United States: New Rules Governing Written Tax Advice

Treasury Department Circular 230 establishes standards of practice for attorneys, accountants and other tax professionals who practice before the Internal Revenue Service. Recent amendments to the regulations issued under Circular 230 have caused most tax professionals to change the way in which they provide written advice to their clients. This article provides some background about the changes to Circular 230.

The Treasury and Internal Revenue Service have explained that the amendments to Circular 230 are part of their ongoing efforts to improve ethical standards for tax advisors and to curb abusive tax avoidance transactions. However, the changes are far-reaching and affect all kinds of written tax advice, including routine tax advice provided in connection with ordinary business transactions. In addition, practitioners who fail to comply with the standards set forth under Circular 230 face stiff penalties that include suspension and disbarment from practice, as well as fines and public censure. The amendments to Circular 230 are effective as of June 21, 2005.

The rules in Circular 230 are not limited to formal tax opinions. As a result, tax professionals must monitor all forms of written communications including emails, letters, memoranda, private offering circulars and other documents. Under the new rules, written tax advice generally falls into one of two categories: It is either (i) a "covered opinion" that provides penalty protection but that requires extensive factual due diligence and legal analysis; or (ii) other written advice that does not offer penalty protection. A cornerstone of the new rules is that in many cases the tax advisor must prominently disclose the consequences of the written advice in order to avoid the burdensome requirements of a covered opinion. For example, unless a covered opinion is being issued, written tax advice must include a legend explaining that the advice cannot be relied upon for penalty protection. In addition, where the tax advice may be used or referred to in marketing, promoting or recommending a transaction to another person, the legend must also explain that the advice was written to support the promotion and marketing of the transaction and that the taxpayer should seek advice based upon the taxpayer’s particular circumstances from an independent tax advisor.

The rules vary depending upon the type of tax advice that is given. Some forms of written tax advice are not subject to the new rules for covered opinions. For example, there are exceptions for tax advice included in documents required to be filed with the Securities and Exchange Commission and for tax advice relating to issues that are reflected in a tax return that has already been filed. Other forms of tax advice are subject to the requirements for covered opinions, but the legends described above cannot be used to avoid those requirements. Such tax advice includes advice relating to a transaction where the "principal purpose" of the transaction (as opposed, for example, to a "significant purpose" of the transaction) is the avoidance or evasion of federal tax and advice relating to certain "listed" transactions specifically identified by the Internal Revenue Service.

In response to final regulations under Circular 230, we (along with most other law firms) will be automatically including legends in our email correspondence and in most of our letters, memoranda or other documents that contain tax advice. The legends will allow our tax advisors to avoid rendering covered opinions in situations where such opinions are not intended or warranted and where our clients would prefer to avoid the additional time and expense associated with issuing such opinions. In these situations, even though our written advice alone cannot be used for penalty protection, our clients may have other defenses to penalties (such as the existence of "substantial authority" to support the positions reflected in our advice).

In the majority of situations, such as casual responses sent by email, we expect that the use of legends will have no practical impact on our clients since neither we nor our clients would have expected the tax advice to be construed as an opinion that alone would provide penalty protection. In other situations, our clients may appropriately want a covered opinion that does not include the disclaimers. In those situations we, of course, will be happy to work with you to provide such advice.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.