CCH Tax Briefing:
CONTROVERSIAL CIRCULAR 230
RULES OF PRACTICE NOW
EFFECTIVE
June 20, 2005
New Rules
For Tax Advice
✔ Covered Opinions
✔ Reliance Opinions
✔ Marketed Opinions
✔ “Legend Out”
Disclosures
✔ Confidence Levels
✔ Best Practices
✔ OPR Enforcement
✔ June 21st
Effective Date
Inside
Reaction ............................. 1
Covered Opinions .............. 2
Standards for
Covered Opinions .............. 4
Exclusions from
Covered Opinions .............. 5
Practitioners
and Promoters .................... 6
Bond Opinions ................... 6
Legends Out ....................... 6
Best Practices .................... 8
Other Circular 230
Standards ........................... 8
Enforcing Circular 230 ..... 10
Sample Client Letter ........ 11
Special Report
New IRS Rules For Giving Tax Advice—
Are You In Compliance?
A
fter years of proposals, debate,
commentary and more debate,
final Circular 230, Rules of
Practice before the IRS, have taken ef-
fect. The final regs turn the old rules
upside down. Many practitioners are
still struggling to understand the full
scope and consequences of new Circu-
lar 230. Because the new regs are such
a change from the old ones, many con-
sequences are unknown.
This CCH TAX BRIEFING high-
lights the key features of new Circular
230 to keep practitioners in compliance.
Final Circular 230 regs were issued in
December 2004. The IRS revised them,
reacting to practitioner concerns in May
2005. Many concerns remain.
Key parts of the new regs on how
tax advice is given are mandatory and
failure to follow them could bring about
significant penalties, including being
barred from practice before the IRS and,
in some cases, having an entire firm sanc-
tioned. Other parts of the new regs are
not mandatory, such as the “best prac-
tices” aspirations designed by the IRS.
However, it’s clear that the IRS expects
practitioners to abide by the highest ethi-
cal standards of client service.
To prevent a small group
of tax shelter advisors and promot-
ers from acting badly, all are effec-
tively punished, complain many
practitioners. “Like using a har-
poon to kill a goldfish,” or “a sledge
hammer to kill a fly,” say others.
Treasury and IRS officials infor-
mally have said, “We hear you,”
and call Circular 230 a “living
document” subject to adjustment
and also subject to administrative in-
terpretation on the enforcement side.
So far, however, no changes have
been announced since the few revi-
sions in May. The IRS reports that
it is sticking to its deadline appli-
cable to all written advice rendered
after June 20, despite pleas for prac-
titioners to do otherwise.
REACTION
Tax practitioners are facing a brave new
world that requires them to comply with
rules of practice for tax shelter opinions, and
they’re not happy about it. They believe
the Circular 230 regs are vague and overly
broad. To avoid the reach of the new law,
firms are developing disclaimers, which
they intend to include with most, if not all,
communications sent outside the firm.
The IRS’s Office of Pro-
fessional Responsibility has been
telling practitioners at public forums
that it will apply new Circular 230
“reasonably.” Many practitioners,
however, are not comforted by the
IRS’s good intentions. They would
rather have the literal language of
Circular 230 corrected to ensure
“reasonable interpretation.”
Many tax attorneys and accountants
are also sending letters to their clients,
alerting them to the new practice of put-
ting disclaimers, or “legends,” on letters,
2
2005 Practice Update
e-mails, and other written communica-
tions that give tax advice (see page 11 of
this Briefing for a sample client letter).
The alternative to putting a dis-
claimer on outside communications is to
comply with the comprehensive require-
ments for “covered opinions” under new
Circular 230. In most cases, practitio-
ners caution that the fees for providing
a covered opinion for routine tax advice
would be substantially disproportionate
to the benefits to the client.
Michael Desmond,
Treasury’s deputy tax legislative
counsel (legislative affairs) re-
cently observed that new Circular
230 has two purposes: to regulate
tax shelter opinions provided for
penalty protection, and to issue
standards for these opinions. Put-
ting a disclaimer on every commu-
nication defeats the purpose of the
regs to ensure that clients are well
informed. “Legends,” by default,
create an opt-in dynamic for ap-
plying the rules, which was not in-
tended by Treasury, Desmond said.
New Circular 230
applies to electronic communica-
tions as well as written communi-
cations. Oral communications are
not covered.
The new standards for
written tax advice also may serve
to lose clients at the examination
stage based on a conflict of inter-
est. The same practitioner who ad-
vised the taxpayer about a tax plan-
ning strategy must help the
taxpayer defend against a penalty
assessment on examination of that
transaction on a later IRS audit.
Not defending vigorously against
the penalty using a reliance de-
fense, when the defense would open
up to scrutiny (and possible IRS
censure) the practitioner’s written
advice procedures, appears to be
C C H T A X B R I E F I N G
enough of a possibility that a con-
flict of interest would be present.
COVERED OPINIONS
The most controversial provisions in new
Circular 230 deal with tax shelter-type
opinions, which the IRS calls “covered
opinions.” Written advice that is a “cov-
ered opinion” must follow heightened
standards of detail and thoroughness in
making factual and legal assumptions.
“Key parts of the
new regs…are
mandatory and fail-
ure to follow them
could bring about
significant penalties”
Practitioners have
complained that a lot more than tra-
ditional tax shelter situations are in-
cluded in the new Circular 230 lan-
guage defining a “covered
opinion.” When read literally, it
covers many “routine advice” situ-
ations. Requiring “full-blown”
advice in each of these situations
effectively rules out dispensing
“routine advice,” which tradition-
ally anticipates considerably less
formal and less time consuming pro-
cess. Many practitioners see no safe
alternative “legend out” language
to every written client communica-
tion, except in those instances in
which full-blown advice is given.
A “covered opinion” under Circu-
lar 230 is any written advice about a:
“Listed transaction (or a transaction
substantially similar);”
Any plan or engagement which has
as its principal purpose tax avoidance
or evasion; or
Any plan or engagement which has
tax avoidance or evasion as a sig-
nificant purpose if the written ad-
vice is:
A reliance opinion;
A marketed opinion;
Subject to conditions of confi-
dentiality; or
Subject to contractual protection.
