Civil Liability of Tax Attorneys and Duties to the System

By David J. Moraine

Tax lawyers’ formal responsibility to their clients is immense, yet their informal responsibility to the “system” and to third-party nonclients has, during the past 40 years, become increasingly important in defining the role of the tax lawyer in the American system of justice.

Evolution of rules of professional responsibility. Under the 1908 ABA Canons of Professional Ethics and the then-prevailing norms, the tax lawyer did not owe a “duty to the system” in the manner in which such duty manifests itself in modern tax law practice. Instead, one of the cornerstones of the Canons was the duty of “zealous representation.” With the social turmoil of the 1960s, however, commentators began to stress a lawyer’s duties to the greater whole of society rather than the individual client. The 1983 ABA Model Rules of Professional Conduct established that a lawyer is not just a representative of his or her clients but is a “public citizen having special responsibility for the quality of justice.” Gone from the body of the Model Rules was the duty of zealous representation, such duty having been relegated to a general, qualified statement in the Preamble.

In the wake of scandals such as those involving Enron, WorldCom, and Tyco, the ABA in 2002 amended the Model Rules by adding a qualifier on the lawyer’s duty of zealous representation; that is, the lawyer owes a duty of zealous representation only where the lawyer first makes an independent determination that the client’s interests are “legitimate.” Model Rule 1.13 was amended to permit lawyers representing corporations and other entities to reveal confidential client information in certain instances.

Tax lawyers, as the professional implementers of the tax system, have a fourfold duty to that system. First, the duty imposes a series of limitations under the Model Rules on lawyers’ zealous representation of clients. Second, the duty serves as a surrogate for the sentiment that lawyers should act honestly and ethically. Third, in some contexts the term “system” refers specifically to the set of law and system of administration that comprise our nation’s revenue-raising process. Fourth, the duty may not be to a “system” as such, but rather to the Internal Revenue Service (the Service), which administers and enforces the tax laws on behalf of the federal government.

Evidence of a developing duty. In 1982, one year prior to the adoption of the Model Rules, the ABA released Formal Opinion 346, which dealt with duties of lawyers who author tax shelter opinions. It was the first time the ABA recognized that nonclients predictably would rely on the opinions rendered by a tax lawyer for the benefit of his or her client in the guidance of their own affairs. The ABA extended the lawyer’s duty not to provide an opinion that ignores or minimizes serious legal risks or misstates the facts or law not only to his or her client but also to the persons who may read or rely on the advice should the lawyer’s identity be contained in the offering materials. In 1992, the ABA released Formal Opinion 92-366, in which the ABA Taxation Section’s Committee on Standards determined that a lawyer has an ongoing obligation to disaffirm work product, regardless of the effect on client confidentiality, if the failure to do so would have the effect of assisting a client’s continuing or future fraud. In 1993, Formal Opinion 93-357 dealt with an attorney’s obligations in dealing with bank examiners: Lawyers cannot mislead examiners but also must be careful to maintain client confidences, avoiding disclosure of matters not required to be disclosed to avoid perpetuation of fraud.

Conflicts in ethical obligations. In IRS Circular 230 (published 1966), the government for the first time established specific rules of practice for attorneys, including duties and restrictions relating to representing clients before the Service and the right of the government to bar anyone from practice who does not meet these standards. Circular 230 represents a clear embodiment of lay regulation of the legal profession. Under it, a lawyer must disclose confidential, nonprivileged information to the government upon request. However, under the lawyer’s professional responsibility obligations, that disclosure is clearly prohibited. The Model Rules specifically require the lawyer to refuse requests for confidential information and to secure a ruling from a court. Disclosure is only permitted under the Model Rules in response to the court’s order, yet, under Circular 230, the lawyer has an independent ethical obligation to produce the information upon request.

Regulations and private tort liability. When certain conduct is established by law as a mandatory minimum standard of practice, nonconformance with that standard becomes the basis for civil liability because of the theoretical underpinning of private claims for negligence-related torts. The mandatory minimum standard of practice set forth in Circular 230 and the Sarbanes-Oxley Act of 2002 are predicated on the notion that the lawyer owes duties to the public and the system. Violation of a mandatory standard of care imposed by Circular 230 or Sarbanes-Oxley could expose the tax lawyer to private liability based on negligence.

Many jurisdictions have held attorneys liable for negligent misrepresentation to nonclients, and negligent misrepresentation has been held to be specifically applicable to tax opinion letters. In one such case, the defendant law firm prepared a tax opinion letter in which it opined that the Service would allow certain deductions in relation to an investment in coal mining. The plaintiffs alleged that the law firm knew that there was no reasonable basis for its opinion. The court held that the law firm was liable for damages caused by its recklessly expressed opinions. The negligence in these cases directly related to the tax lawyer’s violations of standards of practice contained in Circular 230. As the profession redefines itself toward a model where lawyers owe increasing responsibility to nonclients and a duty to the system, causes of action such as negligent misrepresentation will continue to gain popularity as a means for privately enforcing the mandatory minimum standards of practice promulgated by nonlawyers.

It is clearly arguable that Circular 230 imposes standards of care on attorneys that can be enforced by the government, clients, and certain nonclients. But can a similar action be maintained based on a violation of the mandatory minimum standards contained in Sarbanes-Oxley? Section 205 requires the Securities and Exchange Commission (SEC) to prescribe “minimum standards of professional conduct for attorneys.” Any attorney covered by the disclosure requirements of Sarbanes-Oxley has a duty to report to the appropriate entity evidence of an officer, employee, or agent’s breach of fiduciary or similar duty to the issuer recognized under applicable federal or state statute or at common law. The range of attorneys falling within the reach of Sarbanes-Oxley includes any lawyer who conducts business or communicates with the SEC for any reason; represents an issuer of securities in an administrative proceeding, investigation, inquiry, information request, or subpoena; provides advice regarding securities law, SEC rules or regulations, or any document that may be filed with or incorporated into another document that is filed with the SEC, or provides any advice in relation to same; or advises an issuer as to whether information, a statement, an opinion, or other writing is required under securities laws or the SEC’s rules.

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