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 10.35  More likely than not tax shelter opinions.

Summary of Principal Comments

Section 10.35 provides requirements for a tax shelter opinion that concludes that the tax treatment of a tax shelter item is the proper treatment on a "more likely than not" basis or any higher level of confidence. Section 10.35 uniformly applies to opinions issued to both individuals and corporations, regardless of whether or not such opinions are used for marketing or promoting the related tax shelter and whether or not such opinions are intended to provide penalty protection. Similar to section 10.33, relating to third-party opinions that are below the "more likely than not" level, section 10.35 imposes various requirements on the substance of the opinion. Section 10.35 requires that the conclusion as to whether the "more likely than not" standard is met be unambiguous. Section 10.35(c)(2) defines a "tax shelter" by reference to the definition in the accuracy-related penalty provisions of section 6662, with specific exclusions for municipal bonds and qualified retirement plans. Section 10.35(c)(4) defines a "tax shelter opinion" to include any written advice given by a practitioner to a client with respect to the federal income tax aspects of a tax shelter.

Section 10.35 as proposed presents significant issues as to its coverage -- both in terms of uncertainty and potential overbreadth. A practitioner should be able to tell with greater clarity when the heightened standards of section 10.35 apply; and such heightened standards ought to apply to a narrower category of advice than is suggested in the Proposed Amendments.

In October of 1999, the Section submitted a report recommending heightened standards for opinions provided to corporate taxpayers "for the stated purpose of establishing the legal justification of a corporate taxpayer under 26 C.F.R. 6664-4(e)(2) for the tax treatment of a ‘tax shelter item,’ as defined in 26 C.F.R. 1.6662-(4)(g)(3)." The definition of "tax shelter" that was invoked by the cross-reference to section 1.6662-4(g)(3) in the October 1999 report was the narrower one -- based on the "principal purpose" test -- that is recommended above in our comments relating to section 10.33. The definition of a "tax shelter opinion" in proposed section 10.35(c)(4) includes all forms of written advice concerning the Federal tax aspects of a tax shelter item or items, whether or not for the stated purpose of penalty protection, whenever such advice expresses a more likely than not or higher standard of opinion. In addition, section 10.35(c)(2) incorporates the broader "significant purpose" definition of a tax shelter. For the reasons discussed below, these two definitions together would cause section 10.35 to apply to an overly broad category of practitioner advice.

The Section’s earlier suggestion that coverage be limited to formal, "stated purpose" penalty-protection opinions was based in part on the desire for predictability of coverage. The earlier suggestion also assumed no change to existing section 10.33. In light of the significant changes made by the Proposed Amendments, these comments recommend a narrower definition of "tax shelter" as an alternative approach for obtaining greater certainty and appropriate breadth in the coverage of sections 10.33 and 10.35. However, even if the coverage of proposed section 10.33 is not narrowed as recommended in our comments above, we recommend that section 10.35 use a significantly narrower and clearer definition of covered opinions. This objective could be accomplished either through using a narrower definition of "tax shelter" in section 10.35(c)(2) or through the Section’s original suggestion of covering only opinions provided for the "stated purpose" of penalty protection (and possibly opinions used in marketing a tax shelter). Either approach is consistent with our October 1999 report.

Detailed Comments

10.35(a): general; cross references. The introductory material should include cross-references to section 10.33. In addition, the Service should consider clarifying the application of section 10.35 to an opinion where the practitioner provides a "more likely than not" level comfort with respect to certain aspects of the tax treatment of a tax shelter item, but not others. For example, assume that a practitioner’s written opinion provides a "more likely than not" level of comfort with respect to the ability to recognize, and the timing of, a loss produced by a tax shelter, but provides a lesser level of opinion with respect to the character of the loss. In that case, it seems logical that the requirements of section 10.35 would apply to the recognition and timing portion of the opinion, but not the character portion (although section 10.33 might apply to the character portion).

10.35(a)(4): evaluation of material Federal tax issues. Section 10.35(a)(4) has references to investors. To avoid confusion, we again recommend that a definition of "investor" be provided.

10.35(c)(2): definition of tax shelter. Section 10.35(c)(2) defines tax shelter by reference to the statutory definition in section 6662(d)(2)(C)(iii) of the Code, with exclusions for municipal bonds and qualified retirement plans. For the reasons set forth in detail above with respect to section 10.33(c)(2), the Section believes that this definition is inappropriately broad. For purposes of Circular 230, "tax shelters" should preferably be limited to transactions the principal purpose of which is the avoidance or evasion of federal income tax. In the alternative, a lengthy list of excluded transactions should be added to the definition of a "tax shelter."

10.35(c)(4): definition of tax shelter opinion. Section 10.35(c)(4) does not limit the definition of "tax shelter opinion" to opinions that are used in marketing a tax shelter or prepared for penalty protection. For the reasons set forth in detail above with respect to section 10.33(c)(4), the Section believes that the more expansive definition of "tax shelter opinion" in section 10.35(c)(4) is appropriate if, but only if, the definition of a "tax shelter" is appropriately limited. Otherwise, because section 10.35(c)(4) encompasses any written advice provided to a taxpayer with respect to a "tax shelter," a practitioner would be required to provide a full-blown opinion complying with Circular 230 if the practitioner is advising a client with respect to a transaction in which the taxpayer has a significant purpose of tax avoidance.

The scope of this problem in the Proposed Amendments cannot be overstated. Practitioners routinely furnish clients with written advice, usually at a "more likely than not" or higher level of assurance, concerning routine business transactions. Although these transactions are not principally tax motivated, such transactions are usually structured so as to minimize the federal income tax consequences thereof, i.e., the transactions have a "significant purpose" of tax avoidance. If the definitions in section 10.35 of the Proposed Amendments are not altered, many routine business transactions will be swept within the ambit of this provision. Every like-kind exchange would be subject to this rule; every transfer of assets to a partnership (instead of a taxable sale) would arguably be subject to this rule; every tax-free reorganization could be within the broad scope of this rule; even the utilization of a partnership instead of a corporation to conduct a new business would be subject to this rule. The list is virtually endless.

This problem arises not because of the definition of "tax shelter opinion" in section 10.35(c)(4) but, rather, because of the overly-broad definition of a "tax shelter" in section 10.35(c)(2). The Section agrees that a practitioner who provides written advice to a taxpayer with respect to a "tax shelter" (as appropriately defined) should be required to address all material issues concerning that tax shelter. However, if the definition of a "tax shelter" is not appropriately limited, then the requirements of Circular 230 should apply only to opinions used for tax shelter marketing or promotion or prepared to provide penalty protection in order to avoid unduly intruding on the practitioner-client relationship.

Accordingly, if the definition of "tax shelter" were appropriately limited, then the Section believes that it would be appropriate to use the currently proposed definition of "tax shelter opinion" in section 10.35(c)(4). Otherwise, the Section recommends that the definition of "tax shelter opinion" be modified so that it is limited to opinions used for marketing (presumably using the same language as in section 10.33(c)(4) (modified as suggested above in our comments regarding section 10.33)) or prepared for the "stated purpose" of penalty protection (presumably using the language suggested in our October 1999 report). Also, see our comment on the corresponding provision in section 10.33 regarding the need to eliminate the distinction between "preparation" and "review" in the last sentence of section 10.35(c)(4).

10.35(c)(5): material Federal tax issues. See our comment on the counterpart provision of section 10.33.