United States: Tax Talk: Volume 7, No. 2 July 2014


With the halfway mark of 2014 just behind us, we are pleased to share with you in this issue of Tax Talk some of the more noteworthy tax developments from Q2. The most important highlight of the past quarter from our neck of the woods is, without a doubt, FATCA going live July 1, 2014. Although the IRS and U.S. Treasury Department have signaled that the remainder of 2014 and all of 2015 are a "transition period," the government didn't slacken its pace in rolling out updated withholding forms, even as the FATCA deadline rapidly approached. The government also ramped up its intergovernmental approach to FATCA, entering into Intergovernmental Agreements ("IGAs") with countries such as China, India, Saudi Arabia, Singapore, and Hong Kong, just to name a few recent additions. This brings the IGA count to nearly 100, as of July 1, 2014, with more surely to come. For more information on FATCA, please be sure to visit our website, at www.KNOWFatca.com.

In spite of our FATCA preoccupation, this issue of Tax Talk also discusses other significant tax developments, such as the IRS's new regulations under Circular 230 governing written tax advice. In a substantial departure from the previous regulations, the IRS replaced the "covered opinion" rules with a single, simplified approach, designed to subject all written federal tax advice to one standard. As part of this guidance, the IRS made clear that a "one size fits all" Circular 230 email legend is not necessary in attorney/ accountant communications.

In other news, the IRS released private guidance addressing partnerships and financial instruments. In the first piece of guidance, the IRS addressed securities dealer activities of a partnership and whether those activities could be attributed to its partners (no, they cannot). In the second, the IRS addressed the consequences when a partnership no longer treats certain securities transactions as options and, as a result, stops deferring the associated gains, losses, income, or deductions (a change in accounting method and adjustment occurs).

Next, we provide an update on recently released proposed regulations addressing the scope of qualifying real estate assets for REITs: important rules as more and more corporations with nontraditional fixed assets are seeking to be treated as REITs. Turning from real estate to banking, this issue of Tax Talk also discusses a recent private letter ruling addressing a bank's tax reporting obligations with respect to certain fee credit programs maintained for commercial customers.

Finally, this issue of Tax Talk discusses three items on the international tax front. The first clarifies that taxpayers do not need to report virtual currencies on FBARs for 2013. The second describes the IRS's application of the section 956 anti-abuse rule to debunk a transaction designed to minimize a U.S. corporation's section 956 inclusion. The third discusses modifications to the IRS's voluntary offshore disclosure program.

As always, our regular section, MoFo in the News, concludes this issue of Tax Talk.


FATCA went live on July 1, 2014. Just days before the deadline, the IRS and U.S. Treasury Department released the remaining Form W-8 withholding certifications, including instructions. In addition, the number of countries entering into IGAs increased and, as of July 1, 2014, the government had signed 34 Model 1 IGAs and 5 Model 2 IGAs. The government has also agreed in substance to 52 Model 1 IGAs and 8 Model 2 IGAs (these are IGAs that have not yet been signed, but are treated as "in effect" until December 31, 2014, the date they must be signed in order to remain in effect without interruption). This brings the total number of IGAs to just under 100. The IRS has also released a revised Qualified Intermediary agreement, which will be used for agreements with an effective date on or after June 30, 2014. This revised QI agreement now incorporates certain changes necessitated by FATCA, as well as updates to reflect recently released coordination regulations. Finally, in a gesture that appears to tacitly acknowledge the headache implementing FATCA is causing for financial institutions worldwide, the IRS and U.S. Treasury Department announced that 2014 and 2015 would be treated as a "transition period," during which the IRS will approach enforcement with an alleged degree of leniency, provided foreign financial institutions demonstrate a modicum of good-faith compliance. For more information on this development, please see our client alert, "IRS Issues Notice Signaling 2014 and 2015 as FATCA 'Transition Period'."1


On June 9, 2014, the U.S. Treasury Department and IRS issued final regulations replacing the "covered opinion" rules under Circular 230.2 Effective June 12, 2014, the final rules now subject all written federal tax advice to one standard.

From a practical perspective, the most noticeable change tax practitioners (and their clients) will likely appreciate in the short run is the elimination of the need for the ubiquitous Circular 230 disclaimer from written communications, such as the disclaimers that are almost universally appended to emails from lawyers and accountants.

However, a more substantive and significant change will be the elimination of the need for determining whether written advice constitutes a "covered opinion" (as defined under the prior regulations) and whether the advice could instead be delivered in the form of a "limited scope" opinion. In addition, in either case, practitioners will also no longer be required to evaluate whether written advice satisfies all of the detailed requirements of the former Circular 230 rules, including the explicit statement of all facts relevant to the issues, identification of all assumed facts, and, if a limited scope opinion was not permissible, consideration of all significant federal tax issues that are relevant. As a result, practitioners and clients will have more flexibility to limit the scope of written advice to the particular issues of concern to the client.

Elimination of Covered Opinion Rules

The final rules eliminate the former covered opinion rules and replace them with a single "reasonableness" standard applicable to all written tax advice. As revised, Circular 230 requires practitioners in delivering written advice to:

  • base all written advice on reasonable factual and legal assumptions (including assumptions as to future events);
  • reasonably consider all relevant facts and circumstances that the practitioner knows or reasonably should know;
  • use reasonable efforts to identify and ascertain the facts relevant to written advice on each "federal tax matter";
  • not rely upon representations, statements, findings, or agreements (including projections, financial forecasts, or appraisals) of any person if such reliance would be unreasonable;
  • relate applicable law and authorities to facts; and
  • not, in evaluating a federal tax matter, take into account the possibility that a tax return will not be audited or that an issue will not be raised on audit.

