Revised IRS Circular 230 new 6/23/05

The IRS issued new rules effective June 20, 2005 affecting how tax professionals communicate with clients with written advice, including e-mails, faxes, and letters, on tax issues.

The rules grew out of the government’s decision to attack the mechanisms used by tax shelter promoters to sell abusive tax shelters, but apply to advice given on many common and accepted transactions.

The rules address the promoters' practice of obtaining boiler-plate opinions for tax shelters. Taxpayers engaging in abusive transactions use these types of opinions to escape tax penalties of 20% or more on top of taxes they owe by claiming they “reasonably” and “in good faith” relied on the tax opinion for their belief that the transaction was permissible.

The rules apply to tax advice for transactions having a “significant purpose” of tax avoidance. This standard is vague and uncertain, in large part because the IRS did not want to create any loopholes. Consequently, the new rules may sweep in many routine, non-abusive transactions.

In the new IRS rules clients cannot rely on a tax opinion for protection from penalties unless the practitioner provides a comprehensive opinion that considers and discusses:

  1. All relevant facts and applicable law,
  2. The relationship between the facts and the law,
  3. A conclusion as to the legal consequences of each tax issue, and
  4. The likelihood that the taxpayer will prevail if the IRS challenges the transaction.

The penalties to practitioners can be severe for providing written advice that does not meet these requirements, including disbarment from practice before the IRS.

Because of the new rules the cost of securing a comprehensive opinion will be higher. An alternative to writing an expensive opinion is to include a disclaimer on written advice furnished to the client stating that the client cannot rely on the opinion for protection from tax penalties, e.g.,“This written advice is not intended or written to be used and cannot be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer.”

Even with this legend, there are other defenses to penalties available if the IRS challenges a transaction.