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July 2014

Beware of Tax Opinions

by Tom Ochsenschlager, CPA, J.D.

In Schaeffler v. United States, Case No. 1:13-cv-04864 (S.D.N.Y. May 28, 2014), the U.S. District Court for the Southern District of New York took a narrow view of the taxpayer’s right to assert privilege regarding an opinion letter it had received from its accountants. The court found that the memorandum did not satisfy the requirements of the attorney-client privilege generally available for communications from a federally authorized tax practitioner because, under the facts of the case, the “opinion” had been shared with a financial institution that had an economic but not a “legal” interest in the transaction. 

The court also found the “opinion” was not privileged under the work product doctrine because there was no specific reference to litigation in the memorandum. In effect, the court took the position that the memorandum would be privileged only if it had been in response to current or anticipated litigation. 

Although the court has delayed the IRS’s access to the opinion pending Schaeffler’s appeal to the Second Circuit, in the meantime we should be certain that opinion letters are not shared with anyone outside the client regardless of their economic interest in the transaction and that the opinion letter is drafted with language referring to the possibility that the IRS may litigate the issue.


Frank Aragona Trust Met Material Participation Test

by Tom Ochsenschlager, CPA, J.D.

The Tax Court, in a reviewed decision, found that the hours of work performed by trustees who were also full-time employees counted in determining whether the trust was materially active in the trade or business under the passive loss rules (Frank Aragona Trust v. Commissioner, 142 T.C. No. 9). Accordingly, the losses generated by the trust were passed through to the beneficiaries of the trust and not suspended under the passive loss rules. Perhaps of equal importance is the fact that, had the trust been profitable, the income passed through to the beneficiaries would not have been subject to the net investment income tax in the event their adjusted gross income had exceeded the threshold for that implementation.

While this case is important, it does leave some questions unanswered. The IRS in arguing the case had only challenged whether a trust could be materially active in the business as a real estate professional. It did not challenge whether the trustees, in their capacity as employees, had met the 50 percent of personal services performed and the 750 hours of services thresholds. It appears in the facts of the case that only three of the six trustees were full-time employees. The other three were not active in the business. (One of the trustees was disabled, another was a practicing attorney and a third was a financial institution.) Had the IRS challenged the level of activity of the trust as a composite of all the trustees, the case conceivably could have come out differently. Accordingly, where the trust includes a trustee that is not materially active, discretion is advised in taking a tax return position.


IRS Issues Amendments to Circular 230

By William R. Stromsem, CPA, JD

 The IRS has published final regulations related to practice before the IRS, amending Circular 230. The final amended Circular 230 will be available in a few weeks.

In general, the IRS has not made many changes from its proposed regulations and specifically declined to make an important change recommended by the Texas Society of CPAs’ Federal Tax Policy Committee. New section 10.37 regarding covered written opinions changes the burden of proof for whether assumptions used in the opinion are reasonable. In the past, former section 10.37(a) prohibited a practitioner from basing advice on unreasonable factual or legal assumptions. This placed the burden of proof on the IRS to prove that the assumptions were unreasonable. New section 10.37 requires that practitioners base opinions on reasonable facts and legal assumptions, shifting the burden of proof to the practitioner, with the IRS only having to assert that the assumptions were unreasonable. The TSCPA committee raised this issue in comments on the proposed regulations, but the IRS specifically rejected its comment saying that it did not believe this was a substantive change, and that the amendment, “is part of the larger effort undertaken in these regulations to affirmatively state the requirements and standards for practitioners rather than merely specifying prohibited conduct. Treasury and the IRS also disagree that a reasonableness standard is too burdensome.” Note that although the IRS believes the standard is not too burdensome, it nevertheless shifted the burden. 

Other changes include:

  • Section 10.31 is updated to make the prohibition on endorsing refund checks apply to electronic payments as well.
  • Section 10.35 for covered opinion practitioners was changed to eliminate the specific requirements for disclosures in written opinions. This will relieve the practitioner of many unnecessary disclosures, such as past boilerplate in emails. (See related article.) A general competency requirement is put in place that practitioners have the appropriate level of knowledge, skill, thoroughness and preparation necessary for the engagement.
  • Section 10.36 on principle responsibility is expanded, requiring the preparer to know what associates and staff are doing (training and supervision) and that they are complying with Circular 230.
  • Section 10.37 is clarified to cover emails as well as “written” advice. Practitioners can now take into consideration the likelihood of settlement negotiations in opinions.
  • Section 10.82 provides expedited suspensions where there has been a disciplinary action by a state board of accountancy or state bar.