Tax Law and Business Organization Strategy

Covered Opinions under Circular 230

IRS's rules on written advice provided to clients by tax practitioners have been tightened. Anyone who obtains the services of a professional tax advisor should be aware of how these new rules affect the advice they receive.

The rules are contained in “Circular 230” and apply to “covered opinions” (formerly known as “tax shelter opinions”). A covered opinion is defined as written advice, including electronic communications (i.e., e-mail, faxes), on a federal tax issue arising from

  1. a transaction IRS has determined is a tax-avoidance transaction,
  2. a partnership or other entity or investment plan, or any other plan or arrangement, that has tax avoidance or evasion as a principal purpose, or
  3. a partnership or other entity or investment plan, or any other plan or arrangement, that has tax avoidance or evasion as a “significant purpose,” if the written advice is a “reliance opinion” (explained below), or “marketed opinion” (i.e., the opinion will be used by a promoter to market an investment).

Since the term “significant purpose” is not precisely defined, the rules could conceivably apply to routine tax advice provided in writing.

A “reliance opinion” is the type of written advice these rules would most often apply to. A reliance opinion is defined as written advice concluding that it's more likely than not that one or more significant federal tax issues would be resolved in the taxpayer's favor in the event of an IRS challenge. It's called a reliance opinion because a taxpayer normally relies on it to establish reasonable cause to avoid tax penalties which may later arise. However, except for tax avoidance or evasion situations (or certain transactions known as “listed transactions”), written advice will not be treated as a reliance opinion if the practitioner discloses in it that it was not intended or written by the practitioner to be used (and that it cannot be used) by the taxpayer to avoid penalties that may be imposed (a disclaimer).

Under the rules, unless the advice contains the above disclaimer, practitioners are required to do the following regarding the advice:

  1. Use reasonable efforts to identify and ascertain the facts relevant to the transaction, and the advice must identify and consider all facts the practitioner determines to be relevant.
  2. Relate the applicable law to the relevant facts.
  3. Evaluate the significant federal tax issues and provide a conclusion on whether the taxpayer's position on each issue is likely to prevail.
  4. Provide an overall evaluation of the likelihood that the tax treatment of the transaction is proper (with the reasons provided).

Due to the tighter standards imposed by the new rules, the cost of providing undisclaimed written tax opinions will likely be higher.

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