IRS proposes changes to Circular 230 rules governing written tax advice

On Friday, the IRS released proposed regulations that would eliminate the complex rules in Circular 230 governing covered opinions (REG-138367-06). To replace the covered opinion rules, the proposed regulations would expand the requirements for written advice under Circular 230, Section 10.37. The proposed regulations would also make several other changes to Circular 230.

Covered opinions

Current Circular 230, Section 10.35, contains detailed rules for tax opinions that constitute “covered opinions.” Covered opinions include written advice concerning:

1. A listed transaction;
2. A transaction with the principal purpose of tax avoidance or evasion; or
3. A transaction with a significant purpose of tax avoidance or evasion, if the advice is a reliance opinion, marketed opinion, subject to conditions of confidentiality, or subject to a contractual protection.

Practitioners must comply with extensive requirements when providing written advice that constitutes a written opinion, and the IRS acknowledges that they have to expend considerable effort to determine whether advice rendered in a particular circumstance is subject to the covered opinion rules.

The IRS also notes in the preamble to the proposed regulations that, “[y]ears of practical experience, however, have shown that the covered opinion rules in current §10.35 have produced some unintended consequences and should be reconsidered.” For example, the IRS has concluded that many practitioners attempt to exempt their advice from the covered opinion rules by making a prominent disclaimer stating that the opinion cannot be relied on for penalty protection.

The IRS observes that, “Practitioners have consistently voiced their concern over the current rules since their promulgation in 2004.” The IRS has concluded that the rules are overbroad, are difficult to apply, and do not necessarily produce higher-quality tax advice.

Therefore, the IRS is proposing to eliminate Section 10.35 and replace it with a revised Section 10.37. Proposed Section 10.37 would require practitioners to base all written advice on reasonable factual and legal assumptions, exercise reasonable reliance, and consider all relevant facts that the practitioner knows or should know.

Other changes

The proposed regulations withdraw proposed amendments to Section 10.39 governing requirements for state or local bond opinions, and remove the definition of, and exclusion for, state or local bond opinions from the definition of covered opinions.

The proposed regulations broaden the scope of the procedures to ensure compliance under Section 10.36 by requiring that a practitioner with principal authority for overseeing a firm’s federal tax practice take reasonable steps to ensure the firm has adequate procedures in place for purposes of complying with all provisions of Circular 230.

The proposed regulations clarify that practitioners must exercise competence when engaged in practice before the IRS. Under the current version of Circular 230, a practitioner can be sanctioned for incompetent conduct (Section 10.51), but there was no specific requirement that a practitioner exercise competence.

The proposed regulations clarify that the prohibition on a practitioner’s endorsing or otherwise negotiating any check issued to a taxpayer in respect of a federal tax liability applies to government payments made by any means, electronic or otherwise.

The proposed regulations expand the categories of violations subject to the expedited proceedings in Section 10.82 to include failures to comply with a practitioner’s personal tax filing obligations that demonstrate a pattern of willful disreputable conduct.

Finally, the proposed regulations clarify that the IRS Office of Professional Responsibility has exclusive responsibility for matters related to practitioner discipline, including disciplinary proceedings and sanctions.

The IRS has asked for comments on the proposed changes and has scheduled a public hearing for Dec. 7, 2012, in Washington.

The proposed changes will take effect when they are published as final regulations.

—Alistair M. Nevius (anevius@aicpa.org) is the JofA’s editor-in-chief, tax.