Ohio Tax Lawyers: Tax Opinions and Private Letter Rulings
Tax Opinions as an integral part of Tax Planning
On May 18 2005, the IRS clarified the rules governing lawyers and accountants who practice tax law before the IRS, with the regulations taking effect on June 20, 2005.
These rules state that any written advice on any transaction whose purpose is the reduction, elimination, avoidance or evasion of any tax (including income tax, corporate tax, estate tax or gift taxes) must adhere to specific guidelines to protect the taxpayer from tax penalties as high as 40 percent. The opinion must be written by a tax practitioner "knowledgeable in all areas of tax law." An opinion by an advisor without that background will not protect the taxpayer.
What is the purpose of a tax opinion?
- Initially, the proposed format of the tax opinion should dictate the form of the transaction.
- If the transaction is a novel or new transaction, the opinion causes a tax attorney to pause and reflect as to what legal theory or substantial authority will support the transaction as it is currently designed and how it will be reported for tax purposes.
- If additional documentation is necessary, it is crucial that the documentation be prepared contemporaneously with the transaction rather than later.
- To convince the IRS to accept the tax transaction in whole or in part, or if the tax position is challenged, to avoid penalties.
- Penalty protection
Do Tax opinions vary?
Comprehensive non-covered opinion. Four main requirements in addition to a thorough discussion of the issues, the law, and the facts:
- The opinion may not be based on unreasonable factual or legal assumptions. Section 10.37 Circular 230
- The opinion may not unreasonably rely on representations.
- The opinion may not be given if it does not consider all relevant facts that the practitioner knows or should know.
- The opinion may not "take into account" the possibility that (1) a return will not be audited, (2) an issue will not be raised on audit, or (3) an issue will be resolved through settlement.
- Consequences of Noncompliance. If an advisor fails to comply with the requirements of Circular 230, the Treasury Department has statutory authority to disbar or suspend an advisor from practice before the Treasury, as well as to censure the advisor or impose a monetary penalty.
- A limited scope opinion addresses less than all of the significant federal tax issues, provided that the client agrees that his potential reliance on the opinion for purposes of penalty protection is limited to those issues that are addressed.
A limited scope opinion is required to contain prominent disclosure to the effect that:
- The opinion is limited to those issues addressed therein.
- Additional issues may exist that could affect the tax treatment of the transaction, and the opinion does not consider or provide a conclusion with respect to any such issues.
- The opinion may not be relied on for penalty protection with respect to and any issues outside its scope.
Reasonable basis. The reasonable basis tax regulations provide that "reasonable basis" is a "relatively high standard," higher than "merely arguable" or "merely ... colorable." Reasonable basis has significance in four contexts, three of which operate consistently. In light of this, the prevailing interpretation of reasonable basis as requiring something less than a one-in-three chance may not be totally unassailable.
- A taxpayer who is facing a substantial understatement penalty under section 6662(b)(2) can avoid the penalty if (1) he specifically discloses the position, and (2) there is a reasonable basis for the claimed treatment;
- A preparer facing a possible preparer penalty under section 6694 can avoid the penalty if (1) the preparer specifically discloses the position, and (2) there is a reasonable basis for the claimed treatment.
- For negligent disregard penalty of section 6662(b)(1),118, a taxpayer is not treated as negligent in claiming a position for which there exists a reasonable basis. As is the case for substantial authority, the operative legal provisions that directly depend on reasonable basis all turn on whether a reasonable basis is actually found to exist, not on the taxpayer’s belief, reasonable or otherwise.
Substantial authority. There is "substantial authority" for a position if the weight of authorities in support of the position is substantial in relation to the weight of authorities supporting contrary treatment. Reg. § 1.6662-4(d)(3)(i).
- Tax Regulations provide that a wide variety of different types of authority are taken into account in evaluating whether substantial authority exists. Significantly, private letter rulings, technical advice memoranda, and general counsel’s memoranda, which cannot technically be cited as precedent can nonetheless be taken into account when evaluating substantial authority. Both favorable and contrary authorities are taken into account, with the weight accorded to each dependent on its relevance, persuasiveness, type of authority, and in the case of some types of authority, age. There can be substantial authority, even in the absence of any decided cases or rulings on point, based on a well-reasoned construction of the applicable statutory provision. The regulations specifically acknowledge the possibility that there can be substantial authority for more than one position.
The substantial authority standard can be used to avoid penalties.
- Substantial understatement penalty under section 6662(b)(2); Substantial understatement penalty for a corporate taxpayer in connection with a tax shelter.
- Reportable transaction understatement penalty under section 6662A,
- Section 6694 penalty
- A substantial authority opinion can function as a comfort opinion to provide the taxpayer with some comfort that, even if he loses on the substantive issue, he can still avoid a penalty based on substantial authority, but like any comfort opinion, the mere existence of the opinion will not help if the Service disagrees with the opinion’s conclusion.
