Need Clarification on IRS Penalty Policy

[ejalquat]

I met with a tax attorney last week about a tax deferral transaction which I was told by a non-specialist might run up against the economic substance doctrine. During the consultation, the tax attorney told me that he felt he could make it conform to the economic substance doctrine. He also told me that if a taxpayer takes a position that is based on the written advice of a tax attorney and the attorney doesn't overlook any obvious contradictory precedent in making his case and the argument is generally sound but ultimately denied by the IRS anyway, their (IRS) policy is not to slap the taxpayer with a 40% penalty. He added that in fact that is the main reason why some corporations pay for a written opinion in that it acts as an insurance policy against the 40% penalty.

Not being an attorney, I have no idea if this is a fairly accurate description of how the process works or if I was simply the hapless victim of a hard sell. I'm hoping to get some unbiased opinions here as I have no basis on which to decide if what he told me about the penalty is in fact true. Thanks.

[LaVidaRoja]

Pay the money to get a Private Letter Ruling. If the attorney who gave you the advice is not willing to do the PLR request, RUN!!

[ejalquat]

Pay the money to get a Private Letter Ruling. If the attorney who gave you the advice is not willing to do the PLR request, RUN!!

The transaction isn't big enough to justify the cost of a PLR plus time is somewhat of the essence and it probably wouldn't arrive in time even if it made economic sense to get one.

[LaVidaRoja]

Get the attorney's opinion IN WRITING

[ejalquat]

Get the attorney's opinion IN WRITING

Certainly, but what about his claim about the IRS not slapping penalties on taxpayers with an attorney's well-reasoned opinion? Fact or fiction? You're suggesting I get the opinion in writing. Is that because he's basically correct in his IRS claim or simply so I can bitch at him if he's wrong ?

[Number Six]

If he provides a legally-valid letter on your issue, he becomes liable for the consequences, maybe even financially liable for his position?

Gotta love all the tax attorneys and lobbyists on behalf of wealthy clients and corporations geared toward keeping the Buffet-style legal tax-avoidance alive and well....

[jcolvin2]

I met with a tax attorney last week about a tax deferral transaction which I was told by a non-specialist might run up against the economic substance doctrine. During the consultation, the tax attorney told me that he felt he could make it conform to the economic substance doctrine. He also told me that if a taxpayer takes a position that is based on the written advice of a tax attorney and the attorney doesn't overlook any obvious contradictory precedent in making his case and the argument is generally sound but ultimately denied by the IRS anyway, their (IRS) policy is not to slap the taxpayer with a 40% penalty. He added that in fact that is the main reason why some corporations pay for a written opinion in that it acts as an insurance policy against the 40% penalty.

Not being an attorney, I have no idea if this is a fairly accurate description of how the process works or if I was simply the hapless victim of a hard sell. I'm hoping to get some unbiased opinions here as I have no basis on which to decide if what he told me about the penalty is in fact true. Thanks.

With respect to ordinary transactions, the opinions of a tax professional can help the taxpayer establish "reasonable cause and good faith" which allow the taxpayer to avoid the imposition of the accuracy penalty. See Treas.Reg. 1.6664-4. However, the reasonable cause and good faith defense is not applicable to the recently codified economic substance doctrine (CESD) prong of the accuracy penalty. IRC Section 6664(c)(2). If the transaction is devoid of economic substance, the legal opinion will not be worth the paper it is written on. While in the past, a tax opinion might have been given some weight in determining the applicability of the penalty (The IRS is currently litigating penalty issues - fairly successfully - with many taxpayers who believed that the tax opinion that they obtained in connection with their transaction would shield them from penalties), an opinion will not be of help if the transaction lacks economic substance.

That being said, in the last 18 months the IRS (LB&I) has instituted fairly tight controls over imposition of the CESD penalty. Generally, if the transaction fails for some other reason (e.g. it fails a statutory requirement), the IRS has instructed its agents not to assert the penalty. Because the penalty is only applicable to transactions entered after March 30, 2010, there have been few if any assertions of the CESD penalty to date. It is simply too new.

