constitutes a principal or significant purpose of avoiding tax. It does state that if the opinion is relying upon exclusions or deductions that are specifically provided for in the Internal Revenue Code that these opinions are exempt. Thus, it appears you can state such things as “the standard deduction for 2006 is _____” or similar statements. However as mentioned before, the letter regarding the filing of a joint return may have a tax avoidance motive.

There is a safe harbor from the principal purpose test, but it is in name only. It appears the current IRS interpretation requires that the taxpayer must ultimately prevail in his position for the safe harbor to be met.

Circular 230 says a federal tax issue is any issue that concerns the federal tax treatment of income, gain, loss, a deduction, a credit, the existence or absence of a taxable transfer or the value of property. Thus, almost any writing that has anything to do with a federal tax matter is considered to be a covered opinion.

The danger to the CPA is that if the Circular 230 rules are not followed, the CPA can be subject to censure, fines, suspension or disbarment from practice before the IRS. Any or all of these penalties can be imposed for willful violation of the Circular 230 rules, reckless or incompetent violation of the standards for advising clients on tax positions, failing to meet the covered opinion requirements or any of the requirements for other written advice.

As mentioned previously, at this time the “best practices” rules are aspirational and thus these penalties will not be imposed for willful failure to follow this portion of the rules. In addition, under the American Jobs Creation Act of 2004, the IRS can also impose significant fines based upon the gross income derived from tax shelter opinions. It is for these reasons most tax practitioners are taking a very conservative approach to Circular 230 and are including disclaimers as a general rule on all communications not meant to be formal covered opinions.

A reliance opinion is a covered opinion that arrives at a conclusion on a more-likely-than-not standard that one or more significant federal tax issues will be resolved in favor of the taxpayer. More-likely-than-not is a greater than 50 percent likelihood that the taxpayer will prevail. There is no “acting in good faith” exception to these requirements. However, the CPA can protect himself by including a prominent disclaimer disclosure.

The term significant federal tax issue includes any issue to which the IRS has a reasonable basis to challenge a resolution favorable to a taxpayer who is receiving the written advice if it could have a significant impact on the taxpayer’s overall federal tax treatment of the transaction covered by the opinion. If the opinion states there is only a reasonable basis for concluding the taxpayer will prevail, something less than a more-likely-than-not conclusion, it is not a reliance opinion. A Circular 230 disclaimer, described below, will eliminate the necessity to follow the covered opinion rules.

A marketed opinion is a covered opinion involving a significant purpose in which the tax practitioner knows or has reason to know that it will be used for marketing, promoting or recommending an investment or arrangement to one or more taxpayers by someone other than the opinion writer or a member of his firm.

These opinions can be excluded from the covered opinion rules by including not only the normal Circular 230 disclaimer, but additional disclosures stating the opinion was written to support the promotion or marketing of a transaction and the taxpayer should seek separate advice from his or her own independent tax advisor. The disclaimer will not be sufficient if the matter discussed is a listed transaction. The marketing requirement is met even if the opinion is given only to recommend a particular transaction to a client and members of that client’s family.

The final two types of covered opinions are those subject to conditions of confidentiality and those subject to contractual protection. Both of these also only require a significant tax avoidance purpose rather than a principal purpose to be classified as covered opinions. The requirements of the first type are met if the practitioner imposes a restriction on the disclosure of either the tax treatment or the structure of the transaction to protect the confidentiality of the practitioner’s tax strategies. These types of restrictions were often used in some tax shelter opinions.

The contractual protection type of an opinion would provide that the fees could be fully or partially refunded if the intended tax results are not obtained. In the alternative, the practitioner could not collect fees unless a favorable result was reached. The IRS has made it clear the practitioner cannot avoid this type of transaction by classifying something as not being a fee when the IRS determines that it is a fee.

Covered Opinion Requirements
A covered opinion must comply with four specific requirements, each with its own conditions. The first of these is the identification of factual assumptions. These must be individually identified in a separate section so the reader can determine what facts the practitioner relied upon and may be relevant to the taxpayer. The factual assumptions cannot be unreasonable. For this requirement there is a known or should-have-known standard.

Statement No. 3 of the Statements on Standards for Tax Services provides that a CPA can rely, without verification, on information supplied by the taxpayer or third parties. This Standard also requires reasonable inquiries if the information appears incorrect, incomplete or inconsistent. The Circular 230 standard does not allow the practitioner to rely upon unreasonable factual representations, statements or findings of others. It makes no reference to reasonable inquiries if the information appears unreliable. Thus, the practitioner issuing a covered opinion may be at risk if he cannot confirm all factual assumptions.

