Fall 2006
Volume 3, Number 1
Table of Contents

Circular 230-How It Changed Our Lives [Or At Least Our Practices]

By Edward M. Manigault and Steve R. Akers

As most readers should now be aware, the IRS substantially revised Circular 230 effective for written advice given after June 20, 2005. See Edward M. Manigault & Steve R. Akers, Nuts and Bolts of "Covered Opinions" Under Circular 230, Prob. & Prop. 34, Mar./Apr. 2006. As expected, the "covered opinion" requirements of Circular 230 have changed the practice of tax law. Although the authors (part of a group of Section members who prepared comments to Circular 230) expected the covered opinion rules of Circular 230 to have a material effect on tax practice, even they were surprised at the suddenness and the magnitude of the effect of Circular 230.

Here is an anecdotal example of how quickly, and how dramatically, the covered opinion rules changed the way practitioners deliver tax advice. A client wanted to transfer a particular depreciable asset to her children. The asset in question was valuable, but it had materially decreased in value from its purchase price. The advisors determined that if the client gave undivided interests in the asset to her children, the value of the gift would be based on the current fair market value, most likely with a fractional interest discount. If the children subsequently sold the asset, the children would calculate the loss using the fair market value on the date of the gift as the basis under Code §  1015(a). The advisors further determined that if the children retained the asset, they could continue to depreciate the asset using the mother's original purchase price less prior depreciation. Based on the differences between the mother's and children's income tax situations, the children would benefit over time from the gifts of the assets, even if they paid the gift tax as a net gift, and even if there were little or no future appreciation in value.

The advisors prepared a written communication for the mother, explaining the potential transaction, including the risks and potential benefits. The analysis seemed fairly straightforward, because the benefits were based on the difference between basis for determining a loss following a gift (the lower of carryover basis or current fair market value) and the basis used for depreciation (carryover). The advisors did not complete the analysis and memorandum until shortly after June 20, 2005. At that time, it was not clear whether the transaction was a "principal purpose transaction." There was no clearly applicable exception. Unless the client was willing to go through the trouble and expense of a full-blown covered opinion, the advisors did not feel that they could safely provide any written advice. Instead, they met and discussed the transaction in person.

Similarly, the authors know of a well-respected attorney who created a family limited partnership and an irrevocable grantor trust, made gifts to the grantor trust, and sold limited partnership interests to the grantor trust without a single written word from the attorney to the client other than the legal documents themselves.

The authors assumed that planners already have altered substantially their normal practices in light of Circular 230. They therefore thought it would be appropriate to investigate what other practitioners expected to happen with the Circular 230 changes, how their expectations compared to what they actually experienced when the Circular 230 changes became effective, and what actions they have taken or procedures they have implemented in response to the covered opinion rules of Circular 230. As part of that investigation, the authors prepared a survey, which was completed by 200 participants. The survey was not performed scientifically, and not all participants responded to each question. Percentages quoted are of those who responded to the particular question. This article discusses the results of that investigation and survey.

Circular 230--Familiarity, Expectations, and Reality

As a result of anecdotal discussions with other practitioners, the authors had come to believe that many advisers were simply uninformed about Circular 230. Many were not aware of the existence of Circular 230 before the discussion of the recent changes, even though Circular 230 traces its origins back through predecessors promulgated over 100 years ago. Some practitioners were not familiar with the provisions of Circular 230 unrelated to "covered opinions." Not surprisingly, 53% of the survey respondents said that they had still not read Circular 230 in its entirety, even though 91% had filed a Form 2848--Power of Attorney and Declaration of Representative, thus subjecting them to all of Circular 230, not just the covered opinion requirements. Interestingly, Circular 230 arguably may not cover the 9% of respondents who had not filed a Form 2848, including the covered opinion requirements, based on a literal reading of the definition of "practitioner" in sections 10.35(b)(1) and 10.2(e) and those who may practice under section 10.3(a) "by filing with the Internal Revenue Service a written declaration." What did surprise the authors in this context is that 14% of the participants said they had not read even the covered opinion requirements of section 10.35 of Circular 230. Given the importance of the covered opinion rules, every practitioner should read section 10.35, and because of its complexity and nuances, preferably several times.

As with many things in life, the expectations of the surveyed practitioners were not consistent with actual experience. Of the participants responding, 75% said they did not expect that the covered opinions rules would apply to their practices. In sharp contrast, 63% of the participants said that section 10.35 had in fact changed their practices! Perhaps their expectations were based on a lack of familiarity with section 10.35, as many of the responses indicated that participants provided advice that is apparently within the scope of a literal reading of the covered opinion rules. For example:

  • 66% of participants indicated that they prepare projections of the potential financial effects of possible estate planning transactions assuming valuation discounts;
  • 43% indicated that they had prepared, after June 20, 2005, financial projections assuming a valuation discount for an interest in a family limited partnership or LLC;
  • 31% indicated that they had issued, since June 20, 2005, what would be a "reliance opinion" but for a disclaimer that the advice could not be used for penalty protection;
  • 16% had issued, since June 20, 2005, written communications about what they consider to be a "principal purpose" transaction; and
  • 7% had issued formal "covered opinions" after June 20, 2005.

