PROFESSIONAL TAX PRACTICE ISSUES

James R. Hamill, CPA, Ph.D.Reynolds, Hix & Company, P.A.Albuquerque, New Mexico505-828-2900

AUTHORITIES

Treasury Circular 230 AICPA SSTS ABA Model Rules, Opinion 346, Opinion 85-

352 §6694 Preparer Penalties §7216 Information Disclosure Fin 48 (GAAP Tax Disclosures)

Authorities – Recent Trends

Federal Tax Policy has tightened the rules applicable to both “FATPs” and unenrolled preparers

This tightening has been in response to a sense that bad behavior by FATPs has contributed to an ever eroding federal tax base

The same can be said for FBAR reporting

Tax Gap Motivations for Change

Shelters developed by third-party promoters and marketed to individuals; usually high income but not ridiculously high-income

– Examples might be doctors– CPA would evaluate merits upon return preparation

Shelters developed by big accounting and law firms and packaged and marketed to clients and non-clients for enormous fees

– Business (not tax) assessment of whether fees justify legal exposure

– E.g., KPMG fees typically 1.25% of tax loss

Big Firm Tax Shelters

KPMG called it “unlawful conduct” PwC and Arthur Andersen called it “institutional

failure” The structures were “look-alike strategies” or “off the

shelf products” This was a sea change from the CPA’s role as a

personal tax advisor to a single client Law firms worked hand-in-hand with big CPA firms;

Jenkins & Gilchrist was forced to close as a result

Big Firm Shelters

These shelters differed from the 1970/1980 shelters in two respects– The promoters were CPA and law firms rather

than third-parties who often knew little about tax law

– The purchasers were ridiculously wealthy; no longer just the Doctor with $400,000 annual income, now the seller of a business with a $100 million gain to shelter

Example: VIPER Group

In 2009, four E&Y tax partners were convicted of tax fraud

One was the former national wealth planning director, another the personal income tax and retirement planning director

Their work included purported reliance on clearly incorrect statement of facts and outside legal opinions

VIPER Sentences: January 2010

Sentences were for as long as 36 months (well below the 21 years sentencing guidelines)

Post-prison supervised release requires communicating to attorneys and CPAs the dangers of– Misleading the IRS– Going along with everyone else– Thinking you are just doing your job

VIPER Sentencing

U.S. District Judge Sidney Stein said:– “This was an extensive network [within the firm]”– “I understand there was pressure coming from

higher-ups at Ernst & Young to make money”– And [pressure to] “start raking in the millions of

dollars”

BDO Tax Shelters

Charles Bee, tax partner, pleaded guilty and forfeited $20 Million in fees that BDO paid to him for the tax shelters

Michael Kerekes, tax partner, pleaded guilty, and said “I knew what I was doing was against the law”

What Have We Learned?

Many “regular” practitioners, i.e., those charging less than $400+ per hour, had no sympathy for the big firms

In fact, they resented being the dolphins caught in the tuna net when standards changed

On August 5, 2010, the Tax Court dealt with a Big-4 opinion letter, in Canal Corporation, 135 TC No. 9, that has actually been defended by many, albeit mostly big firm practitioners

Canal Corporation : When is an Opinion Reasonable to Rely Upon?

Company was to sell assets to Georgia Pacific for $755 Million

Desired to avoid paying tax “Leveraged Partnership” product suggested

– Taxpayer transfers assets– Partnership borrows money– Partnership distributes to Taxpayer– Taxpayer indemnity to create loan basis

Canal Corporation

Taxpayer insisted on “should” opinion from PwC– This is a high standard– Below “will” but above “more likely than not”

Fee was a flat $800,000, regardless of time spent

Canal Corporation

The issue was whether Canal had engaged in a “disguised sale”

GP guaranteed the debt; Canal’s indemnity was intended to avoid a disguised sale due to continuing economic risk of loss

The indemnity came through the subsidiary whose assets were to be sold (WISCO)

Canal Corporation

WISCO had few assets The indemnity was only for principal, which

was not due for 30 years GP had to proceed against partnership

assets before trying to enforce indemnity Company told Moody’s and Standard &

Poor’s that the indemnity created no risk

Canal Corporation

The Tax Court assessed a 20% penalty on Canal

The PwC opinion was not reasonable as a defense

Strangely, to me, many tax advisors have expressed varying levels of outrage that an opinion from a prominent firm would be ignored

Defense Against the Dark Arts

The best defense is personal responsibility But we also need to be aware of the myriad

of professional responsibilities that are to guide our actions– Awareness need not be expertise– Other firm personnel as a sounding board

Based on tax law assessment NOT the “bad guy” business assessment

§6694 Preparer Penalty Changes

Used to be reasonable basis, then realistic possibility of success

May 2007 changed to more-likely-than-not October 2008 changed to substantial

authority, retroactive to May 2007 Transition rules for May 2007 to 2008

change; we now live under substantial authority standard

Research and Writing (or other communication)

How should we determine the appropriate treatment of an item?