“Listed transactions.” These are
transactions that the IRS has identified
as patently abusive tax avoidance trans-
actions. The IRS has labeled 31 trans-
actions as “listed transactions.” Ex-
amples are Son of BOSS, abusive lease
stripping, contingent liability and basis-
shifting transactions, and schemes using
Roth IRAs to shelter business income.
Principal purpose of tax avoidance
or evasion. A transaction will have the
principal purpose of avoidance or eva-
sion if avoidance or evasion exceeds any
other purpose. A transaction structured
to claim tax benefits in a manner in-
tended by the Tax Code and Congress
will not be deemed to have the principal
purpose of avoiding or evading tax.
A transaction can be
a “listed transaction” or have the
significant purpose of tax avoid-
ance even if it lacks the principal
purpose of tax avoidance.
Reliance opinions. Written tax advice
is a reliance opinion if it concludes at a con-
fidence level of more likely than not that
one or more significant federal tax issues
could be resolved in the taxpayer’s favor.
Given the definition of a
“reliance opinion,” one way to
make certain that advice is not con-
sidered a reliance opinion is to state
that “because of varying interpre-
tation of the law, the advice at this
point on a confidence level scale is
less than ‘more likely than not’ that
one or more significant federal tax
issues would be resolved in the
taxpayer’s favor.”
An opinion that is other-
wise considered a “reliance opin-
©2005, CCH INCORPORATED

Part of the problem with complying with
new Circular 230 is in the ambiguity of
the terms used. In the end, an evalua-
tion of the confidence level in which
advice is influenced by subjective fac-
tors that may put certain advice in one
category or another. A client may inter-
pret the description of advice differently
from what the practitioner intends in
using such “confidence level” terms of
art in correspondence to the client.
“Substantially similar.” Advice
related to a transaction “substantially
similar” to a listed transaction is au-
tomatically considered a covered
opinion. “Substantially similar” is
not defined.
“Principal purpose.” Advice re-
lated to a plan or arrangement, the
“principal purpose” of which is the
avoidance or evasion of any tax im-
posed under the Code, is automatically
considered a covered opinion. A prin-
cipal purpose exceeds any other
prupose and does not include claiming
tax benefits in a manner consistent with
the Code and congressional intent.
“Significant purpose.” Advice
is also considered a covered opinion
if related to a plan or arrangement,
the “significant purpose” of which is
the avoidance or evasion of any tax
imposed under the Code (and is ei-
ther a reliance opinion, a marketed
ion,” however, can also escape be-
ing considered if the practitioner
properly notifies the client in the
written advice that the advice is des-
ignated as a type that cannot be re-
lied on to protect against any IRS
penalties for negligence, substantial
understatement of income or the
like. For details on how this so-
called “legend out” disclaimer
works, see page 6.
Marketed opinions. If a practitio-
ner knows that his or her written advice
will be used to promote, market or rec-
Critical Definitions
opinion, subject to confidentiality, or
subject to contractual protection). While
this “confidence level” is greater than
“more likely than not,” precisely how
much greater remains a subject of con-
cern. Does the dollar amount involved
make an issue more significant? It also
requires an evaluation that the transac-
tion does not have “a significant purpose
of tax avoidance or evasion.” As a re-
sult, assuming that advice for all tax
opinions must pass the “more-like-than-
not” confidence level (see “reliance
opinion,” immediately below) appears
to be the more cautious approach.
“More likely than not.” Advice
given at a confidence level of “more
likely than not” to prevail is defined as
“a greater than 50 percent likelihood of
the position being upheld.”
“Significant federal tax issue.” An
issue is no longer an issue that is subject
to a covered opinion if the conclusion is
that the IRS has no reasonable basis for
challenge. However, the “Other Written
Advice” standards still must be met.
“Substantial authority.” Not in
Circular 230 at all, but very relevant to
the client is an additional criteria for ad-
vice, “substantial authority” for purposes
of avoiding the substantial underpay-
ment of income tax penalty. The regs
under Code Sec. 6662 state, “The sub-
stantial authority standard is less strin-
ommend a partnership or other entity,
investment plan or arrangement, the
written advice is a marketed opinion.
The same rule applies if the practitioner
should have known his or her written
advice would be used in promotion.
This category is broad
and may trap any advice that the
taxpayer expected to pass along
to a third party. However, in pro-
tecting against falling into this
category, the practitioner also
needs to guard against the advice
being subject to “conditions of
C C H
3
June 20, 2005
gent than the more likely than not
standard (the standard that is met
when there is a greater than 50-per-
cent likelihood of the position being
upheld), but more stringent than the
reasonable basis standard as defined
in §1.6662-3(b)(3).”
“Reasonable basis.” A position
that is not a covered opinion still must
have a reasonable basis behind it. A
“reasonable basis position” has a 10
to 25 percent likelihood of success;
under Reg 1.6662-3(b) it is a “rela-
tively high standard” significantly
higher than “not frivolous.” For pur-
poses of the negligence penalty, the
reasonable basis standard is not sat-
isfied by a return position that is
“merely arguable” or that is “merely
a colorable claim.”
“Realistic possibility.” A po-
sition is considered to have a “real-
istic possibility” of being sustained
if it has approximately a one in three
or greater likelihood of being sus-
tained on its merits. Under Circular
230, section 10.34, a practitioner
may not advise a taxpayer to take a
position on a tax return unless the
position satisfies the “realistic pos-
sibility” standard or the position is
not frivolous and the practitioner ad-
vises the client to adequately dis-
close the position on the return.
confidentiality.” One suggested
clause reads, “this advice is in-
tended solely for your use and may
not be relied on by third parties;
however, you may freely share this
tax advice with third parties.”
If the advice concerns other than a
“listed transaction” or a transaction that
has the principal purpose of tax avoid-
ance or evasion, the practitioner can treat
what would otherwise be a marketed
opinion as a non-marketed opinion by
adding a “legend out” notice of no pen-
alty protection. The legend out process
T A X B R I E F I N G
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2005 Practice Update
can be used to avoid reliance opinion sta-
tus, and is explained further on page 6.
