To avoid penalties a tax opinion letter must comply with Circular 230. In recent years, the IRS has cracked down on the protections of a tax opinion letter. Prior to 2004, a tax opinion letter taking a tax position could protect taxpayers from significant penalties based on their reliance of that opinion letter. This led to tax practitioners taking aggressive tax position even when the facts and legal precedent didn’t support their findings. Many taxpayers who implemented abusive tax shelters were not penalized for their evasive activity. This all came to an end in 2004 & 2005 when the IRS amended Circular 230.
The Circular 230 amendments defined the standards that tax professionals must abide by when providing written tax advice. It further defined the content of a tax opinion letter which reviewed transactions, plans, or arrangements where the significant or principal purpose was to avoid or evade taxes. If tax opinions do not meet the standards of Circular 230, taxpayers will still be subject to hefty IRS penalties if the IRS determines a deficiency exists.
A good tax opinion letter will contain an extensive review of the relevant facts and technical tax issues. Furthermore, substantial legal authority and analysis must be discussed in the opinion. Tax opinion letters must view the transaction from all perspectives and come to a well-reasoned conclusion. Generally, if the letter meets the threshold of more-likely-than-not, it can be used to protect a taxpayer from any future penalty liabilities.
A recent Tax Court decision, Canal Corp. v. Comm’r, 135 T.C. No. 9 (2010), affirmed the ongoing importance in taxpayers hiring independent, disinterested tax professionals to write tax opinions. That court held that a well-reasoned tax opinion can nonetheless result in penalties if the tax advisor had been closely involved in the structuring of the transaction the tax opinion scrutinized. This conflict of interest results in an expensive penalty that could be avoided by hiring an independent tax professional.
While IRS penalty protection seems to be a legitimate reason to hire an attorney to write a tax opinion, an opinion letter has other value as well. Penalty protection is merely a safety net of a thorough tax opinion. The overriding goal of a tax opinion letter really is to have the tax position upheld.
Business transactions can be structured in a multitude of ways with a myriad of tax consequences. Contacting an experienced tax professional early in the process of business transactions, allows a trained professional to provide input to assure that any favorable tax impact is upheld. A tax opinion provides taxpayers an opportunity to minimize their tax exposure with the added protection from penalty assessments.