[fortinbras]

I assume this tax attorney is the real thing. I don't know how much tax could be involved but presumably more than this guy's fee for writing you a letter providing his legal opinion approving your position.

The frivolous pleading penalty is ordinarily activated when someone goes off the tracks on the basic and most thoroughly established legal issues, but if this is, as you indicated, a relatively new or obscure transaction whose tax implications have not yet been clearly settled, I think that, even if you lose, you can avoid the frivolous penalty.

[ejalquat]

If he provides a legally-valid letter on your issue, he becomes liable for the consequences, maybe even financially liable for his position?

Never having bought and paid for the opinion of a tax attorney before, I would assume that they preface the opinion with all sorts of disclaimers that clearly proclaim that this is their opinion only and opinions are like asses, everyone has one etc.

If so, how can an attorney be held financially liable for a well-reasoned opinion that turns out to be denied? It would seem similar to a financial adviser being held responsible for making a sound case for why you should buy a certain stock that is clearly within your stated risk parameters only to have the stock head south due to an unexpected development and your being able to sue him and recover your loss. An opinion is just that, an opinion, not a statement of fact.

[Kestrel]

Never having bought and paid for the opinion of a tax attorney before, I would assume that they preface the opinion with all sorts of disclaimers that clearly proclaim that this is their opinion only and opinions are like asses, everyone has one etc.

If so, how can an attorney be held financially liable for a well-reasoned opinion that turns out to be denied? It would seem similar to a financial adviser being held responsible for making a sound case for why you should buy a certain stock that is clearly within your stated risk parameters only to have the stock head south due to an unexpected development and your being able to sue him and recover your loss. An opinion is just that, an opinion, not a statement of fact.

It's a lot more than crystal-ball stock market prognostication. An attorney who provides tax advice is presumed by the IRS to be a professional who is in a position to "know better" and has a heightened obligation to not give potentially questionable advice. The IRS plays hardball.

IRC § 6694 – Understatement of taxpayer’s liability by tax return preparer.

IRC § 6694(a) – Understatement due to unreasonable positions. The penalty is the greater of $1,000 or 50% of the income derived by the tax return preparer with respect to the return or claim for refund.

IRC § 6694(b) – Understatement due to willful or reckless conduct. The penalty is the greater of $5,000 or 50% of the income derived by the tax return preparer with respect to the return or claim for refund.

Here's the full list: Summary of Tax Preparer Penalties under Title 26.

[ejalquat]

IRC § 6694 – Understatement of taxpayer’s liability by tax return preparer.

IRC § 6694(a) – Understatement due to unreasonable positions. The penalty is the greater of $1,000 or 50% of the income derived by the tax return preparer with respect to the return or claim for refund.

IRC § 6694(b) – Understatement due to willful or reckless conduct. The penalty is the greater of $5,000 or 50% of the income derived by the tax return preparer with respect to the return or claim for refund.

Thanks for the clarification though I do have to chuckle at those penalties. For a high-priced law firm that doesn't even qualify as a slap on the wrist. Perhaps a caress...... Even forfeiting 50% of the income is just a mild annoyance. (btw, the firm will of course argue that the income derived is a small percentage of the gross fee) A tax attorney must have devised those penalties for the IRS!

[Kestrel]

Thanks for the clarification though I do have to chuckle at those penalties. For a high-priced law firm that doesn't even qualify as a slap on the wrist. Perhaps a caress...... Even forfeiting 50% of the income is just a mild annoyance. (btw, the firm will of course argue that the income derived is a small percentage of the gross fee) A tax attorney must have devised those penalties for the IRS!

There's more at risk than just the specific penalty on an individual return.

The IRS's Paid Taxpayer Identification Number (PTIN) system dictates who is and is not permitted to assist in tax return preparation. Presumptively, attorneys and CPAs are automatically eligible. But everyone still has to pass a Tax Compliance Check before a PTIN will be issued or renewed, and background checks are coming soon. See the Overview of Tax Return Preparer Requirements.

You don't strictly comply with the tax laws and give well-grounded advice? You don't get authorized to prepare ANYONE'S tax return again. Bye-bye livelihood.