Comments Regarding Proposed Amendments to the Regulations
Governing Practice Before the Internal Revenue Service
(Title 31, Code of Federal Regulations, Subtitle A, Part 10)
April 23, 2001

Section 10.33  Tax shelter opinions used by third parties to market tax shelters.

Summary of Principal Comments

Section 10.33 of the Proposed Amendments provides requirements for a tax shelter opinion that does not conclude that the tax treatment of a tax shelter item is more likely than not the proper treatment. Section 10.33(c)(2) defines a "tax shelter" broadly by reference to section 6662(d)(2)(C)(iii) of the Code. Section 10.33(c)(4) defines a "tax shelter opinion," for purposes of section 10.33, in a manner that limits the definition to advice that the practitioner knows or has reason to believe will be used or referred to by a person other than the practitioner in promoting, marketing, or recommending a tax shelter to one or more taxpayers. As explained in more detail below, section 10.35(c)(4) of the Proposed Amendments, which addresses tax shelters for which a practitioner is providing a "more likely than not" opinion, uses a much more expansive definition of "tax shelter opinion" than section 10.33(c)(4). The definition in section 10.35(c)(4) does not restrict a "tax shelter opinion" to opinions marketed to third parties.

The Section believes that the definition of "tax shelter" in sections 10.33(c)(2) and 10.35(c)(2) of the Proposed Amendments is inappropriately broad. The definition of "tax shelter" would preferably be limited to transactions the principal (rather than "a significant") purpose of which is the avoidance or evasion of federal income tax. In the alternative, a lengthy list of excluded transactions would need to be added to the definition of a "tax shelter." If the definition of "tax shelter" is limited in such fashion, then the definition of "tax shelter opinion" in section 10.33(c)(4) should be expanded to cover all opinions that are used, or that are provided by practitioners involved, in the marketing or promotion of the related tax shelter.¹

Section 10.33 imposes various requirements on both the substance of the opinion and its form, for example a requirement that the opinion must disclose on the first page that it does not conclude that the tax treatment is more likely than not the proper treatment and is not intended to establish reasonable belief, reasonable cause or good faith for penalty purposes. Although some of the individuals who participated in the preparation of these comments believe that these formal requirements may intrude excessively into the professional relationship between the practitioner and the client and that reliance on a general requirement of fair disclosure would be preferable, the Section believes that the specific requirements as to form in section 10.33 will simplify the matter for both practitioners and clients. Again, this divergence of views is ameliorated if the definition of "tax shelter" is appropriately limited.

The Section recommends that sections 10.33 and 10.35 be better coordinated and that uniform definitions be employed to the extent possible so as to avoid confusion and unintentional noncompliance.

Detailed Comments

Heading and cross-references. The heading to section 10.33 reflects its origin in the present regulations by referring to "tax shelter opinions used by third parties to market tax shelters." Consideration could be given to having the heading include a reference to "tax shelter opinions below a ‘more likely than not’ standard." Use of this language would clarify the relationship between section 10.33 and section 10.35 which deals with opinions that are at a "more likely than not" or higher level of confidence. In any event, the introductory language for each section could cross-refer to the other so that a reader of either would realize there are two separate rules.

10.33(a)(1) through (3): facts, law, and analysis. These provisions set forth the requirements for a section 10.33 opinion in respect of factual matters, relating the applicable law to the relevant facts, and analysis of material Federal tax issues. They are similar to the equivalent provisions in section 10.35, dealing with opinions that the tax treatment of a tax shelter item is more likely than not the proper treatment, except for one important difference. That difference is that section 10.35(a)(1)(ii)(C) specifically requires that a section 10.35 opinion may not use a factual assumption that a transaction has a business reason, is profitable, or complies with a material valuation issue. There is no counterpart prohibition in section 10.33.

10.33(a)(3) and (a)(4): "typical investors". Section 10.33(a)(3), dealing with analysis of material Federal tax issues, is based generally on the tax liability of a "typical investor." Contrasting language referring to "the taxpayer" appears in section 10.35. The Section assumes that this difference in language reflects the differing definitions of "tax shelter opinion" in these two provisions. In order to avoid confusion, a definition of "typical investor" should be provided in section 10.33.