The final regulations also clarify that it is unreasonable for a practitioner to rely on representations if the practitioner knows or reasonably should know that one or more representations (or assumptions on which any representation is based) are incorrect, incomplete, or inconsistent.

The final regulations permit a practitioner, in providing written advice, to rely on advice of another person unless the practitioner knows or has reason to know that the opinion of the other person should not be relied on (including because such person either lacks the qualifications necessary to give the advice or has a conflict of interest that violates Circular 230 standards).

Finally, because the final regulations eliminate the disclosure requirements that were part of the covered opinion rules, practitioners will no longer need to include Circular 230 disclaimers to avoid the covered opinion rules. This will come as welcome news to practitioners and their clients alike because, as explained in the Preamble to the final regulations, Circular 230 "disclaimers are routinely inserted in any written transmission, including writings that do not contain any tax advice." As a result, the final rules effectively eliminate the use of Circular 230 disclaimers in emails and other written communications so that tax advice can be delivered on discrete issues without risk of violation of the covered opinion rules.

Heightened Standard of Review for Marketed Opinions

While the IRS will generally apply a "reasonable practitioner" standard that takes into account all facts and circumstances in reviewing practitioner compliance with the new written requirement rules, the IRS will give more weight to the additional risk caused by a practitioner's lack of knowledge of the taxpayer's particular circumstances in transactions in which the practitioner knows or has to reason to know the opinion will be used in promoting or marketing a potentially abusive tax shelter.


In a recent Chief Counsel Advice (CCA),3 the IRS rejected a taxpayer's attempt to mark to market mortgage loans held in a non-REMIC securitization trust, finding, among other things, that loan modifications alone were not sufficient dealer activity. Unfortunately, the CCA's tangled analysis raises more questions than it answers.

In the CCA, the taxpayer was a partner in a partnership that originated and securitized mortgages. Some of the mortgages were securitized in non-REMIC trusts. Each trust that held the mortgages would issue notes to investors in exchange for cash. The trust residual was held by the partnership. The CCA does not state whether the mortgages were residential or commercial nor does it identify the type of securitization transaction.

The partnership was a dealer in securities; however, it also held some of its mortgages for investment. It is possible, although by no means clear, that the mortgages in the trusts at issue were held for investment. In any event, in a tax year after the trusts were created, the partnership sold the trust residuals to the taxpayer. The taxpayer took a basis in the mortgages equal to the amount of the trust debt plus the cash it paid to the partnership.

The taxpayer then tried to mark to market the mortgages, presumably in an attempt to claim an ordinary loss equal to the difference between the tax basis in the mortgages and their fair market value. (It would not be surprising if the mortgages were substantially depreciated when the taxpayer acquired them.) The taxpayer argued that it was a dealer in securities for federal income tax purposes either because (i) it was a partner in the partnership and the partnership was a dealer or (ii) modifications of the mortgages held by the trust (which were executed by the trust's sub-servicer) were dealer activity.

Not surprisingly, the IRS rejected the taxpayer's arguments. However, the reasoning of the CCA is contorted and is already being questioned.4 One issue in the analysis: the IRS concluded that the sub-servicer was not the taxpayer's agent. The IRS reasoned that there was no express agency under local law and that the sub-servicer was described as an "independent contractor" in the subservicing agreement. However, the construct for federal income tax purposes has always been that a mortgage servicer is a mortgage owner's agent. That is why a mortgage owner includes the full amount of income on a mortgage loan and then deducts mortgage servicing fees as an ordinary and necessary business expense or section 212 expense.5 The IRS, instead, went off on a tangent about National Carbide Corp. v. Commissioner, 336 U.S. 422 (1943), and Commissioner v. Bollinger, 485 U.S. 340 (1988), which deal with whether a corporation that is in form an owner can actually be an agent for federal income tax purposes. It is hard to see what those cases have to do with the CCA's facts; there was never any issue about whether the sub-servicer owned the mortgage loans.

In any event, the IRS also found that merely modifying loans was not a dealer activity. However, the analysis is fuzzy as to whether this is legally impossible or whether the loan modifications were not sufficiently regular and continuous in this particular case.

In an unusual twist, the IRS also had some helpful advice for the taxpayer, suggesting that perhaps the partnership could have marked to market the loans under Prop Reg. section 1.475-2(a), which requires a mark immediately before disposition by a mark-to-market taxpayer. One assumes that would only get the taxpayer half a loaf because it would only get its share of the partnership's loss rather than the full loss it anticipated.

To read this Newsletter in full, please click here.


1. Our May 8, 2014 client alert on Notice 2014-33 can be found at: http://media.mofo.com/files/Uploads/Images/140508-FATCA-Transition.pdf.

2. T.D. 9668, RIN 1454-BF96 (June 9, 2014).

3. CCA 201423019 (June 6, 2014).

4. Sheppard, "Inbound Mortgage Modifications Confound the IRS," Tax Notes, July 14, 2014, p. 105.

5. See Rev. Rul. 91-46.

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Morrison & Foerster LLP. All rights reserved

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