5.         Methods of Disclosure

Disclosure is, and was under the old law, an important means by which both the preparer and the taxpayer could avoid penalties.  Regulations under the old statute provide that the necessary disclosure could be made in different ways by different preparers.  A person who signs a return or claim for refund as preparer could disclose a position (i.e., one with no realistic possibility of being sustained on the merits) either by describing the position on Form 8275-R (Regulation Disclosure Statement, used to disclose positions contrary to Treasury regulations) or on Form 8275 (Disclosure Statement, used to disclose all other items or positions), or by complying with the annual Revenue Procedure (e.g., Rev. Proc. 2006-48) issued to provide guidance on standards for adequate disclosure of certain specific items and positions. ³²  The revenue procedures offer guidance on the disclosure of a limited number of common items (e.g., certain itemized deductions, certain trade or business expenses, and moving expenses) ³³; therefore, with respect to less common items or positions, the preparer would need to file Form 8275 or 8275-R with the tax return.

A preparer who did not sign a return, but advised a taxpayer directly with respect to a specific entry, could also meet the disclosure requirement by disclosing on Form 8275, 8275-R, or as advised by the annual revenue procedure.  In addition, such preparer could also satisfy his or her disclosure obligations by including with his advice a statement that the position taken is not supported by substantial authority, and inform the taxpayer of his or her obligation to disclose under Code Section 6662(d). ³⁴  This statement had to be written if the advice itself was written, but could be oral if the advice was oral.  The determination of whether oral advice was actually given is based on all facts and circumstances, although generally, contemporaneously prepared documentation of the oral advice is considered sufficient.  Similarly, a preparer who advised another preparer (rather than signing a return or advising a taxpayer directly) could meet the disclosure requirement if a Form 8275 or 8275-R is filed, if the annual revenue procedure is followed, or if, in advising the other preparer, the preparer had included a statement that the position was not supported by substantial authority and needed to be disclosed under Code Section 6694(a). ³⁵

Although old Section 6694 (like the current version) did not provide a disclosure exception to the penalty for intentional disregard of rules or regulations, the regulations under the old Section 6694 do provide one.  If a position contrary to a rule or a regulation is not frivolous and, in the case of a position contrary to a regulation, represents a good faith challenge to the validity of the regulation, then a preparer will not be considered to have “recklessly or intentionally” disregarded the regulation if the position is adequately disclosed.  Disclosure is only adequate, in the case of signing preparers, if made on Form 8275 or 8275-R (the annual revenue procedure is not applicable), and the rule or regulation being challenged is adequately identified.  Nonsigning preparers who advise taxpayers can similarly rely on disclosure on Form 8275 or 8275-R (along with identification of the challenged rule), or include with their advice a statement that the position is contrary to a rule or regulation (and if the latter, must represent a good faith challenge to the validity of the regulation) and must be disclosed under Code Section 6662(c).  Nonsigning preparers who advise other preparers can also rely on disclosure and identification on Form 8275 or 8275-R, or include a statement that disclosure under Section 6694(b) is required.

Those are the regulations under the previous version of the statute, which for income tax return preparers remain in effect during the transitional period.  For all other types of tax return preparers, the transitional relief in Notice 2007-54 provides that the reasonable basis standard set forth in the regulations under Code Section 6662 will be applied, without regard to the disclosure requirements contained therein.  This means that a preparer will not be subject to penalty with respect to any position with a 20 percent or greater chance of success will not be penalized, even if undisclosed.

But what of the future?  The new law leaves the same statutory disclosure language in place, which implies that the regulatory requirements will also remain the same.  In Notice 2007-54, the IRS stated that new guidance, procedures, and forms would be needed with respect to disclosure, although under both the old and the new versions of the statute, disclosure would be adequate if made on Form 8275 or 8275-R.  The IRS did not expressly state that new regulations would be needed on the topic of disclosure.  Accordingly, it seems likely that the disclosure provisions will remain largely unchanged.

6.         Circular 230

Circular 230, Section 10.34, provides standards specifically for practitioners advising a client with respect to a position on a tax return, or practitioners preparing or signing a tax return.  These standards are essentially identical to the requirements under old Section 6694.  Therefore, under the stricter new Section 6694, this part of Circular 230 imposes no additional burdens.