10.33(a)(5): overall conclusion; required disclosures. Section 10.33(a)(5) requires that (1) an opinion must clearly state that the practitioner is unable to reach an overall conclusion (if that is the case), (2) the failure to reach a "more likely than not" overall conclusion or to reach any overall conclusion must be clearly and prominently disclosed on the first page, and (3) the opinion must clearly and prominently disclose on the first page that the opinion was not written for the purpose of establishing a taxpayer’s reasonable belief, reasonable cause, or good faith for purposes of cited penalty provisions in section 6662 and 6664. Although some of the individuals who assisted in the preparation of these comments believe that the formal requirements may intrude excessively into the professional relationship between practitioner and client and may raise a question as to authority for the regulation,² the Section believes that these proposals will add uniformity and certainty. The Section strongly agrees with the goal of furthering disclosure of the limited nature of the opinion.

10.33(c)(2): definition of tax shelter. The Section’s most significant concern about the Proposed Amendment to section 10.33 is the definition of a "tax shelter." Section 10.33(c)(2) defines tax shelter by reference to section 6662(d)(2)(C)(iii) of the Code, imposing the accuracy-related penalty. The same definition appears in section 10.35, relating to "more likely than not" opinions, except that in section 10.35 there is a specific exclusion for municipal bonds and qualified retirement plans.

The Section agrees that the definition of a "tax shelter" in section 10.33(c)(2) of the current regulations is outdated. The Section further believes that Section 10.33 should use the same definition of "tax shelter" as section 10.35. However, the Section believes that the definition set forth in section 6662(d)(2)(C)(iii) of the Code is overly broad for use in the Circular 230 context because it encompasses transactions "a significant" purpose of which is tax avoidance. Using that definition would draw in numerous transactions that should not be viewed as "tax shelters" for Circular 230 purposes. Because many routine business transactions are structured in a manner in which tax avoidance is a "significant" purpose, adoption of the statutory definition of a "tax shelter" in section 6662(d)(2)(C)(iii) would extend the rules of Circular 230 to many (if not most) tax opinions furnished in connection with routine business transactions. Such an expansion of the impact of Circular 230 is unwarranted and would unduly intrude on the practitioner-client relationship.

The Section recommends that a "tax shelter" be defined for purposes of Circular 230 by reference to the language utilized in section 6662(d)(2)(C)(iii) prior to its amendment in 1997. Specifically, the Section believes that a "tax shelter" should be limited to situations in which the principal purpose is the avoidance or evasion of federal income tax. In this regard, the regulations that were issued prior to 1997 under section 6662(d)(2)(C)(iii) (section 1.6662-4(g)(2)(ii)) provide a useful frame of reference. These regulations elaborate the substantive standards of "principal purpose" (the pre-1997 standard before the statutory change to "significant purpose") and "avoidance or evasion" of tax so as to exclude arrangements with a purpose of claiming exclusions from income, accelerated deductions or other tax benefits in a manner consistent with the Code and Congressional purpose.

The section 6662 regulations contain a number of examples covered by this exclusion, including purchasing or holding a tax-exempt municipal bond or establishing a qualified retirement plan and also several other specific tax-advantaged transactions. If the Service does not accept the Section’s proposed definition of a "tax shelter," the Section recommends, in the alternative, that numerous routine transactions that have a significant purpose of tax avoidance be excluded from the definition of a "tax shelter." The list of exclusions should include:

• Transactions generating tax credits under Code section 29 or 42.
   
• The failure of a partnership to make a Code section 754 election.
   
• Other transactions expressly permitted by the partnership anti-abuse regulations in Treasury regulations section 1.701-2.
   
• Choice of entity or checking the box.
   
• Transactions permitted by the Supreme Court’s decision in Cottage Savings.
   
• Partnership redemptions that use property rather than cash.
   
• Like-kind exchanges that are part of a sale of an asset.
   
• Substituting debt for equity or choosing to issue debt instead of equity.
   
• Transferring insurance operations to a subsidiary.
   
• Corporate reorganizations.
   
• Qualified stock option plans.
   

These exclusion examples would be in addition to the list already set out in section 1.6662-4(g).

The above list is indicative of the problems that the Section believes are inherent in the definition of "tax shelter" in section 10.33(c)(2) of the Proposed Amendments. Many routine business transactions, including (for example) a like-kind exchange or using a partnership rather than a corporation to make an investment, have a significant purpose of the avoidance of federal income tax. Furnishing a written opinion to a client concerning such routine business transactions should not require a practitioner to address all of the matters required by sections 10.33 and 10.35 of Circular 230.