Individuals also must be advised to seek
advice from an independent tax advisor.
The IRS warns that if a
practitioner is unable to reach a
“more likely than not” conclusion,
he or she must not provide the mar-
keted opinion at all, under penalty
of suspension or disbarment.
Many practitioners
worry that advice that may be
passed along to any third party, not
necessarily in the tax shelter setting,
can literally be considered a mar-
keted opinion subject to new Circu-
lar 230’s heightened standards.
Confidentiality. This attribute looks
at disclosure and protection of confidenti-
ality of tax strategies. If written advice limits
disclosure to protect the practitioner’s tax
strategies, this is a condition of confidenti-
ality. It does not matter if the limitation on
disclosure is legally binding.
A claim that a transac-
tion is proprietary or exclusive
may not necessarily be considered
a limitation on disclosure. To be
safe, however, a practitioner might
confirm to all recipients that there
is no limitation on disclosure and
this confirmation would override
any claim that a transaction is
proprietary or exclusive.
Contractual protection. A covered
opinion exists if a client has the right to
full or partial refund of fees if all or some
of the intended tax consequences ad-
dressed in the written opinion are not
sustained. Contractual protection is also
present if fees are contingent on the re-
alization of tax benefits.
Designating fees as other
amounts will not discourage IRS
scrutiny. The IRS warned that it will
C C H T A X B R I E F I N G
look at all the facts and circum-
stances to determine if a fee is re-
fundable or contingent, including the
right to reimbursement of amounts
not specifically designated as fees.
REQUIREMENTS FOR
COVERED OPINIONS
Circular 230 describes in detail the re-
quirements practitioners must follow for
covered opinions. These requirements
address idnetifying of facts and issues,
applying assumptions, relating the law to
the facts, and reaching conclusions.
A practitioner giving
written advice that is a covered
opinion must now give details and
extensive analysis that no longer
likely fits into a client’s idea of
what is an informal opinion or one
that carries a modest fee.
These requirements
force the practitioner to spend a
great deal of time making sure that
the long list of mandatory consid-
erations is covered. Practitioners
say that this will force any advice
that is a covered opinion to cost
significantly more, paid for by sur-
prised clients or absorbed by
overworked practitioners.
Factual matters. The facts of a
transaction must be laid bare. The opin-
ion must identify and consider all rel-
evant facts. Moreover, opinions must
not be based on unreasonable factual
assumptions. All factual assumptions
must be identified in a separate section
of the opinion. Similarly, practitioners
must ignore unreasonable factual repre-
sentations, statements or findings by the
taxpayer or others. Factual representa-
tions also must be identified in a sepa-
rate section of the opinion.
“To require practitio-
ners to exercise due diligence in
identifying and understanding all
the facts, relating the law to the
circumstances and requiring a
competent and thorough evalua-
tion of federal tax issues in ren-
dering formal opinions should be
an expectation,” the National As-
sociation of Tax Professionals told
CCH INCORPORATED.
Reaching a conclusion. The opin-
ion must relate the law and judicial doc-
trines to the facts and consider all sig-
nificant federal tax issues. Practitioners
must come to some conclusion about the
likelihood of the taxpayer prevailing. If
the practitioner concludes the taxpayer
will prevail, he or she must set forth the
reasons. The same is true if the practi-
tioner concludes the taxpayer will not
prevail. If the practitioner is unable to
reach a conclusion, he or she must ex-
plain why no conclusion is reached.
Whenever a practitioner relies on the
opinion of another practitioner, he or she
must expressly identify the other opin-
ion and the conclusions in that opinion.
An opinion that does
not conclude that the taxpayer will
more likely than not prevail must
prominently disclose this conclu-
sion. It must be readily apparent
to the reader.
Limited scope opinions. New Cir-
cular 230 offers ‘limited scope opinion”
rules as a solution to having to provide
extensive analysis on all related issues
when giving advice in writing. While these
rules allow more likely than not opinions
selectively on the significant federal tax
issues that are addressed (and which are
not marketed opinions), the rules also re-
quire prominent disclosure that the advice
may not be used for penalty protection for
non-covered issues. This presents the
same delicate issue of having the client
concerned about the effort and expertise
being put into the overall advice.
New Circular 230 requires that the
limited scope opinion must prominently
disclose that:
©2005, CCH INCORPORATED

The opinion is limited to the one or
more federal tax issues addressed in
the opinion;
Additional issues may exist that could
affect the federal tax treatment of the
transaction or matter that is the sub-
ject of the opinion and the opinion
does not consider or provide a con-
clusion with respect to any additional
issues; and
With respect to any significant federal
tax issues outside the limited scope of
the opinion, the opinion was not writ-
ten, and cannot be used by the taxpayer,
for the purpose of avoiding penalties
that may be imposed on the taxpayer.
Practitioners have sug-
gested that the language that ap-
pears above, be used verbatim,
prefaced by, “Pursuant to IRS
rules, this advice constitutes a lim-
ited scope opinion.”
EXCLUSIONS FROM
COVERED OPINIONS
New Circular 230 excludes some impor-
tant items from the definition of a cov-
ered opinion.
Written advice prepared after a re-
turn is filed. Written advice prepared for
and provided to a taxpayer after the tax-
payer has filed a return for the transaction
is generally excluded. However, if the
practitioner knows or has reason to know
that the taxpayer will use the advice for a
future return, including an amended return,
the advice is a covered opinion.
In-house advice. Written advice
from in-house counsel to an employer
solely to determine the employer’s tax
liability is generally excluded. The ad-
vice must be given by the practitioner
as an employee of the employer.