Interestingly, 16% of participants believe they had issued written communications about "principal purpose" transactions, but only 7% had issued formal covered opinions. Circular 230, however, does not exempt a written communication about a "principal purpose transaction" from meeting the requirements of a covered opinion (other than the very limited exceptions in section 10.35(b)(2)(ii)). Therefore, some participants must not understand or are simply ignoring the requirement that written communications about "principal purpose transactions" meet the requirements of a covered opinion.

Another interesting result is that only 16% had issued written communications regarding what they consider to be a "principal purpose transaction." The authors do not know how many participants had delivered any written communications describing the use of family limited partnerships or limited liability companies in wealth transfer planning, although 43% had prepared written financial projections that assumed a discount on an interest in an FLP or LLC. Apparently, practitioners who prepare written summaries of transfer planning alternatives with FLPs or LLCs believe they are not "principal purpose transactions," even though the IRS has taken the position in a number of the reported FLP cases that the dominant reason for using the FLP was to take advantage of valuation discounts.

The differences between expectations and experience also might be based on the expectations of clients, as compared to the literal terms of Circular 230. Consistent with the authors' experiences, 94% of participants believe their clients want written communications primarily to educate them about the possible transactions, rather than for penalty protection.

When given a chance to comment on the covered opinion rules, and their experiences with them generally, participants expressed some strong feelings:

  • "I am still having problems understanding Circular 230...."
  • "The amendments to [Circular] 230 are an unwarranted and very destructive...."
  • "Circular 230 is a gross overreaction to fraudulent practices by the big accounting firms."
  • "Circular 230 is unconstitutional and it interferes with the attorney-client privilege. It is reminiscent of the stupid privacy statements the FTC tried to impose on us a few years ago. A waste of trees and time and over-broad. Stupid, stupid!!"

Covered Opinion Rules--What Are Practitioners Doing?

One does not have to be well-versed in the intricacies of Circular 230 generally, or section 10.35 specifically, to see that many practitioners have taken some steps in response to the covered opinion rules. The "Circular 230" e-mail legend is the most obvious (and according to many survey respondents, ridiculous) reaction. What is still not clear is the extent to which practitioners have implemented other procedures and practices in response to Circular 230. It is clear that there is no uniform response.

Circular 230 Disclaimers

A very high percentage of practitioners have adopted some variation of the Circular 230 disclaimer. The most common form of the disclaimer is usually similar to the following example:

    IRS Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

Although there seems to be general consensus about the language to be used in the disclaimer, practitioners disagree about what communications require the disclaimer, which authors must use the disclaimer, and who has the authority to remove the disclaimer.

Disclaimers on E-mails. A group of the largest law firms, most of which are either based in or have a significant presence in New York, developed the disclaimer language quoted above following a series of conference calls before June 20, 2005. Most of those participating in that ad hoc consortium agreed that the use of the disclaimer on all e-mails, even though not required, was practically expedient in that it relieved the practitioner of the burden of deciding whether to include the disclaimer on a case-by-case basis. Of those responding, 68% have apparently adopted this rationale and require disclaimers on all e-mails. This approach is not without its detractors. Some participants had some interesting things to say, both about the results of this practice and about those who follow it.

  • "All communications now have that silly disclaimer on them."
  • "Huge waste of space."
  • "I have rejected the idea of putting [the Circular 230 disclaimer] on every written communication. When I see practitioners doing that, I think it looks stupid."
  • "I think it reflects badly on practitioners who adopt the policy of putting the disclaimer on all communications."
  • "Use some common sense for Pete's sake."
  • "The bar's response of making it 'industry standard' to include the legend is also a gross overreaction to Circular 230. Hopefully saner heads will correct this nonsense."
  • "On the rare occasion that a client asks about it, they're told, 'don't worry; it's just another silly IRS rule."'

Despite these reasons for being more selective in using e-mail disclaimers, the fact is that most practitioners are using the disclaimers on all e-mail messages.

  • "Circular 230 'legends' on almost all written advice."
  • "Circular 230 Disclaimer added to all e-mails issued from this office."
  • "I now include a version of the Circular 230 disclaimer in most letters and messages."
  • "We use a 230 notice on all fax cover sheets, e-mails, and most client letters."

Disclaimers on Other Written Communications. Although most practitioners have chosen to use disclaimers on all e-mails, the opposite is true for other forms of written communications. Of participants responding, 60% had not adopted a policy requiring the use of disclaimers on written forms of communications other than e-mails. Many participants explained that they do not require the disclaimers when no advice is given, such as in transmittal letters. Others appear to determine whether a disclaimer *35 is warranted based on the nature of the advice, excluding the disclaimer if the advice is "plain vanilla" or if "clear under existing law." Some participants conceded that they have still not adopted any policy.

