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IRS Circular 230 and Its Effect on Estate Planning Practice By Glenn A. Henkel, Esquire Kulzer & DiPadova, PA, Haddonfield, NJ In January, 2005, the estate planning community discovered that the IRS had provided an unusual holiday gift to estate tax advisors in the enactment of the revised and “final” Treasury Regulation referred to as “Circular 230.” These Regulations were released on December 20, 2004 and caught estate tax advisors by surprise, largely because the “final” regulations differed substantially from the previously “proposed” regulations. Typically, a set of Treasury Regulations will be proposed for a period of time before enactment, allowing the tax community to provide comments. In this situation, the IRS chose to expand the applicability of the final regulations to “federal tax issues” which include “Federal tax treatment of an item of income, gain, loss, deduction, or credit, the existence or absence of a taxable transfer of property, or the value of property for Federal tax purposes” See Section 10.35 (b)(3). The earlier “proposed” regulations focused on “tax shelter opinions” and did not seem to address estate tax planning. Nevertheless, it has been the estate planning community that has most vociferously objected to the rules. In the April 6, 2005 letter to the IRS from the American College of Trust and Estate Council (“ACTEC”), many concerns and objections were presented to the IRS. Many of the issues presented in the ACTEC letter were addressed in May 18, 2005 revisions to the Regulation by the IRS. What is “Circular 230”? Title 31 of the United States Code, Section 330, allows the Secretary of the Department of the Treasury to regulate “practice before” the Department (i.e. IRS). “Circular 230” are the regulations which govern this statutory provision and are released through the Code of Federal Regulations. The “Circular 230” regulations were amended to be effective after June 20, 2005 (Volume 69, Number 243, CFR, amended December 20, 2004). These regulations apply to anyone that “practices before” the Internal Revenue Service. It is not entirely clear what it means to “practice before” the IRS, but it has been generally construed broadly to include anyone (attorney, accountant, enrolled agent) that provides any type of tax advice, whether by written opinion, recommendation or tax return preparation. The “final” regulations released in December were “clarified” by the IRS on May 18, 2005, largely due to comments from tax advisors. See T.D. 9201. The IRS stated that it was and is concerned tax practitioners were providing advice to clients which could undermine public confidence in the self-assessing tax structure. Therefore, these rules seek to prevent advice from being rendered- unless the advice is thorough and precise. In fact, by revising the rules for tax practitioners, the IRS may have inhibited the flow of information from tax practitioners to the public on all transactions because of what the IRS has subjectively deemed to be potentially abusive transactions. By now, most estate planners have noticed that all letters, e-mails, memos, engagement letters, fax transmittals sheets and other correspondence from anyone remotely connected to tax practice bears a banner “disclaiming” the right of the reader to rely on the writing for penalty protection. What effect has this practice had on tax practice? Probably less than had been originally feared. Early on, some commentators suggested a sea change in the relationship between tax advisors and their clients. I, for one, have not had a single question from clients about the new “disclaimer banners”. Was this “disclaimer” practice the intended objective of the IRS? No, the IRS has attempted to discourage disclaimers and instead has advocated a conscious decision for each advisor to attempt to determine whether each piece of correspondence is a transaction subject to the rules. Most tax advisors and their firms have determined that it is too difficult to consider the question with each piece of correspondence and, in fact, many firms have mandated the “disclaimer banners” on all correspondence unless otherwise determined (through special procedures) that it could be deleted. How did this situation occur? Previously, Congress had attempted to restrict questionable tax positions by authorizing the IRS to impose penalties on taxpayers who take positions which are later deemed to be contrary to existing law. However, one mechanism for penalty abatement by the taxpayer is a claim of reliance on a competent tax advisor, tax attorney, licensed public accountant or enrolled agent. A penalty may be abated for “reasonable cause” where the advice is based upon all pertinent facts and circumstances and the law as it relates to those facts and circumstances. The Circular 230 Regulations have attempted to limit instances in which a taxpayer can claim that reliance on a tax expert’s advice amounts to “reasonable cause.” The unique aspect of Circular 230 is the manner in which the government obtains this goal. Under Circular 230, if a tax practitioner issues a written tax opinion that is based upon unreasonable factual or legal assumptions, unreasonably relies on representations, statements, findings or agreements of the taxpayer or any other person, fails to consider all relevant facts, or takes into account the possibility that a tax return will not be audited, an issue will not be raised on audit, or that an issue will be settled – the tax practitioner faces sanctions. The result being that the tax practitioner now has a vested interest in making certain the information