The Ongoing Impact of Loving: The IRS May Not Be Able to Regulate Tax Opinions

Loving vs. IRSUnder Circular 230, the IRS regulates tax professionals in a variety of ways. For example, a tax practitioner who learns that a client has made an error in a return must promptly advise the client of the error and its consequences. 31 C.F.R. § 10.21. Among the subjects regulated under Circular 230 is written tax advice, which is subject to a reasonable practitioner standard. 31 C.F.R. § 10.37. Violations of the requirements of Circular 230 expose tax professionals to disciplinary proceedings before the IRS Office of Professional Responsibility (“OPR”). The authority of the IRS to regulate tax professionals rests on a statute that authorizes the Treasury Department to “regulate the practice of representatives of persons before the Department of the Treasury.” 31 U.S.C. § 330(a)(1).

The IRS sought to regulate return preparers based upon this grant of authority, but in 2014, the D.C. Circuit ruled that it did not have authority to regulate return preparers because they were not acting as “representatives.” Loving v. IRS, 742 F.3d 1013, 1016-17 (D.C. Cir. 2014). Loving strongly suggested that the IRS might not be able to regulate the behavior of attorneys and accountants when they were not actually involved in an administrative proceeding. Last week, a district judge in Nevada ruled that written advice provided in connection with return preparation was not subject to the OPR’s disciplinary authority. Sexton v. Hawkins, No. 2:13-cv-00893-RFB-VCF, 2017 U.S. Dist. LEXIS 38706 (D. Nev. Mar. 17, 2017).

James Sexton was an attorney who was disbarred after pleading guilty to four counts of mail fraud and one count of money laundering. Sexton, 2017 U.S. Dist. LEXIS 38706 at *2. As a consequence, he was suspended from practice before the IRS. Id. Mr. Sexton was the president of Esquire Group, LLC, and he assisted with the preparation of tax returns for its clients following his suspension and apparently offered written tax advice in that context. Id. at *2-*3. When a client of Esquire learned Sexton had been disbarred, she filed a complaint with OPR, which opened an investigation. Id. at *3. In response, Sexton filed an action seeking declaratory and injunctive relief; he asked the court to determine that OPR lacked authority over Sexton and Esquire and to enjoin OPR from compelling him to furnish information. Id. at *4-*5.

The district court addressed the case in the context of competing dispositive motions; Sexton requested judgment on the pleadings, and OPR sought summary judgment. At the outset, the court endorsed the Loving Court’s holding that return preparation did not constitute practice before the IRS. Id. at *8. While OPR argued that it had inherent authority to regulate those who were formerly admitted to practice before the IRS, the court rejected that assertion: “[T]he fact that an individual was formerly a practitioner before the IRS cannot expand IRS jurisdiction into an area where no jurisdiction previously existed.” Id. at *15.

The court then considered whether the IRS had authority to discipline those who offer written tax advice outside the context of an actual tax controversy. OPR argued that the definition of practice before the IRS included “rendering written advice with respect to any entity, transaction, plan or arrangement, or other plan or arrangement having a potential for tax avoidance or evasion.” Id. at *16 (quoting 31 C.F.R. § 10.2(a)(4)). Here OPR argued that it had authority to regulate written advice under another clause of the relevant statute, which provides as follows:

Nothing in this section or in any other provision of law shall be construed to limit the authority of the Secretary of the Treasury to impose standards applicable to the rendering of written advice with respect to any entity, transaction plan or arrangement, or other plan or arrangement, which is of a type which the Secretary determines as having a potential for tax avoidance or evasion.

31 U.S.C. § 330(e). But in the court’s view, this provision did not give OPR authority to impose discipline: “At most, [section 330(e)] allows the Secretary to impose standards to the (sic) rendering of such advice—but does not provide a mechanism to sanction such advice.” 2017 U.S. Dist. LEXIS 38706 at *18-*19 (emphasis in the original). For good measure, the court expressed the view that the logic of Loving applied with equal force to section 330(e). Id. at *19-*20. Under this view, only advice rendered in the course of an actual proceeding would be subject to regulation under Circular 230.

On one level, Sexton represents a logical extension of Loving. The court’s holding that OPR could not discipline Sexton for preparing returns is completely consistent with the D.C. Circuit’s determination that the IRS could not regulate return preparers.

The court’s treatment of the general area of written advice, however, is likely to prove more controversial. Tax lawyers frequently provide opinion letters on the likely tax treatment of particular transactions. These opinions are rendered contemporaneously with a transaction, and they serve two purposes: First, they guide the client by predicting the likely tax treatment; second, they are frequently intended to provide the client with a defense to penalties if the IRS views the tax consequences of the transaction differently. For this reason, the IRS very much cares about the content of tax opinions, which is why it imposes standards on other written advice in Circular 230. For example, Circular 230 expressly provides that written advice cannot reach a conclusion on the appropriate tax treatment under the Code based on an assumption that the client’s return will not be audited or that the relevant issue won’t be raised during an audit. 10 C.F.R. § 1o.37(a)(2)(vi).

In contrast, written advice during an actual administrative proceeding is unlikely to involve a formal opinion. This is because the penalty defense turns on whether the taxpayer acted reasonably and in good faith. An after-the-fact opinion is not going to help make that showing. Consequently, what the Sexton opinion suggests is that the IRS is only able to impose standards on a limited category of tax advice that is frankly of far less concern to the government’s interests and is unable to regulate opinions that are directly involved in penalty determinations. From a policy perspective that does not make much sense. As a consequence, I would expect the government to pursue an appeal here.

How the government would fare on appeal is difficult to predict. OPR’s argument that section 330(e) is an independent source of regulatory authority seem debatable. The language of that provision seems to suggest that if standards were going to be imposed that they would be imposed on the basis of some separate statutory authority:

Nothing in this section or in any other provision of law shall be construed to limit the authority of the Secretary of the Treasury to impose standards applicable to the rendering of written advice with respect to any entity, transaction plan or arrangement, or other plan or arrangement, which is of a type which the Secretary determines as having a potential for tax avoidance or evasion.

31 U.S.C. § 330(e) (emphasis supplied). In other words,  it appears that the authority to regulate “the rendering of written advice” must rest either on section 330(a) or on some other provision that, to date, the government has not cited. This may be a situation where the scope of the Secretary’s authority over practitioners needs to be re-examined. A series of bills have been introduced that would grant the Treasury Department the authority necessary to regulate return preparers, but none of them would address the broader implications of Loving.

In the meantime, practitioners are not likely to ignore the requirements of Circular 230 when they offer written advice. First, much of what the current standards require is simply good practice, such as relying on reasonable assumptions and considering relevant authority. Second, since tax opinions are frequently intended to provide the client with a defense to a penalty assessment, an opinion that does not follow the requirements of Circular 230 is going to be inherently less persuasive and, therefore, self-defeating.

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