The New Rules on Tax Advice

These new regulations, which became effective on June 20, 2005, impose tough new requirements on professionals issuing any written tax advice. With the new regulations, the IRS is able to easily crack down on tax professionals who promote illegal tax schemes. Tax practitioners violating these new regulations may be penalized, censured, suspended, or disbarred from practicing before the IRS.

Tax practitioners giving written advice are now required to identify and consider all relevant facts and relate those facts to the law, including any judicial decisions. They must also use reasonable methods and assumptions to determine the facts. Circular 230 states that it is not unreasonable to rely on a projection, financial forecast or appraisal, unless the practitioner knows that it would be bad judgment to rely on it.

Practitioners must evaluate all material federal tax issues, except when the client and the practitioner agree to limit the scope of the opinion. This opinion cannot be marketed and must contain disclosures regarding the scope and use of the opinion.

Tax practitioners must also provide a “more likely than not” conclusion to every material federal tax issue, stating that if challenged by the IRS, the practitioner believes the tax benefits will more likely than not stand up. Also, the reasons for that conclusion must be explained. The practitioners are required to be knowledgeable in all tax aspects of any opinion given to a client.

Tax practitioners cannot base written federal tax advice on unreasonable factual or legal assumptions, including assumptions as to future events. They cannot rely on unreasonable representations, statements, findings, or agreements of the client or any other person.

When evaluating a federal tax issue, practitioners cannot consider the possibility that the tax return will not be audited, that an issue will not be raised during an audit, or that an issue will be settled favorably. This prevents, for example, professionals from playing the “audit lottery” by recommending a tax scheme based on the expectation that the tax return will probably not be audited or that the auditor will not understand the scheme.

Practitioners must take into account all relevant facts that they have knowledge of, or should have knowledge of, when giving written tax advice to a client.

Even with these new rules in place, practitioners should continue to provide tax advice in writing, rather than verbally, for everyone’s protection.

Tax professionals should limit each letter or other written advice to a single tax issue. They should also notify their clients about the new rules so the clients will not be surprised by the new disclosures and terminology.

Tax practitioners should also keep tight quality controls over their firms’ tax advice. They should authorize only certain firm members to provide issue written tax advice.

The keys to complying with these new Circular 230 regulations are to know these new rules, understand the tax laws, know the client’s facts, and take the time to write it all out carefully.