Posted Jul 13, 2004 09:26 pm CDT
Reform is needed to deal with serious abuses, says Richard A. Shaw, a San Diego lawyer who chairs the ABA Section of Taxation. But he cites concerns that the new rules could affect even ordinary business transactions.
As an example, Shaw points to temporary regulations that define a tax shelter as broadly as possible to include almost any sale of a business involving a confidentiality agreement.
Consequently, Shaw says, the section has been promoting needed reform while trying to prevent the new rules from having too wide a sweep. Section members, along with members from the ABA Section of Business Law, are also part of the Task Force on Tax Shelter Issues established by the ABA earlier this year to assure that professional standards and best practices are met.
A tax shelter can, of course, be a legal and appropriate way to reduce income tax. But news accounts have detailed an increasing number of questionable practices involving tax transactions with no valid business purpose.
In some cases, lawyers have been accused of charging high fees—as much as $50,000 or more—for minimal work done on a single, boilerplate opinion letter. Opinion letters stating that a tax transaction is likely to pass muster with the Internal Revenue Service have been used by taxpayers to show good faith when defending against IRS penalties for underpayment of taxes.
Key to the legislative reform efforts are proposed revisions to certain Treasury Department regulations. They are temporarily in effect right now, contained in Circular 230, which was revised late last year. But practitioners “are planning for that to be the reality,” says Kathleen Pakenham, a New York City tax lawyer who is a member of the Taxation Section’s Committee on Court Procedure and Practice.
All tax lawyers must “be aware of what’s going on with respect to Circular 230,” Pakenham says, “even if they do just their ordinary transactional-type work” and their practice does not focus on tax shelters.
New or revised sections of Circular 230 codify best practices to be used by lawyers writing tax shelter opinion letters and require law firms to establish procedures to make sure individual lawyers are in compliance with the requirements. For example, lawyers who draft the letters must have full knowledge of the facts, consider all material legal issues and apply appropriate legal standards before issuing an opinion letter. Otherwise, a client cannot rely on the opinion to avoid tax penalties.
“If the practitioner is unable to reach an overall conclusion, the opinion must state that and describe the reasons for the practitioner’s inability to reach that conclusion,” Shaw notes.
To ensure compliance, firms must now designate one attorney who must make reasonable efforts to see that all firm lawyers are following the new rules.
Congress is likely to address another problem—a lack of effective penalties to deter promotion of abusive tax shelters, Shaw says. Often, he says, “The money to be made far exceeded the risk of fines.” He cites one reported incident in which an accountant allegedly realized a tax shelter was problematic: The potential fine was only about $30,000, while the potential profit was more than $300,000.
As far as the new best practices are concerned, “I would hope that most of us were already living up to the standards,” Pakenham says. However, “The definition of tax shelter is giving people pause because it is broader than what you would commonly think to be an abusive-type transaction.” As a result, Circular 230 requirements could apply to tax advice even when there is no formal written opinion. “I think it’s going to make the practice of tax law a lot more onerous.”