Modifying Opinion Letters for Tax Shelters

[SoCalActuary]

IRS just published changes in Circular 230, covering practice before the IRS.

By way of background, some promoters of tax shelters received opinion letters from law firms that a particular program would satisfy requirements for favorable tax treatment. These opinion letters are used in the marketing promotion materials.

The IRS has found that some of these programs did not work as contemplated by the law firm, or simply disagreed on the tax benefit. After declaring that the tax benefits did not exist, the IRS sought to impose penalties unpon the taxpayers for taking an unreasonable position. The taxpayers got penalties waived by reference to the original opinion letter.

The new IRS position is to force the originators of these opinion letters to issue more caveats about their use, or to hold the writers responsible for their action.

for more info: http://www.irs.gov/2005-04_IRB/ar10.html

[rcline46]

If the promotors of the tax shelter don't have the guts to take a client in for at least a private letter ruling, then they should be avoided like the plague.

The additional cost after getting an attorney to draft an opinion is minimal. Not doing so certainly exposes their greed at the very least.

[Guest Harry O]

I don't think whether the IRS will give you a PLR should be the standard of whether something passes muster. There are many issues where the IRS will not issue PLRs even though the law is clear. Similarly, with all due respect to our friends at the IRS, there are times when the IRS is simply wrong. It is the job of the courts sort this out. You pay your lawyer to analyze the law and give you his or her opinion on your possibility of having the transaction sustained in court, not on the possibility of whether the IRS will issue a favorable private letter ruling!

[mbozek]

I dont agree with you view of the purpose of opinion letters. Under prior law many opinion letters were issued that rendered minimal opinions, i.e., they were written in order to provide that necessary sintilla of "substantial authority" under some tax law precedent which allowed the taxpayer to avoid the substantial understatment penalites of up to 75% of the tax owed if the IRS disallowed the transaction. In other words the purpose of the opinion was to reduce the risk to the client to having to pay the amount of taxes that were otherwise due under the tax law. Under the Jobs act such opinion letters will no longer shield the client from the understatment penalities which were doubled.

[SoCalActuary]

mbozek: the teeth of that measure is found in the new circular 230 issued as a proposed regulatory position. If you issue a general opinion of suitability for a program, and you do not place the proper warnings on it, the IRS will come looking for you.

[E as in ERISA]

In the past, a taxpayer could use a "more likely than not" opinion from a tax advisor to avoid penalties. A "more likely than not" opinion was supposed to be an opinion from the tax advisor concluding that based on the current law there appeared to be at least a 50% chance that the IRS would agree with the position that the taxpayer is taking in regard to the transaction. If the IRS disagrees with the taxpayer's treatment on audit, then the taxpayer is at least protected from certain penalties.

The use of the "more likely than not" opinion is not intended to give assurances about the tax position itself. It's only a 50% opinion. It is used to protect from penalties. I think one of mbozek's primary points (?). If a taxpayer wanted assurances about the tax position, that is a different issue and they had various alternatives. They could get advice from their own consultants about their position. Or they could go for an individual PLR.

The problem is that there are now lots of "more likely than not" opinions out there that really aren't very good. In some cases, a marketed opinion is being used by a variety of different taxpayers in different factual situations, so it can't possibly be specific enough to comment on any individual's tax position. Some are just discussing an issue at a very high level. Some are only discussing a related issue -- and not the core issue on which the IRS would make its decision on the tax result. And frankly there are some out there that are probably very questionable in regard to whether there is a 50% chance that the IRS would ever agree.

As mbozek notes, the Jobs Act now changes that. It requires certain standards for those opinions in cases where there may be potential for tax avoidance or evasion. Circular 230 provides the details of what those standards are. They don't apply to all opinions. It's primarily those where the "more likely than not" might be questionable -- because the person issuing the opinion is not looking at the specific taxpayer's facts, or because its a listed transaction (one which the IRS has highlighted as being aggressive...). The Circular also allows opinions to be caveated so that they can't be used as "more likely than not opinions" for avoiding penalties.

http://benefitslink.com/taxregs/td9165.pdf

[mbozek]

The accounting firms sold tax shelters to corporations and wealthy individuals in return for 3-5% percent of the tax savings which could be into 9 figures. A law firm would provide the necessary opinion that there was substantial authority under the tax law for the tax shelter for anywhere from 50k to -1M to avoid the imposition of the tax penalites for substantial understatement (regardless of how minimial the authority for the opinion). There are several multi million $ lawsuits by clients against law firms who rendered tax shelter opinions on strategies which have been deemed illegal by the IRS. One tax lawyer was paid 93M during a 5 year period for preparing TS shelter documents for a firm that netted 271 M.

The problem with most opinion letters that are written for TS promoters is that they do not automatically extend to the purchasers of the tax shelter where the facts are different than the facts that presented by the promotetr. The letter disclaims any responsibility to any individual taxpayers who purchase the shelter (to avoid giving a free opinion).

Also the IRS does not have to give a ruling to a taxpayer and there are many areas that are subject to a no ruling policy.

[Guest Harry O]

Let's all get on the same page with our terminology as it previously existed! <g>

To avoid a negligence penalty, you needed an opinion with a "reasonable basis".

To avoid a substantial understatement penalty for NON-TAX SHELTER positions, you need either (1) a "reasonable basis" opinion PLUS disclosure, or (2) "substantial authority".

For TAX SHELTER positions, you need a "more likely than not" opinion.

For a tax practitioner to sign a return under the rules of Circular 230 (governing the standards for practicing before the IRS) or to avoid the tax return preparer penalty, the position taken on the return must have a "realistic possibility" of being sustained on its merits.

Finally, the standard used by accounting firms for public companies to record tax benefits from a transaction on their financial statements is somewhat unclear. But in most cases the standard is between a "more likely than not" opinion and a "should" opinion. This is the reason that many public companies seek opinions - they want the tax benefits from their transactions to be reflected in the financial statements. If you get a "should" opinion you have covered your bases - you are clear of IRS penalties and you satisfy your auditors.

An individual taxpayer, on the other hand, doesn't issue financial statements. They would probably seek a "substantial authority" opinion (which is generally viewed as less than a "more likely than not" opinion) to avoid penalties and disclosure.

I haven't reviewed the new Jobs Act and Circular 230 rules yet . . .

[E as in ERISA]

We were talking about tax shelters.