The next requirement is that the opinion must relate the applicable law to the facts. Applicable law includes “potentially applicable judicial doctrines.” It is generally understood these doctrines will include the substance over form doctrine, the business purpose doctrine, the step transaction doctrine and the reciprocal trust or reciprocal transfer doctrine.

In arriving at an opinion, the practitioner can assume a favorable resolution of any significant tax issue only where the opinion is a limited scope opinion or the practitioner is relying on the opinion of another practitioner who is competent to give advice on the issue presented. There is also a requirement that the opinion not contain any internally inconsistent legal analyses or conclusions.

The next requirement is the opinion must evaluate all significant federal tax issues. It must analyze each issue and come to a conclusion as to whether the taxpayer will prevail on each issue. Again, the limited scope opinion and reliance on the opinion of others exceptions may apply.

The opinion must arrive at an overall conclusion as to the likelihood that the federal tax treatment of the transaction is proper and state the reasons for this conclusion. As stated earlier, when the opinion is a marketed opinion, the conclusion must be a more-likely-than-not conclusion.

Limited Scope Opinions and Other Written Advice
Sec. 10.35(C)(3)(v) allows a written opinion to be a limited scope opinion and thus meet less stringent standards. The CPA and the taxpayer must agree the scope of the opinion is limited, and the reliance on the opinion for penalty avoidance is also limited. This form of opinion will need to include a Circular 230 disclaimer. It cannot involve a listed transaction and it cannot be a marketed opinion.

The best way to establish these limits is in the engagement letter.

This form of opinion is a good alternative when the tax issues are difficult and the transaction has a significant tax avoidance purpose. In this form of an opinion, the CPA can make reasonable assumptions regarding favorable resolution of certain tax issues for the purpose of arriving at an opinion on the remaining issues. If these favorable assumptions are used, the CPA must identify each of them in a separate section of the opinion.

Other written advice includes preliminary advice when it is understood that a subsequent opinion will be issued, advice concerning the qualification of a qualified plan, bond opinions and opinions in SEC filed documents. Advice given as to the tax benefits of a transaction is also allowed after the tax return containing the transaction has already been filed. A CPA may also give written advice to his or her employer as to matters relating to the employer’s tax liability. Initially, it was not possible to issue a negative opinion that the matter would not be resolved in the taxpayer’s favor. In Treasury Decision 9201 issued on May 18, 2005, this was overturned and the CPA can now issue a negative opinion.

Circular 230 Disclaimers
As mentioned earlier, the CPA should institute a standard to include a disclaimer on anything relating to federal taxes given to a client or potential client unless the CPA intends to issue a covered opinion. Failure to do so, and a subsequent determination by the IRS that the “writing” constitutes a covered opinion and does not meet the required standards, could result in sanctions.

Thus, the “best practice” is to include the disclaimer.

Initially it was proposed the “prominent disclosure” of the disclaimer meant it must be in a typeface larger than any portion of the writing. This was subsequently changed so it only needs to be in the same size as the largest text in the writing.

If you do a web search on “Circular 230 Disclaimers” you will find a wide range of wording. Some are extensive and some are very brief such as, “This document was not intended or written to be used, and it cannot be used, for the purpose of avoiding tax penalties that may be imposed upon the taxpayer.”

Some firms use different disclaimers for different purposes including using a disclaimer in an engagement letter. One concern of the CPA is the client’s perception of the disclaimer, especially when they are reading it in light of the invoice they just received for the work that included the disclaimer.

After reviewing a number of disclaimers, you should determine what best suits the firm for its various purposes. Remember the necessity to include such a disclaimer on e-mail and faxes.

Recently, members of a Detroit-area CPA firm indicated they often send out handwritten notes along with tax returns or other correspondence. Firms who utilize a similar technique in their practices might want to consider a rubber stamp with a disclaimer for these notes along with admonition to those using them to print small. One example of a disclaimer is as follows:

Circular 230 Disclosure: The following disclosure is required pursuant to Circular 230 which sets forth best practices for tax advisors.

To the extent the above contains an opinion on one or more federal tax issues such opinion was not written to be used and cannot be used for the purpose of avoiding penalties. If you would like a written opinion on one or more federal tax issues addressed above upon which you can rely for the purpose of avoiding penalties please contact me.