Disclaimers--Who Includes and Who Can Remove? For those firms that use disclaimers, there seems to be a lack of uniformity on who within the firm uses it. For example, some participants stated that they require the disclaimer to be used by all personnel, not just attorneys. Others stated that only lawyers, or only lawyers and paralegals, must use the disclaimer. Still others distinguished based on the author's area of practice, such as tax, trusts and estates, or ERISA/employee benefits, with the same variations (all personnel, lawyers only, lawyers and paralegals, or secretaries of those groups).

The amount of discretion, if any, given to practitioners to remove or omit the disclaimer on written communications varies widely. Some participants gave each attorney the discretion not to use the disclaimer. At least one participant left the decision to use a disclaimer to a tax partner. The authors know of at least one firm that requires the use of the disclaimer on all written communications containing tax advice, unless the written advice is in the form of a full-blown covered opinion, or an absolute exception in section 10.35(b)(2)(ii)(A), (C), (D), or (E) applies. This particular policy does not permit an attorney to conclude that section 10.35 does not apply based on the level, or absence thereof, of intent to avoid or evade taxes.

Other Responses and Firm Policies

Many commentators warned that the covered opinion rules would merely lead to reduced written communications. The survey results support this premonition, as 52% of responders indicated that they had reduced the amount of written communications in response to section 10.35. An amazing 14% of responders had completely eliminated written communications in favor of verbal communications. Some of the comments on this issue are interesting:

  • "Client calls and wants options in estate planning for GRATs, FLPs, etc. We cannot put them in writing unless we charge an exorbitant fee, so we discuss in person."
  • "I'm much more hesitant to write now; in fact, I have not written an in-depth discussion of any planning since June 20, 2005."
  • "It is more difficult to provide written guidance to clients so that they can understand the potential tax consequences of proposed transactions because of concerns that the transaction may be deemed a principal purpose transaction that would require an extensive covered opinion even if the disclaimer is included."
  • "I give a lot more advice over the telephone. I have actively discouraged clients from requesting written advice." (Emphasis added.)
  • "I have stopped responding to clients' tax questions by e-mail. I now call them on the telephone."

In contrast, some practitioners are writing more, not less. For example, two participants commented: "more gobbledygook in my correspondence!!" and "I now provide more detailed memorandum opinions for transactions no matter how settled the law is and no matter how basic the issue."

In addition to the "covered opinion" rules of section 10.35, the IRS revised Circular 230 to require practitioners to adopt certain internal policies and procedures to govern tax practice. Under section 10.36(a), each practitioner who either individually or as part of a group has principal authority and responsibility for overseeing a firm's practice of providing federal tax advice must take "reasonable steps to ensure the firm has adequate procedures in effect" for all members, associates, and employees for purposes of complying with the requirements for covered opinions under section 10.35. A failure to meet the requirements of section 10.36 could lead to fines, censure, suspension, or disbarment of the lawyer with oversight responsibility.

The survey asked participants if their firms had adopted any additional requirements (apart from any requirement for attaching legends to e-mails) consistent with section 10.36. One-half of the participants indicated that they had not adopted any such additional policies or procedures as required by section 10.36. Maybe this response reflects a basic issue with section 10.36-- it is not clear what steps a practitioner must take to comply with the rule. Although the survey did not ask for examples of the policies or other steps taken by firms to try to comply with section 10.36, the authors are aware that some firms have already adopted or amended existing internal compliance procedures. These compliance procedures can include "guiding principles" and opinion issuance policies. Some firms have formed internal "Circular 230 Committees." Others have either adopted or reaffirmed policies requiring two-partner review of formal opinions. It is expected that firms also will take steps to educate attorneys in the firm of the section 10.35 requirements. Of course, all such steps will probably be documented.

Conclusion

The authors believe that the majority of advisors were surprised by the effect of the covered opinion rules of Circular 230. It is not yet clear that the tax community has a widespread understanding of the covered opinion rules. Certainly there is no uniformity in responses to Circular 230. Only time will tell if a consensus grows or if "best practices" develop among practitioners.

Edward M. Manigault is a partner in the Atlanta, Georgia, office of Jones Day and chair of the Estate and Gift Tax Committee. Steve R. Akers is in the Dallas, Texas, office of Bessemer Trust and is Vice-Chair of the Probate and Trust Division. The views set forth herein are the personal views of the authors and do not necessarily reflect those of Jones Day or Bessemer Trust.

Copr. (C) 2006 West, a Thomson business. No claim to orig. U.S. govt. works. This article is reprinted with permission from West, a primary sponsor of the General Practice, Solo and Small Firm Division.

 

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