Other excluded advice. So long it
does not encompass a “listed transac-
tion” or a “principal purpose” transac-
tion, other excluded adivce includes:
Written advice about the qualification
of a qualified plan;
5
June 20, 2005
Written advice included in documents
New Circular 230 re-
filed with the SEC; and
quires that preliminary advice be
Written advice given to a client during
“during the course of an engage-
the course of an engagement if the prac-
ment,” which generally requires
titioner is expected to provide subsequent
a written understanding; at least
advice that satisfies new Circular 230.
it is more than an engagement that
Negative advice the practitioner may assume ex-
ists. Intervening events could
Many practitioners had concerns if nega-
arise to scuttle the deal, includ-
tive advice (advice concluding that a fed-
ing the client simply not wanting
eral tax issue will not be resolved in a client’s
to pay for more advice but rather
favor) should be considered a covered opin-
“take his chances.”
ion. In May 2005, when the IRS revised
the final Circular 230 regs, it addressed
Using language to escape initial
some of their concerns. Generally, nega-
qualification as covered opinion. A
tive advice is not a covered opinion.
client usually is not aware of the nuances
However, if the advice reaches a con-
of confidence levels that have been cre-
clusion favorable to the taxpayer at any level
ated under the tax law. As a result, ex-
with respect to the client’s tax issue, the
plaining to the client in the written ad-
advice may be a covered opinion. The IRS
vice that the advice is confirmed by sub-
gives some examples, such as concluding
stantial authority or a reasonable basis
that an issue is not frivolous, has a realistic
may exempt the advice on a non-tax
possibility of success or has a reasonable
shelter matter from being a covered
basis. This treatment reflects concerns that
opinion, avoiding the need to add “leg-
negative advice could nonetheless be con-
end out” language to the correspon-
strued as encouraging taxpayers to take ag-
dence. However, the practitioner must
gressive positions on their returns.
make certain that the principal purpose
of advice is not tax avoidance and the
Practitioners identified advice does not state or imply that it
two areas where negative advice reaches the more-likely-than not confi-
could be a covered opinion. First, dence level.
in the context of written advice
relating to a “listed transaction”
Many practitioners
or a “principal purpose” trans-
believe that assuming no princi-
action. Second, in situations
pal purpose or more-likely-than-
where written advice addresses
not, or that advice is considered
more than one federal tax issue
preliminary, is too dangerous, es-
and concludes that one or more
pecially considering the disciplin-
federal tax issues will not be re-
ary consequences of being wrong.
solved in the taxpayer’s favor.
They argue that they have no
choice but to include “legend out”
language to every piece of writ-
Preliminary advice
ten advice.
If advice is given and the expectation is
that it is preliminary to a full analysis, then
the advice need not be “full blown.” Of
course, it is just because of such an as- Even if the advice is
sumption that the client cannot rely on not a covered opinion, it still must
the preliminary advice for penalty pro- meet the standards of “other writ-
tection. In these instances, the practitio- ten advice.” Although more flex-
ner may give informal and “incomplete” ible, these standards are also en-
advice without having to place a “legend forced through disciplinary
out” statement in the communication. measures if not met.
C C H T A X B R I E F I N G
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2005 Practice Update
Other written advice
While not triggering the burdensome
requirements for advice that is a covered
opinion, all other written tax advice also
must meet certain standards. The prac-
titioner cannot under any circumastances
give advice that is based, in whole or in
part, on unreasonable factual or legal
assumptions, or if the practitioner un-
reasonably relies on the representations
of others, fails to consider all the relevant
facts, or considers the audit lottery risks
in the evaluation.
“Other written advice” need not be
as detailed as covered opinions. The ex-
pectation, as being announced infor-
mally by Treasury and IRS officials, is
that most written advice will fall outside
of the “covered opinion” category and
into the “other written advice” category.
Of course, many practitioners are upset
that the actual language of Circular 230
itself implies otherwise.
Written advice that contains inter-
nally inconsistent legal analyses or con-
clusions is prohibited. Practitioners have
complained that this limitation prevents
common “alternative theories” opinions
in which opinions are given depending
upon how several variations on how the
facts may be interpreted.
PRACTITIONERS
AND PROMOTERS
Promoters are the main target in the
IRS’s campaign to terminate the tax shel-
ter industry. The 2004 Jobs Act greatly
empowers the IRS to go after promot-
ers, material advisors – indeed anyone
– involved in tax shelters. New Circu-
lar 230 reflects the government’s intense
focus on identifying promoters and
through them investors.
A covered opinion must disclose the
relationship between practitioner and
promoter. If there is a referral fee or
other type of compensation arrange-
ment, it must be revealed in the opin-
ion. Likewise, the existence of a refer-
ral agreement must be disclosed.
Similar standards apply to marketed
opinions. The opinion must reveal that
C C H T A X B R I E F I N G
it was written to support the promotion
or marketing of the product.
Rampant tax shelter pro-
motion fueled the IRS’s quest to
toughen Circular 230. The agency
hasn’t let up in its campaign to shut
down abusive tax shelters. IRS offi-
cials jave repeated echoed the
agency’s mantra that the government
will use all the tools at its disposal to
identify tax shelter promoters and in-
vestors. Circular 230 is one impor-
tant tool. Practitioners need to tread
very carefully in their relationships
with tax shelter promoters.
BOND OPINIONS
At the same time the IRS issued final
general Circular 230 regs, it also issued
proposed regs governing bond opinions.
The proposed regs immediately sparked
a negative reaction from bond practitio-
ners. The final general Circular 230 regs
and the proposed Circular 230 regs ap-
peared to overlap and many practitioners
were unsure where they stood. Many
bond practitioners also feared that the
regs would disrupt the bond market.
Bond practitioners have been very
active in pushing for changes to the bond
opinion rules. They succeeded in June
2005 in having the IRS revise some of
the proposed regs. The IRS enhanced
the definition of a state or local bond
opinion. A state or local bond opinion
is written advice concerning:
The excludability of interest on a state
or local bond from gross income un-
der Code Sec. 103;
The status of a state or local bond as a
qualified zone academy bond under
Code Sec. 1397E;
One or more federal tax issues reason-
ably related and ancillary to tax-ex-
empt bonds; or
Any combination of the above.
More changes are likely. The IRS may
permit bond practitioners to render opin-
ions addressing less than all the significant
federal tax issues and make other changes.