How should we communicate our findings to the taxpayer?

Satisfying SSTS No. 1

Establish relevant background facts Identify relevant questions Locate authorities to answer questions Resolve the questions using authorities Arrive at a conclusion

Facts-Issue(s)-Authorities-Conclusion

Satisfying SSTS No. 7

Establish facts Evaluate reasonableness of assumptions Apply authorities Consider business purpose and economic

substance Reach a conclusion

Applies to oral and written opinions

Communications

I suspect we need to do more written tax communication than we are accustomed to doing, with opt out language

Communications may be more casual when simply explaining a general tax planning idea without use of the client’s specific facts

SSTS 7 advice to consider business purpose and economic substance, I think, need not be explicitly included in the memo

Best Practices - §10.33

Clear communication regarding terms of the engagement

Establish facts, which facts are relevant, how reasonable are assumptions, what is the applicable law, what is the conclusion (apply law to the facts) – notice the recurrence of this approach

Advise client of conclusions, including applicability of any penalties

SECTION 7216

Prohibits certain disclosures of tax return information

Misdemeanor offense, penalties – Monetary, up to $1000, plus costs of prosecution– Prison, up to one year

Disclosures without consent Disclosures with consent

Tax Return Information

Any taxpayer provided information furnished to prepare the return

May be furnished on behalf of the taxpayer, such as by a guardian, fiduciary, principal, etc.

Disclosures Without Consent

Any disclosure to IRS Any disclosure pursuant to some other IRC

provision Any same firm (not affiliates) disclosure for

return preparation, if firm is located in U.S. (consent required to disclose to non-U.S. firm member or firm outside the U.S.)

Disclosures Without Consent

Preparer-to-preparer disclosure OK if no substantive determination of liability is involved– Processing center in U.S.– E file provider

Related Party Disclosure– Disclosure not adverse to first party– Taxpayer did not expressly prohibit

Related Parties

Husband and wife Child and parent Grandchild and grandparent Partner and partnership Estate/trust and beneficiary Corporation and shareholder Controlled group members

Disclosure Without Consent

Court or administrative body order/subpoena Professional association ethics investigatory

committee PCAOB (Sarbanes-Oxley) Obtaining legal advice (e.g., actions against

the return preparer) – to firm located in U.S.

Disclosures Without Consent

Disclosure to taxpayer’s fiduciary (duly authorized agent)

Payment processing (e.g., name, credit card information)

Quality or peer reviews of the firm Report commission of a crime (good faith

protection)

Form Of Consent

Consent must be in writing, signed and dated by taxpayer

Consent must be knowing and voluntary (cannot condition services on receipt of consent)

Must include name of taxpayer and preparer, intended disclosure, recipient, use, information to be disclosed

Form of Consent

If all requirements satisfied, may be in an engagement letter

Consent for use for non-return services may not be requested after return is delivered

Consent cannot be obtained after disclosure or use Once consent is declined, the preparer may not ask

for consent again (taxpayer may initiate)

Form of Consent

While the consent may authorize disclosure of the entire return, such a consent must provide that the taxpayer has the ability to make a more limited disclosure

Copy must be provided to taxpayer at the time of execution (taxpayer may be given the opportunity to print the consent or save it electronically)

Disclosure versus Use

Disclosure involves the return preparer disclosing taxpayer information to third parties. Identity theft is a concern with disclosure.

Use refers to what the return preparer can do with the taxpayer’s information in the return preparer’s hands. Identity theft is not an issue with use.

Disclosure versus Use Consents

Taxpayers may consent to one but not the other

A single written consent may not be used for both disclosure and use

A single written document may authorize multiple disclosures or multiple uses, provided it does not authorize both disclosures and uses.

Duration of Consent

Consent may specify the duration for which it is effective

Where no time is specified, the consent is valid for one year after it is signed (note that a valid consent must be dated)