10.33(c)(4): definition of tax shelter opinion. Section 10.33(c)(4) defines tax shelter opinion for purposes of section 10.33 as, in general, an opinion that will be used by a promoter in marketing a tax shelter. By doing so, section 10.33(c)(4) in effect creates an exception to section 10.33 for opinions delivered directly to a taxpayer. There is no analogous exception under section 10.35(c)(4) for "more likely than not" opinions.

While section 10.35 applies to opinions that potentially can be used by taxpayers to obtain penalty protection under sections 6662(d)(2)(C)(i)(II) and 6664(c)(1) of the Code, the opinions covered by section 10.33 cannot be used for such purposes. Accordingly, the Section feels that it is appropriate to limit the scope of section 10.33 to opinions that are used by a promoter in marketing a tax shelter, particularly if the broad definition of "tax shelter" contained in the Proposed Amendments is ultimately adopted. To remove that limitation would unduly impinge on the practitioner-client relationship and, in many cases, would cause sophisticated taxpayers, many of whom have their own in-house tax professionals, to pay for more analysis and advice from outside tax advisors than they want.

One possible "loophole" that the Service should consider closing is the limitation in section 10.33(c)(4) that causes section 10.33 to apply only to opinions used by "a person other than the practitioner" in marketing a tax shelter. That limitation allows a practitioner to engage in tax shelter marketing to a large number of potential investors using his or her opinion as a promotional device without such opinion being subject to section 10.33. Assuming that the Section’s recommendation regarding narrowing the definition of "tax shelter" is adopted, we believe that the tax shelter opinion definition should be expanded to cover an opinion provided by a practitioner who participates in the promotion or marketing of a tax shelter.³

This expansion, however, must be carefully crafted to avoid impinging on the ability of a practitioner who is not involved in promoting or marketing a tax shelter to provide limited advice to a client regarding the tax shelter in a one-on-one setting (assuming that the advice given is not subject to section 10.35). Specifically, we recommend that the first sentence of section 10.33(c)(4) be revised to read as follows:

4. A tax shelter opinion, as the term is used in this section, is written advice by a practitioner concerning the Federal tax aspects of a tax shelter item or items (i) that a practitioner knows or has reason to believe will be used or referred to by a person other than the practitioner (or a person who is a member of, associated with, or employed by the practitioner’s firm or company) in promoting, marketing, or recommending the tax shelter to one or more taxpayers or (ii) where the practitioner (or a person who is a member of, associated with, or employed by the practitioner’s firm or company) has participated or is participating in promoting, marketing, or recommending the tax shelter to one or more taxpayers, in each case irrespective of whether such promotional, marketing, or similar activities are conducted privately or publicly.⁴

Finally, both section 10.33(c)(4) and section 10.35(c)(4) appear to draw a distinction between "preparing" and "reviewing" portions of tax shelter offering materials in situations where neither the practitioner nor his firm is referred to in the offering materials or the related sales promotion efforts. The practitioner apparently is treated as providing a tax shelter opinion in the former case, but not the latter. The distinction between preparing and reviewing the tax consequences section or sections of offering materials is blurry at best and is a tenuous basis for deciding whether a tax shelter opinion has been given. The exception appropriately focuses on the key indicia of a tax shelter opinion, namely, whether the practitioner’s name, firm, or advice is referred to in the offering materials. Consequently, the Section recommends that the exception contained in the last sentence of sections 10.33(c)(4) and 10.35(c)(4) be expanded to cover both preparation and review activities, so long as the other requirements for the exception are met.

10.33(c)(5): material Federal tax issues: "significant effect" test. Section 10.33 requires that a practitioner must ascertain that all material Federal tax issues have been considered. The definition of material Federal tax issue in section 10.33(c)(5) includes generally any Federal tax issue the resolution of which could have a "significant impact" on a taxpayer under any reasonably foreseeable circumstance. In order to avoid the question of whether a large dollar item is significant to a very large taxpayer, this definition could be rephrased to include any issue the resolution of which could have a significant impact on the taxpayer either in terms of foreseeable percentage of total tax liability or absolute amount of tax liability.