Thursday, July 24, 2014

Tax Advisors - Why We Matter (Levels of Assurance)

Introduction

Hi.

Since this is my first post, I should probably introduce myself. My name is Paul Haimowitz. I studied law at Georgetown University and am admitted to practice in New York State. Since graduating, I have worked at 2 of the Big Four accounting firms in a variety of roles revolving around tax. I have spent significant amounts of time in tax compliance as well as consulting. My areas of focus have been mostly international issues, both on the compliance and consulting side.

I am not the only person doing what I do. There are lots of very bright people out there providing similar services and there is a huge amount of demand to keep these people busy. But tax is hard. It's an enormous subject matter and I clearly recall the strong initial impression that it was overwhelming. At the same time, I was enamored of the people I met who had apparently mastered the art (the late Professor Martin Ginsburg, with whom I had the privilege of taking all of his available courses while I was at Georgetown, personified the tax expert in my eyes as a student) and I wanted to become like them. My thinking was that if you aren't truly an expert at something, you haven't accomplished anything worth accomplishing. I still feel this way, but the difference between then and now is that I now feel like I am on the path and heading in the right direction. But everyone needs to start somewhere and it doesn't seem like anyone I have spoken to really attempts to break down the process of becoming adept at tax law into manageable pieces. 

So I hope with this blog to accomplish two things. I want to talk about interesting cases that I haven't seen in any readily available literature. I frequently come across situations that seem like they should be relatively common, and yet nobody has written about them. So I'm going to do my part and relate the analyses and conclusions I and my coworkers arrived at in the course of our practice.

Second, I want to make the practice of tax a little bit simpler to appreciate and digest. I want to give people who are lost or on the fence or feel overwhelmed a starting point. And I want them to understand that giving advice is a process which mixes effort, uncertainty, and best judgment. Particularly in the complex world of tax, it is vital to develop a feel for the discipline and in particular to develop a feel for when you have done 'enough' to provide a good and valuable service.

With that being said, let's move on to my first (and hopefully you will agree highly appropriate) topic.


Why We Matter (Levels of Assurance)


I have been doing work in tax for several years now following graduation from law school. In that time, I've been involved in the preparation of numerous tax returns and drafted memos concerning a wide range of issues. Although I am admittedly somewhat removed from many of the economic aspects of what I do (something I am certain I will become more familiar with in time as I become a more senior practitioner), it only recently occurred to me that I had never adequately answered some fairly fundamental questions regarding the provision of tax services. First, why do so many of the tax return preparers I have worked with assign such gravity to insuring the correctness of the information in the return? There appears to be a particular sensitivity to this amongst the people signing off on the returns. What motivates this concern, especially if a client is willing to take responsibility for any doubtful tax return positions

Second, what is the benefit for a client of receiving a tax opinion from a tax professional (either a law firm or an accounting firm)? I always assumed that it might simply be a corporate legal issue where the Board of Directors, in its fiduciary capacity, might need to show it engaged in sufficient due diligence for corporate liability purposes.

Both of the above questions seem pretty fundamental but I have never really heard from any of my various mentors about the topic. I have been aware that the art of memo drafting contains a concept where the memo issuer offers varying levels of assurance but knowing that still begs the question of what exactly do different levels of assurance buy you aside from perhaps some sort of limited indemnity from the firm issuing the opinion.

This question is answered, at least in part, in IRC Section 6694. This section lays out rules for the avoidance of penalties by virtue of the taxpayer having done their due diligence to check up on unclear tax issues and challengeable positions. Obviously, if you take a position and the IRS successfully challenges it, you will be liable for any additional tax liability arising from the IRS adjustment. But it might seem unfair that the taxpayer should additionally be hit by penalties where the taxpayer made their best effort to comply. Often, the taxpayer is simply trying to be as correct as possible but the IRS still disagrees (rather than aggressively trying to save some money). So the Code has a safe harbor provision which protects taxpayers in these and other similarly well-intentioned situations through the definition of "unreasonable positions".

The rules in this section were updated to reflect new legislation passed in 2007 as part of the Small Business and Work Opportunity Act of 2007. The IRS issued guidance on the rule in Notice 2008-13 - I won't go into the historical rules in this discussion. The new rules allow for the reliance (for purposes of penalty avoidance) by a tax return preparer based on several distinct levels of assurance.

The first, "substantial authority", requires that the taxpayer believe that the chances that the taxpayer is correctly applying the tax rules are greater than the chances that the taxpayer is incorrectly applying the tax rule. I understand this to be a plurality rule, by which I mean the taxpayer's position must be the most likely to be correct of all the various possible interpretations. This is akin to a "more likely than not" type of standard. If the taxpayer can support this, then they will be exempt from penalties under this section. But this is a tough standard to meet. After all, if the IRS doesn't agree with your position, they probably aren't going to agree that it was the most reasonable of all the positions to take.

This is where tax advisors come in. If you can show the IRS that you received an opinion from a competent tax authority, in which it is opined that there is substantial authority to support your position.

The second standard, "reasonable basis", is a lower standard of certainty than "substantial authority" and is allowed only with the inclusion of an additional factor; disclosure. In order to rely on a reasonable basis opinion, the taxpayer needs to disclosed to the IRS "the relevant facts affecting the item's tax treatment" on their tax return. It's worth pointing out that this doesn't require you to show all your cards; you don't have to do disclose the position or your reasoning. All you need to disclose are the facts and it is up to the IRS to put them together in order to challenge your position.

The final standard is the "more likely than not" standard. IRC Section 6694(a)(2)(C) indicates that this standard requires that the position be more likely than not to be sustained based on the merits. This standard is the most difficult to reach of the above 3 positions but it gives the added benefit of eliminating the penalty where the taxpayer is found to have created a tax shelter as well as positions to which IRC Section 6662A apply (reportable transactions).

I encourage both advisers and consumers of tax advice to read the above citations and the associated regulations. It will give advisers a better feel for the amount of value they bring to their clients and it will inform consumers as to what they are actually purchasing. Obviously, there is a lot more to the value of tax advise than abatement of penalties. But this is a concrete source of value that is more easily quantifiable. As a tax advisor, I appreciate any point of reference that provides a framework from which I can help my clients appreciate the value I can bring them.

I would appreciate any comments and especially technical corrections. Please feel free to post because I'd love to hear your thoughts.

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