“LEGEND OUT”
Will the new rules put an end to infor-
mal advice, which now must be identi-
fied through a “legend” that is so em-
barrassing to the practitioner that no in-
formal advice will be given? Since in-
formal advice is essential in building
client relationships and is a large part of
any tax practice, it seems unreasonable
that this is the proper solution. Instead,
coming up with “legend out” language
that will be accepted by the client and
by the IRS (albeit, begrudgingly) likely
is the solution, at least until tax profes-
sionals might convince the IRS to
change the regs.
In giving written tax advice, a prac-
titioner now has three choices:
(1) Give a complete opinion that fully
complies with the rules;
(2) Conclude that the IRS has no rea-
sonable basis for challenging the
issue(s) and not offer any disclaimer
to the client; or
(3) Prominently “legend out” a disclosure
in the correspondence that follows the
language of new Circular 230 indi-
cating that it is an opinion that cannot
be relied on for avoiding IRS penal-
ties if the advice is incorrect.
All three options are problematic and
the consequences are unknown. For ex-
ample, giving a complete opinion that fully
complies with the rules could be very
costly to clients in minor matters. It could
discourage clients from seeking clarifica-
tion of minor matters. Many practitioners
believe that option 3 is the only practical
course to take in most everyday client cor-
respondence but as of yet there is no con-
sensus on what “legend out” language
practitioners should use.
If the advice concerns
an opinion or transaction with its
principal purpose tax avoidance,
no legend out is effective. Only
when a non-listed transaction has
tax reduction as a significant but
not principal purpose, may the ad-
vice be less than complete is a leg-
end out is added.
©2005, CCH INCORPORATED

Practitioners who are
putting disclaimers on their
communications are uncomfort-
able when they inform a client
that the client cannot rely on the
advice for tax penalty protection.
This is unfair, many practitio-
ners argue, because it implies
that the advice is incorrect or in-
adequate. It is also unfair to cli-
ents who may need advice but
are uncomfortable with the “leg-
end out” language.
The new rules tend to
penalize small businesses and un-
sophisticated taxpayers. Sophis-
ticated taxpayers and large cor-
porations are more likely to be
able to form their own opinion
about potential shelter transac-
tions. For others, the only choice
is to rely on their practitioner’s
advice, but that reliance is not
available unless the client pays
high fees for a covered opinion.
“LEGEND OUT”
LANGUAGE
The IRS hasn’t provided any example
language. It only draws the parameters
within Circular 230 and, unfortunately,
leaves the “details” to interpretation.
Section 10.35(b)(4) in Circular 230
provides “Written advice…is not treated
as a reliance opinion if the practitioner
predominately discloses in the written
advice that it was not intended or writ-
ten by the practitioner to be used, and
that it cannot be used by the taxpayer,
for the purpose of avoiding penalties that
may be imposed on the taxpayer.”
Many practitioners plan to place
“legend out” language on correspon-
dence as a matter of course. “Legend
out” language for what is otherwise a
reliance opinion must disclose, must
disclose “that it was not intended or writ-
ten by the practitioner to be used, and
7
June 20, 2005
that it cannot be used by the taxpayer,
The greatest challenge
for the purpose of avoiding penalties that
in writing and placing the legend
may be imposed on the taxpayer.”
is to make certain that clients un-
Similarly, Circular 230 states that
derstand that it is not an excuse
legend out language for what is other-
for sloppy advice. Practitioners
wise a marketed opinion must commu-
need to assure clients that the
nicate that (1) the advice was not in-
quality of the advice is still excel-
tended or written by the practitioner to
lent but its scope is limited be-
be used, and that it cannot be used by
cause of government regulations.
the taxpayer, for the purpose of avoid-
Many firms have already begun
ing penalties that may be imposed on the
the process of “client education.”
taxpayer; (2) the advice was written to
support the promotion of marketing of
New Circular 230 requires that the
the transaction or matters addressed by
“legend out” statement be prominently
the written advice; and (3) the taxpayer
disclosed. An item is prominently dis-
also should seek advice from an inde-
closed if it is readily apparent to a reader
pendent tax advisor based on the
of the written advice. Circular 230 uses
taxpayer’s particular circumstances.
a facts and circumstances test to deter-
Based on this language from Circular
mine if an item is prominently disclosed.
230, at least two “legend out” statements –
At a minimum, a “legend out” must be
as an alternative to quoting Circular 230
placed in a separate section in a type-
exactly, which may be a bit awkward—
face that is the same size or larger than
have been proposed by practitioners.
the typeface used in the advice.
“Legend out” statement #1
“This written advice is not intended or A “legend out” state-
written to be used, and it cannot be used ment cannot be in a footnote.
by an taxpayer, for the prupose of avoid-
ing penalties that may be imposed on the Emails
taxpayer.” (See the Sample Client Let-
Emails raise special concerns. Can a “leg-
ter on page 11 for further details.)
end out” statement be added to, or appear
“Legend out” statement #2 immediately before, the typical boilerplate
confidentiality statement common at the
“Additional issues may exist that could
end of professional emails. Would the IRS
affect the federal tax treatment of the
consider this a prohibited “footnote?”
transaction on the matter that is the sub-
Ending the correspondence with a clos-
ject of this advice and this advice does
ing and signature before the “legend out”
not provide a conclusion with respect to
statement would probably run afoul of
such issues. With respect to such issues
Circular 230. Placing the “legend out”
outside the limited scope of this advice,
statement in the last paragraph of every
the advice was not written and cannot
correspondence probably would be ad-
be used for penalty protection.”
equate. However, many practitioners hope
“Legend out” statement #3 that such placement will read like
boilerplate language and not attract a
“Please be advised that, based on cur-
reader’s full, critical attention as a result.
rent IRS rules and standards, the advice
contained herein is not intended to be
used, nor can it be used, for the avoid- What about text mes-
ance of any tax penalty that the IRS sages? Circular 230 is silent if a
should assess related to this matter. That “legend out” statement must be
said, please do not hesitate to call me if part of a text message. One prob-
you have any further questions regard- lem is the size of the typeface and
ing this matter.” the length of the response.