Sanctions for Circular 230 Violations
The IRS Office of Professional Liability can impose fines, censure, suspension or disbarment from practice before the IRS for a number of reasons. One reason is for the willful violation of any of the Circular 230 rules other than the “best practices” rules, since those are considered aspirational.

In addition, sanctions can be imposed upon a tax practitioner for recklessly, or through gross incompetence, violating other Circular 230 provisions including (10.34) advising with respect to tax return positions and for preparing or signing of tax returns; (10.35) the requirements for covered opinions; (10.36) the procedures to ensure compliance with covered opinion rules; and (10.37) the requirements for written advice other than covered
opinions. Prior to June 21, 2005, these sanctions applied
to willful violations, the Sec. 10.34 requirements and
tax shelter opinions.

Complaints can be filed both by IRS employees, the public
or other tax practitioners. Similar to an MACPA ethics complaint, if the referral appears to have merit, the Office
of Professional Responsibility notifies the tax practitioner
in writing and requests a response. The tax practitioner
can also request a conference prior to the evaluation
of the case.

Subsequent to the evaluation, the matter is either dismissed, the parties agree to the form of sanction or if no agreement is reached the matter is turned over for an administrative hearing. Sanctions are published in the Internal Revenue Bulletin and published on the IRS web site. In addition the IRS may notify the accountancy board or other state licensing agency of the sanctions. The Office of Professional Responsibility is seeking legislative changes making disciplinary hearings public.

Guidance on Firm Tax Policy
Traditionally, Circular 230 involved practitioner-oriented requirements and sanctions. This has now been expanded. Section 10.36 requires those practitioners “who have or share principal authority and responsibility for overseeing a firm’s practice of providing advice concerning federal tax issues must take steps to ensure that the firm has adequate procedures in effect for all members, associates and employee for purposes of complying” with the covered opinion requirements of Circular 230. As previously noted, sanctions can be imposed not just at the individual level but also against the firm for failing to have adequate procedures in place.

The AICPA Tax Executive Committee has issued Proposed Statement of Standards for Tax Services, Quality Control, dated Dec. 30, 2005. There is a comment period until
Aug. 31, 2006. The final Statement is expected to become effective June 30, 2007. This Proposed Statement recommends both CPA firms and CPAs in industry establish quality control standards to insure member compliance with the AICPA Code of Professional Conduct in the performance of tax services, and that an adequate monitoring and documentation system be established for this purpose.

The Proposed Statement goes beyond the Circular 230 requirements, but the June 30, 2007 effective date requires that a CPA firm at a minimum adopt an interim policy to deal with Circular 230. In adopting the interim policy, the CPA firm should consider reviewing the proposed AICPA requirements and attempt to include them within the interim policy.

It is highly recommended that the CPA firm not wait until June 30, 2007 to put a policy into place. Even though the best practices requirements are aspirational, Sec. 10.36 in referring to best practices, states “tax professionals are expected to observe these practices to preserve public confidence in the tax system.” Thus, it is recommended even an interim policy make reference to following both the Code of Professional Conduct and the Statements on Standards for Tax Services as part of the CPA firm’s best practices.

Overall Conclusion as to Circular 230
The effective date was June 21, 2005, but the rules are still evolving and are not clear. Practicing Law Institute, an arm of Thompson, was slated to publish a Circular 230 Manual. Due to publishing difficulties, it has been delayed twice. This is indicative of the problems practitioners are having with these new rules and requirements.

CPAs should immediately begin using disclaimers and explaining to their clients why they are using them. CPA firms should institute policies on written opinions in order to protect themselves. They should also make sure the policies are followed. They should also consider what range of fees they will need to charge to issue a covered opinion.

Over the next year or so, we should see more definitive information regarding Circular 230. Both the AICPA and the Tax Section of the American Bar Association are very active in communicating these problems with the IRS, and can be expected to continue to do so. The AICPA and others including malpractice insurance carriers will be also providing additional guidance on including Circular 230 issues in engagement letters.

About the Author
Raymond T. Rowe is licensed to practice law in the State of Michigan and is registered as a Certified Public Accountant. He frequently lectures at MACPA events and serves both on the Board of Directors and a number of task forces including Ethics.

This article has been written to provide general information to the readers thereof and does not create a client relationship with the author. The information also is not intended or written to be used nor may it be relied upon to avoid any penalties that may be imposed under the Internal Revenue Code on the reader.

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