upon which they are relying in issuing a written tax opinion is true and correct. Unfortunately, it appears that this regulation has gone too far because it exacts the same standard to sophisticated transactions and many non-controversial or “routine” tax advice. IRS Chief Counsel Don Korb and IRS Office of Professional Responsibility Director Cono Namorato have advised that practitioners should try to adopt a “common sense” approach when dealing with the regulations, notwithstanding the broad scope of the written words. The operative rules are, essentially, very simple. Unfortunately, however, because the rules are very sensitive to many definitions, trying to obtain a complete understanding of the operative rules can be problematic. The essential requirement is that when a tax practitioner renders tax advice which is not exempted by certain exceptions (called a “covered opinion”), a large and substantial quantity of due diligence and legal work needs to be performed by the advisor so as to prevent a client from later claiming that they did not understand the nature of the transaction in which they are engaged or that the advisor misunderstood the facts upon which the advice was based. Unfortunately, there is no dollar threshold for this requirement and thus it can create economic difficulties for clients seeking advice where they do not wish to spend as much as $30,000 (or more!) on a legal opinion for a relatively small and non-controversial transaction. Moreover, there is no excuse for an advisor if the recommendation is, on its face, routine. One particular problem in estate practice is that a routine recommendation at the outset (while the advisor is involved) may ultimately become “aggressive” in implementation, perhaps without the involvement of the original planner. For example, suppose a family acquires an investment property with the help of the family lawyer. Many years later, there could be a transfer of units that make the original transaction appear to have been a “family limited partnership” of the type that has so deeply upset the IRS in many recent cases. Similar examples could be made for “Crummy Trusts”, “By-Pass trusts” and other seemingly routine transactions. The operative rules of Circular 230 will apply in three circumstances. If a tax advisor is giving out written advice about (1) a listed transaction (or a transaction “substantially similar” to a listed transaction); or (2) on a partnership or other entity, investment plan or arrangement or any other plan or arrangement, the principal purpose of which is the avoidance or evasion of tax (the principal purpose transaction); or (3) a partnership or other entity, investment plan or arrangement or any other part of a plan in which a significant purpose is the avoidance or evasion of tax. The special rules for use of a disclaimer can apply to a “significant purpose” arrangement; however, “listed transactions” and “principal purpose” transactions require a full legal opinion in all events unless the opinion is negative (i.e. that the position will not succeed). Questions had also been raised whether tax articles and instructional materials can be deemed to be “marketed opinions” under Circular 230, as they meet all of the criteria for the definitional guideline. However, two New York attorneys wrote to the IRS confirming their earlier discussion with the IRS that it is not “tax advice.” This caused more controversy as Michael J. Desmond, Treasury Acting Deputy tax legislative counsel, advised that unanswered letters about private discussions are not IRS “guidance.” Instead, he advocated revision to the Circular rules “after the dust had settled.” While the IRS had lofty goals in establishing the Circular 230 Guidelines, the breadth of the language used has created an unintended result. Under Circular 230, more aggressive advice will often be provided “orally,” as the standards do not apply unless written. The “disclaimer” on ALL correspondence is, of course, ridiculous; however, it is seemingly unnoticed by most clients. Since senior IRS officials have lamented that the results (of routine disclaimers on all correspondence) were not expected and should be discouraged it can be assumed that there will be modifications. However, to date, the IRS has refused to weaken the language for fear that crafty counselors may slip through its reach. Nevertheless, some experts have suggested that, while originally a mark of unworthiness, the “disclaimer” has become a badge of honor to sophisticated tax planners. For some, however, a disclaimer is misleading because the taxpayer may be able to rely on the writing for penalty protection– notwithstanding the disclaimer. In a nutshell, the Circular 230 rules have not caused the havoc in estate practice that could have occurred without the May 18, 2005 revisions. However, they do not appear to have achieved the IRS’ goals, at least as to routine estate planning transactions. Thus, some revision can be expected at some time “when the dust has settled” and in the interim, planners should continue to take due care in their correspondence to clients and add appropriate “disclaimer” banners on writings to prevent possible repercussions against the advisor. Department of Treasury Regulation Circular 230 requires that we notify you that you cannot rely on this advice for protection against tax penalty. This article was neither intended to be used for the purposeof avoiding any tax penalty nor relied on in support of any marketed transaction. You should seek advice from an independent tax advisor based upon your personal circumstances.
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