C C H T A X B R I E F I N G
8
2005 Practice Update
According to Jeffrey
Paravano, a former Treasury official
now with Baker & Hostetler, a con-
sortium of roughly 50 law firms has
been meeting to devise consistent
practices for complying with the new
regs and issuing disclaimers. Some
firms intend to require disclaimers
for communications issued by par-
ticular practice areas (in addition to
tax), such as real estate and corpo-
rate law. For other practice areas,
some firms are devising computer
search programs that will look for
particular words, such as “tax,” in
outside communications and trigger
the use of the disclaimer language.
The New York State Bar
Association’s Tax Section recom-
mends keeping the “legend-out”
requirement for marketed opinions
and listed transactions but “flip-
ping” the requirement for reliance
opinions. It recommended that a
statement from the practitioner be
required only when the intention is
to give penalty protection. So far,
the IRS has rejected this approach.
Can client assume full advice without
“legend out?”
If the practitioner violates new Circular
230, the client is not home free. Before a
taxpayer may be considered to have rea-
sonably relied in good faith on advice, two
threshold requirements must be satisfied:
(1) The advice must be based upon all per-
tinent facts and circumstances and the
law as it relates to those facts and cir-
cumstances, including taking into ac-
count the taxpayer’s purpose for enter-
ing into a transaction and for structur-
ing a transaction in a particular man-
ner, and is not adequate if the taxpayer
fails to disclose a fact that it knows, or
should know, to be relevant to the
proper tax treatment of an item; and
(2) The advice must not be based on un-
reasonable factual and legal assump-
C C H T A X B R I E F I N G
tions (including assumptions as to
future events) and must not unreason-
ably rely on the representations, state-
ments, findings, or agreements of the
taxpayer or any other person, includ-
ing a representation or assumption the
taxpayer knows, or has reason to
know, is unlikely to be true.
“BEST PRACTICES”
Another important part of the new Cir-
cular 230 is the “best practices.” The
IRS expects practitioners to observe
these practices to provide clients with
the highest quality service.
The IRS calls the best
practices “aspirational.” Failure
to comply does not automatically
subject a practitioner to sanctions.
However, practitioners expect that
those standards will raised the bar
generally since they likely will
now be used as a benchmark un-
der state-law malpractice actions.
What are best practices?
New Circular 230 describes what the
IRS means by “best practices.”
Practitioners are expected to communi-
cate clearly with clients about the terms
of the engagement. The IRS gives an
example. Practitioners must determine
the client’s expected purpose for
and use of the advice and they should
have a clear understanding with the
client about the form and scope of the
advice and assistance.
Practitioners should establish the facts
and determine which facts are relevant.
They should evaluate the reasonable-
ness of any assumptions or represen-
tations and relate the applicable law to
the relevant facts. Potentially appli-
cable judicial doctrines also must be
explored. Conclusions must be sup-
ported by law and the facts.
Practitioners should advise clients
about the importance of the conclu-
sions they reach. This would encom-
pass, the IRS explained, advising a
client that he or she may avoid the
accuracy-related penalties if the cli-
ent acts in reliance on the advice.
Practitioners are expected to act fairly
and with integrity when practicing
before the IRS.
Supervisors
Practitioners with supervisory authority
have additional responsibility. They
should take reasonable steps to ensure
that their firm’s procedures comply with
Circular 230’s best practices guidelines.
”OTHER” CIRCULAR
230 REQUIREMENTS
While “covered opinions” and “best prac-
tices” clearly hold the current spotlight,
the IRS Office of Professional Responsi-
bility (OPR) is reminding practitioners
that there is a lot more to Circular 230
and that practitioners will be held to all
the rules. A summary of these rules in-
cludes the following highpoints:
Who may practice?
The ability to practice before the IRS is
limited to attorneys, CPAs, enrolled agents
and enrolled actuaries. CPAs, attorneys
and enrolled actuaries must submit a writ-
ten declaration that they are licensed and
authorized to represent a designated party.
Certain government
employees cannot practice be-
fore the IRS including federal
employees and officers, mem-
bers of Congress, officers and
employees of the District of Co-
lumbia, and state officers and
employees that handle tax mat-
ters for the state government.
The IRS is considering
extending the privilege to practice
before it to another group of pro-
fessionals: public accountants.
Currently only, public accountants
in three states, Pennsylvania, New
Jersey and Rhode Island, can
practice before the IRS.
©2005, CCH INCORPORATED

Maintaining active status. After be-
ing granted active enrollment, each indi-
vidual must have their enrollment re-
newed. The deadline for enrollment re-
newal depends on the date of the individu-
als’ initial enrollment and the last number
of the individuals’ Social Security num-
ber or Tax Identification Number.
To qualify for renewal, a practitioner
must satisfy continuing professional edu-
cation requirements. Currently, 16 hours
of credits must be completed each year,
however for renewals after April 1, 2007,
72 hours of credits must be completed
every three years with a minimum of 16
credits completed each of the three years.
Practitioners must keep records of their
credit hours for three years after the date
that their enrollment was renewed.
Failure to meet these
requirements or to file a timely ap-
plication for renewal will result in
a practitioner being placed inac-
tive status. An individual on inac-
tive status is ineligible to practice
before the IRS.
Due diligence
A practitioner is required to exercise due
diligence when preparing, approving
and filing tax returns, documents, affi-
davits, and other papers to the IRS. In
addition, due diligence must be exer-
cised when determining whether oral or
written representations to the Treasury
or IRS are correct.
Reliance on the work
product of another creates a pre-
sumption of due diligence if the
practitioner used reasonable care
in engaging, supervising, training
and evaluating the person.
Knowledge of client’s omission.
Circular 230 covers situations involving
practitioners with knowledge that a cli-
ent has committed a violation of the Tax
Code or has omitted or failed to provide
information in a return or document sub-
mitted to the IRS. In such a case, the
practitioner has a duty to advise the cli-
ent of the presence and consequences of
the noncompliance, omission or error.