- More likely than not. "More likely than not" means a greater than 50% chance. Nonetheless, the term may be deceptively simple. In some situations, issues can arise as to the practical application of "more likely than not." Under FASB FIN 48 in order to determine whether any portion of the claimed tax benefit can be recognized at all, the standard is "more likely than not"; that the company must conclude that, on its merits, the position would more likely than not be sustained.
- Should Opinion. A "should" opinion" suggests a reasonably high level of confidence that the position will be sustained— significantly higher than "more likely than not"—but allows for a not insignificant risk of being wrong.
- Will Opinion. A "will" opinion is consistent with a conclusion that there is no material risk of being wrong. It represents a level of comfort such that if public disclosure were prepared on the issue, it would not be necessary to disclose the risk of being wrong.
When should the opinion be written?
- If the return position precedes the opinion, the reasonable cause defense may not apply. After all, a taxpayer must first receive tax advice to claim good-faith reliance on it.
- While tax advice is broadly defined to include any communication containing the adviser’s conclusion, and that includes verbal advice. It may be risky to prove that the verbal advice and written advice was the same.
Should a tax opinion be given to my accountant or return preparer or to the IRS?
- No. this will provide a road map to the IRS as to the pros and cons of the transaction and will impliedly waive the attorney client privilege. The accountants who will prepare the return are not protected by the attorney-client privilege unless the lawyer uses a Kovell letter to engage the accountants directly. If the client provides the full opinion letter to the accountants this allows the IRS to obtain the opinion.
In lieu of the accountant can be provided with a short summary letter that:
An opinion should aid in handling a tax controversy. Due to the constraints in IRS examination and Audits, it will be a great advantage to have a fully developed argument at your fingertips and can cause the advantage to shift to your side. These can be selectively used in 30-day appeal.
- notes that the lawyer was engaged by the client to render a tax opinion on a particular issue;
- states that the opinion is protected by attorney client privilege, which is not waived by the short summary;
- notes that the accountant is the return preparer for the client and that the opinion concludes there is substantial authority (or another standard) for the return position;
- instructs the return preparer to rely on the lawyer for this return position;
- instructs the return preparer to disclose the item (if appropriate) and suggests exactly how to do it; and if desired, requests the accountant to send the lawyer a draft of the return so the lawyer can verify these points before the return is filed.
When does the attorney drafting the opinion become the tax preparer?
The statutory definition of a tax return preparer (section 6694 and 7701(a)(36)) is "any person who prepares ... for compensation ... all or a substantial portion of any return ...."
This includes: (1) signing tax return preparers, who have primary responsibility for the overall substantive accuracy of a return; and (2) non-signing preparer is any tax return preparer who prepares all or a substantial portion of a return with respect to events that have occurred at the time the advice is rendered.
Substantial portion of the return is based on whether the potential preparer knows or reasonably should know that the tax attributable to such item is a substantial portion of the total tax required to be shown on such return. A safe harbor provides that an item is not substantial if it involves an amount of gross income, a deduction, or an amount on the basis of which a credit is determined that is (1) less than $10,000, or (2) less than (a) $400,000 and (b) 20% of the gross income item on the return.
Private Letter Rulings
A taxpayer may request an advance ruling, based a certain set of facts, from the IRS, which, once secured binds both the taxpayer and the IRS on those certain transaction and tax consequences.
- A favorable ruling will provide taxpayers with a measure of certainty as to the tax consequences of a particular transaction, unless, of course, the facts surrounding the transaction turn out to be materially different from those previously stated in the ruling request.
- A typical ruling request may involve a 9100 Relief where the taxpayer is requesting the IRS to excuse the failure to act on a timely basis, such as the failure to file an election or a similar matter.
- Our firm has requested and received numerous favorable private letter rulings.
- In addition to the benefit of a favorable ruling, the ruling process itself may prove advantageous to a taxpayer, where the Service may recommend changes in a proposed transaction to assist the taxpayer in reaching the desired tax result.
Negative reasons to apply for a ruling request.
- The IRS has significantly increased the user fee to process a private letter ruling from a modest fee any taxpayer could afford to approximately $ 26,000.00 (2015).
- Professional fees have to be paid in obtaining a ruling.
- With fewer Service personnel, there may be a substantial delay to obtain a ruling.
- The response to requesting a ruling may be unfavorable.
- If the ruling request is withdrawn, it should be anticipated that the National Office will notify the field office and, as a consequence, there will be a greater likelihood of an audit or examination of the transaction than if no ruling request had been filed.
- The National Office attorney or technical personnel may raise collateral issues in the course of the ruling request process that may not be easily answered or dealt with.