However, since a nonsigning preparer may satisfy his or her disclosure obligations via a statement to another preparer or the taxpayer, such preparer must consider the possible application of Circular 230.  Circular 230 requires advisors to meet certain standards with respect to written “covered opinions” concerning federal tax advice.  Broadly speaking, these covered opinions include any tax opinion regarding:  (i) a transaction identified by the IRS as a “listed transaction” pursuant to Code Section 6011, (ii) a plan or entity having a principal purpose of tax avoidance, or (iii) any plan or entity having a significant purpose of tax avoidance, if the opinion is a reliance opinion or a marketing opinion or is subject to confidentiality or contractual protection. ³⁶

The only type of covered opinion that turns upon confidence level is the reliance opinion.  Circular 230 defines a reliance opinion as one that concludes at a confidence level of at least more likely than not that one or more significant federal tax issues would be resolved in the taxpayer’s favor, unless the practitioner who wrote the opinion prominently discloses that it may not be relied upon for penalty protection. ³⁷  However, under new Section 6694, a preparer will only be prompted to prepare a statement if the confidence level is less than more likely than not that the position would be upheld.  Thus, a statement made by the preparer solely to protect himself or herself from penalties under 6694 generally would not be subject to Circular 230 (though it may still be, if it fits one of the other categories of covered opinion). 

On the other hand, if a preparer, or a non-preparer advisor, concludes that a position is more likely than not to be sustained, he or she may be asked by another preparer (or by the taxpayer) to prepare written advice to that effect, so that the other preparer can rely on that advice for his or her own protection from Section 6694 penalties. ³⁸  Such advice, if written, would constitute a reliance opinion, and would be subject to Circular 230.  Note, however, that in order to avoid being considered a reliance opinion, advice produced by non-preparer advisors sometimes includes a statement that it was not intended to be used, and cannot be used by the taxpayer, for the purposes of avoiding penalties that may be imposed on the taxpayer.  If such language, specific to “taxpayer” is used, it may be possible to argue that, while the statement is not a covered reliance opinion, it may yet be used by a preparer for purposes of avoiding penalties under Section 6694.  This possibility obviously has not been tested.

Theoretically, another way for a preparer to receive some protection from penalties under Section 6694 without requiring that a formal Circular 230 covered opinion be prepared would be to rely upon oral advice.  Oral advice from a preparer or other advisor, stating that a particular position is more likely than not to be sustained, is not covered by Circular 230, but may be relied upon to protect the preparer from penalties (at least under the old Section 6694 regulations). ³⁹  However, we cannot recommend this strategy, because the preparer who relies on such oral advice would bear the burden of establishing that he or she actually received such advice.

7.         Reliance on Other Preparers
           
Taxpayers often rely on the advice of multiple parties in the preparation of a specific tax return.  For example, a taxpayer may hire an attorney to determine the appropriate tax treatment of a specific transaction, and later hire an accountant to prepare the income tax return for the year in which the transaction occurred.  An obvious question is whether each preparer is required to make his or her own separate determination of the strength of each position, or whether a preparer is allowed to rely on the opinion of others (even those who are not technically preparers).

Both the current version and the previous version of Section 6694 contain a reasonable cause exception to the penalty, under which no penalty will be imposed if the preparer can show that there was reasonable cause for the understatement and that the preparer acted in good faith. ⁴⁰  The language in both versions is similar, so it may be safe to assume that the regulatory guidance produced under the prior version will remain in place.  Those existing regulations explain that the applicability of this exception depends on all the facts and circumstances.  Several potentially relevant factors are listed, including “reliance on the advice of another preparer.” ⁴¹  The regulation states that the “reasonable cause and good faith exception applies if the preparer relied in good faith on the advice of another preparer . . . who the preparer had reason to believe was competent to render such advice.” ⁴²   A preparer can also rely on the advice of a non-preparer – e.g., a law firm that provides a tax opinion before a transaction is carried out – if the non-preparer would have been considered a preparer had the advice constituted preparation of a substantial portion of the return. 

This broad language indicates that a preparer is protected if he or she relies on the advice of another.  However, the reliance must be in good faith, and the regulations state that there is no good faith if (i) the advice is unreasonable on its face, (ii) if the preparer knew or should have known that the advisor was not aware of all relevant facts, or (iii) if the preparer knew or should have known (“given the nature of the preparer’s practice”) at the time the return was being prepared that the advice was no longer reliable because of changes in the law. ⁴³  Thus, while a preparer is not necessarily required to re-examine an issue that has already been passed upon by another advisor, he or she cannot blindly accept the advice of another.  A preparer must review the advice for reasonableness, and must consider whether or not the advisor was aware of all relevant facts and applicable law at the time he or she rendered the opinion.