However, Circular 230 does not indicate
that the practitioner must inform OPR
or the IRS of the taxpayer’s noncompli-
ance, omission or error.
Information to be furnished. A
practitioner must submit any information
or documents requested by an agent of
the IRS unless the practitioner believes
in good faith and on reasonable grounds
that the material is privileged. If the re-
quested material is not in the hands of
the practitioner or the practitioner’s cli-
ent, the practitioner must notify the IRS.
The practitioner must also provide the
IRS agent with information on who the
practitioner believes may have possession
of the documents or information. The
practitioner is required to make a reason-
able inquiry of the client regarding the
whereabouts of the material.
The practitioner is not
required to independently verify
the information supplied by the
client or ask persons other than
the client about the whereabouts
of the documents or information.
Violations of Circular 230. A prac-
titioner must reveal any information re-
garding a violation of Circular 230 when
requested by the OPR director unless the
practitioner believes in good faith and
on reasonable grounds that the informa-
tion is privileged.
Interference. Circular 230 also for-
bids any practitioner from interfering or
attempting to interfere with a proper and
lawful effort by the IRS or OPR to ob-
tain documents or information unless
practitioner believes that the information
is privileged. In addition, a practitio-
ner must not unreasonably delay the
prompt disposition of any IRS matter.
Fees
A practitioner may not charge a client
an “unconscionable fee” for represen-
tation before the IRS. Since Circular
C C H
9
June 20, 2005
230 does not elaborate on the defini-
tion of unconscionable, practitioners
are left on their own to determine if a
fee is unconscionable.
Charging clients contingent fees
for providing tax advice is limited by
Circular 230. A contingency fee is de-
fined as a fee arrangement in which a
practitioner will reimburse a client’s fee
if a position taken on a tax return or
other filing is challenged or sustained
by the IRS. A contingency fee arrange-
ment for preparing an original tax re-
turn or for advice in connection with a
position relating to an original tax re-
turn is prohibited under Circular 230.
However, a contingency fee may be
charged for advice regarding an
amended tax return or a claim for a re-
fund if the practitioner reasonably an-
ticipates that the amended return or re-
fund claim will receive substantive re-
view by the IRS.
If a practitioner pub-
lishes information on fees, the
practitioner is bound by the pub-
lished amounts for at least 30 days
after the last publishing date.
Conflict of Interest
Circular 230 prohibits a practitioner from
representing a client before the IRS if the
representation involves a conflict of in-
terest. A conflict of interest is present if:
Representation of one client will be
directly adverse to another client; or
A significant risk exists that represen-
tation of the client will be materially
limited by the practitioner’s responsi-
bilities to others.
Even if a conflict of interest exists,
the practitioner may still represent a cli-
ent if three elements are met:
The practitioner reasonably believes
that the practitioner can provide com-
petent and diligent representation to
each client;
The representation is not prohibited
by law
Each affected client given informed,
written consent.
T A X B R I E F I N G
10
2005 Practice Update
Circular 230 requires
practitioners to keep the written
consents for at least three years
from the conclusion of the repre-
sentation. The practitioner must
relinquish these written consents
if requested by an agent of the IRS.
Return of client records
At the request of a client, a practitioner is
generally required to promptly return all
client records necessary for the client to
comply with his or her tax obligations. A
dispute between the practitioner and the
client does not relieve the practitioner of
this obligation. Circular 230 defines cli-
ent records rather broadly to include
nearly all documents in connected with
the representation of the client. However,
a practitioner may continue to withhold
a document if the client has not satisfied
its contractual duty to pay fees associated
with the document.
Advertising
The method and manner in which a prac-
titioner may advertise or solicit services is
also restricted by Circular 230. Many of
these restrictions mirror regulations pro-
mulgated by state bar association for at-
torneys. For instance, a practitioner may
not use any false, fraudulent, misleading,
deceptive, or coercive statement or form
of public communication. A solicitation
must identify itself as a solicitation. Prac-
titioners must keep copies of radio and tele-
vision advertisements for at least three
years after the actual transmission.
A practitioner is also barred from
contacting a prospective client if the pro-
spective client has communicated that
they do not wish to be solicited.
ENFORCING
CIRCULAR 230
Many practitioners want to know how
Circular 230 sanctions and enforcement
will be handled. While the IRS published
as part of Circular 230 “aspirational best
practices” for which non-compliance
holds no penalty, all other Circular 230
C C H T A X B R I E F I N G
sections are mandatory. The penalties for
violating Circular 230 are severe.
IRS Office of Professional Responsibility
The IRS Office of Professional Respon-
sibility (OPR) handles Circular 230 in-
vestigations, compliance efforts, educa-
tion, and sanctions for failing to com-
ply. In the past, IRS enforcement ef-
forts have been stymied by personnel
and funding shortages. Now, implemen-
tation of the new standards in Circular
230 is one of the IRS’s top four enforce-
ment goals. OPR’s budget has increased
and its staff has doubled.
OPR Director Cono
Namorato recently highlighted
OPR’s renewed emphasis on main-
taining the highest quality standards
of practice. While in the past the
bulk of OPR cases had been mat-
ters involving personal tax noncom-
pliance by enrolled agents, the fo-
cus now has shifted to address tax
abuses. Namorato reported that
OPR is selecting cases “to leverage
a small office of professional re-
sponsibility into an effective arm of
tax administration.” He cited tax
professionals as playing a key role
in the abusive transactions of the
past ten years. Too often, practitio-
ners knew what was going on in
connection with a client’s unre-
ported income and looked the other
way or they were active participants
in facilitating abusive behavior.
While characterizing these practi-
tioners as only a relatively small
number, Namorato observed that all
practitioners are impacted.
Some practitioners have
complained that in the bureaucratic
environment of the federal govern-
ment, an organization, such as OPR,
with a budget and little to do will find
something to do. In this case, once
OPR runs out of egregious tax-shel-
ter related cases, the fear is that it
will begin investigating other, more
routine matters, looking for viola-
tions of Circular 230.
Allegations of misconduct
OPR gets allegations of misconduct in
two ways:
(1) From IRS employees who will make
an OPR referral after establishing a
pattern of misconduct on the part of
the practitioner; or
(2) From the general public, including
former clients and other practitio-
ners, by way of “good faith letters”
pointing to misconduct.
A practitioner may not learn about
an accusation against him or her, de-
pending on the seriousness of the claim,
and whether any action is taken. If ac-
tion is taken against the practitioner, of
course, a series of events is set into mo-
tion. Because the IRS has the authority
to censure, suspend or disbar from prac-
tice before the IRS any practitioner who
willfully, recklessly or through gross
negligence violates Circular 230, the
standards for fact-finding are strict.
Steps in the process
When the IRS receives either an oral or
written statement from an IRS employee
or third party alleging misconduct, after
an initial examination, if it seems as
though a violation has indeed occurred,
a written report is “promptly” made to
OPR. Upon receipt of the report, OPR
may do nothing, may issue a reprimand,
or may commence proceedings to cen-
sure, suspend or disbar a practitioner
from practice before the IRS.
OPR may call a confer-
ence with the practitioner, regard-
less of whether a disciplinary pro-
ceeding has been instituted.
Formal disciplinary proceedings
If formal proceedings are brought for
discipline, OPR must issue a complaint.
The complaint must state with specific-
ity, providing “a clear and concise de-
scription” of the actions, facts, and law
©2005, CCH INCORPORATED

that serve as the basis for the proceed-
ing. It must also name the practitioner
and be signed by an OPR representative.
During the disciplinary proceeding,
the rules of evidence do not apply. Fail-
ure to appear at a hearing is considered
a waiver of the right to a hearing and a
decision may be entered against the ab-
sent party by default.
The hearing’s decision must include a
statement of the findings and conclusions,
as well as an explanation for reaching those
conclusions. If the sanction sought is cen-
sure or suspension of less than six months,
the alleging party must show the miscon-
duct by a preponderance of the evidence.
By contrast, if the sanction sought is IRS
disbarment or suspension of six months or
longer, the standard is “clear and convinc-
ing evidence” of misconduct.
An appeal may be made
within 30 days from the date of the
decision by either party.
Oversight responsibility
Part of what makes Circular 230 so
troublesome is that a practitioner who ac-
tually commits the misconduct may not
be the only person on the hook in a disci-
plinary proceeding. Any practitioner who
has as his or her primary responsibility
the authority to oversee a firm’s practice
of advice concerning federal tax issues
“must take reasonable steps to ensure that
the firm has adequate procedures in ef-
fect for all members, associates, and em-
ployees for purposes of complying” with
the Circular 230 rules.
If the practitioner responsible for
the firm’s Circular 230 compliance will-
fully, recklessly, or with gross negli-
gence fails to do so, or if one or more of
the individuals for whom that practitio-
ner is responsible engages in a pattern
or practice of misconduct, the oversight
practitioner may be sanctioned as well.
Additionally, the practitioner with the
authority to oversee compliance with
Circular 230 may be sanctioned for fail-
ing to take prompt action against the
noncompliance if he or she knew or
11
June 20, 2005
should have known that one or more in the firm’s tax department, com-
subordinates engaged in a prohibited act. plies. This may include, for example,
correspondence to a client from a
The reality of this man- partner in the corporate department
date is that firms will have to adopt passing along a tax conclusion
a procedure for ensuring that every- drawn in an intra-firm conversation
one in the firm, even individuals not with a tax partner or associate.
SAMPLE CLIENT LETTER
The following letter can be used to inform clients about the Circular 230
and the use of a disclaimer in your communications.
Dear Client:
The IRS has issued new rules that will affect how we, tax professionals, communi-
cate with you, our client. The rules, which took effect June 21, apply whenever a prac-
titioner provides written advice, including e-mails, faxes, and letters, on tax issues. While
the rules are motivated by the government’s well-founded concern with abusive tax shel-
ters, they will apply to advice given on many common and accepted transactions.
The rules grew out of the government’s decision to attack the mechanisms used by
tax shelter promoters to sell abusive tax shelters. The new rules address the practice of
promoters to obtain boiler-plate opinions for tax shelters. Taxpayers engaging in abu-
sive transactions use these types of opinions to escape tax penalties of 20 percent or
more, on top of what they owe in taxes, by claiming they “reasonably” and “in good
faith” relied on the tax opinion for their belief that the transaction was permissible.
In the new IRS rules, clients cannot rely on a tax opinion for protection from penal-
ties unless the practitioner provides a comprehensive opinion that considers and discusses:
• All relevant facts and applicable law,
• The relationship between the facts and the law,
• A conclusion as to the legal consequences of each tax issue, and
• The likelihood that the taxpayer will prevail if the IRS challenges the transaction.
The new rules apply to tax advice for transactions that have a “significant pur-
pose” of tax avoidance. This standard is vague and uncertain, in large part because
the IRS did not want to create any loopholes. Consequently, the new rules may sweep
in many routine, non-abusive transactions. The penalties to practitioners can be se-
vere for providing written advice that does not meet these requirements, including
disbarment from practice before the IRS.
Because of the new rules, the cost of securing a comprehensive opinion will be higher.
An alternative to writing an expensive opinion is to include a disclaimer on written advice
furnished to the client. This disclaimer will state that the client cannot rely on the opinion for
protection from tax penalties. Accordingly, effective June 21, this firm will routinely include
the following language in written communications:
“This written advice is not intended or written to be used, and it cannot be
used by any taxpayer, for the purpose of avoiding penalties that may be imposed
on the taxpayer.”
Even with this legend, there are other penalty defenses to penalties. You will not
automatically be penalized if the IRS challenges a transaction.
Please be assured that we will continue to act diligently to meet your needs. The
use of this legend does not change the quality of our service and the advice you have
come to expect from us. In appropriate cases, after consultation with you, we will
provide a comprehensive opinion that meets the new rules.
If you have any questions about this important development, please contact us.
Sincerely,
C C H T A X B R I E F I N G
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