This entry describes general matters relating to the tax opinion practice. For a helpful overview of the “tax opinion practice,” see Robert P. Rothman, “Tax Opinion Practice,” originally published at 64 The Tax Lawyer 301 (Winter 2011) and Joseph M. Erwin, “How Much Tax is in that Opinion,” Dallas Bar Association – Section of Taxation, Sept. 4, 2012.
Confidence Levels for Written Tax Advice:
- “Will” opinion: 90-95% probability of position being sustained.
- Use this opinion in connection with SEC securities registrations. See SEC Staff Legal Bulletin No. 19.
- Often used in customary practice as a condition for closing a transaction.
- This opinion provides the highest level of comfort. But note that “a legal opinion is not an insurance policy.” A judge could still decide adversely on the matter, so the opinion should not be considered a guarantee of absolute certainty.
- The conclusion of the opinion giver may be that there is no material risk of being wrong.
- “Should” opinion: 70% to 75% probability of position being sustained.
- Use this in connection with SEC securities registration. See SEC Staff Legal Bulletin No. 19.
- May also be used in memorandums, notes, etc. in support of tax items on GAAP financial statements. See FAS 5.
- This opinion standard implies a reasonably high level of confidence that the position will be sustained and is significantly higher than the “more likely than not” standard but allows for a not insignificant risk of being wrong.
- “More likely than not” opinion: More than 50% probability of position being sustained.
- If considering likelihood of audit, settlement possibilities and approach of tax authority, e.g., for GAAP financial statements, see FIN 48 (interpreting FAS 109)
- If not considering likelihood of audit, e.g., for covered opinions, see pre-June 2014 version of Circular 230, Sec. 10.35
- Regulations impose minimum requirements that must be satisfied in order for an opinion to provide a possible mechanism to establish the reasonable cause-good faith defense of I.R.C. § 6664(c) to avoid the imposition of the substantial understatement penalty (I.R.C. § 6662(b)(2)) against a corporate taxpayer in connection with a tax shelter (Treas. Reg. § 1.6664-4(f)). One of these requirements is that the opinion “unambiguously [state] that the tax advisor concludes that there is a greater than 50-percent likelihood that the tax treatment of the item will be upheld if challenged.”
- If the IRS asserts a reportable transaction understatement penalty (tax-exempt bonds are not reportable transactions) under I.R.C. § 6662A, a taxpayer may be able to avoid the penalty by meeting the requirements of I.R.C. § 6664(d). Among the requirements imposed by I.R.C. § 6664(d) is that the taxpayer must have reasonably believed that the claimed treatment was more likely than not correct.
- A tax return preparer who claims a position with respect to a tax shelter or reportable transaction may be subject to a penalty under I.R.C. § 6694 unless it is reasonable to believe that the position would more likely than not be sustained.
- “One situation where an issue can arise is where the weight of authority, as between two possible outcomes, is almost evenly balanced. There are two schools of thought concerning this situation. One school of thought reasons that, for any proposition of law, either that proposition or its converse must be more likely than not correct, and goes on to conclude that it should therefore always be possible to render a ‘more likely than not’ opinion on one side or the other of a binary issue. Accordingly to this school of thought, if a practitioner has any doubt about whether he can render an opinion that the consequences of a particular transaction will more likely than not be X, he need only ask himself if he could render an opinion that the consequences would more likely than not be something other than X; if the answer to that question is negative, he can always give the X opinion.” Other practitioners, however allow for the possibility that there can exist issues that are simply too close to call.
- “Substantial authority” opinion: Less than “more likely than not” but greater than “reasonable basis” (34% to 40% likelihood)
- Helpful for substantial underpayment penalty for reportable transactions under I.R.C. 6662A. See I.R.C. 6664(d)(1), (3)
- Substantial understatement penalty for tax shelter items for non-corporate taxpayers. See Treas. Reg. 1.6662-4(g)
- Substantial understatement penalty for tax shelter items for corporate taxpayers. See Treas. Reg. 1.6664-4(f)
- Workpaper/opinion for tax return preparer for reportable transaction and tax shelter items. See Treas. Reg. 1.6694-2(a)(1)(i)
- There is “substantial authority” for a position if the weight of authorities in support of the position is substantial in relation to the weight of authorities supporting contrary treatment. The standard is less stringent than “more likely than not,” but requires more than a “reasonable basis.”
- “Significant” authorities that can be taken into consideration includes PLRs, TAMs, GCMs, which technically cannot be cited as precedent but are still acceptable for evaluating substantial authority.
- The regulations (Treas. Reg. § 1.6662-4(d)(3)(i)) specifically acknowledge the possibility that there can be substantial authority for more than one position.
- “The substantial authority standard is a creature of statute and is relevant in specific circumstances for purposes of avoiding penalties.”
- Can be used to avoid substantial understatement penalty for non-disclosed non-reportable transactions, etc. tax return positions, other than tax shelters. See I.R.C. 6662(d)(2)(B)(i)
- Minimum standard for non-disclosed non-reportable transactions, etc. tax return positions for tax return preparers. See I.R.C. 6694(a)(2)(A); Treas. Reg. 1.6694-2(d)(1), (2)
- Limited scope opinions. See Circular 230, Sec. 10.35
- If the IRS asserts a reportable transaction understatement penalty under I.R.C. § 6662A, the taxpayer may be able to avoid the penalty by meeting the requirements of I.R.C. § 6664(d), including that substantial authority for the position actually exists (and the taxpayer has a reasonable belief that the claimed treatment was more likely than not correct).
- Tax return preparer may use this standard to avoid a possible penalty under I.R.C. § 6694 (but not in connection with a tax shelter or reportable transaction).
- The IRS or court reviewing the determination will make its own independent determination of whether there is substantial authority – if it determines that there was not substantial authority, the taxpayer’s belief that there was, no matter how reasonable, is not relevant.
- “The mere existence of the opinion will not help if the Service disagrees with the opinion’s conclusion.”
- Realistic possibility of being sustained on its merits: One-in-three possibility (33%)
- Disclosed position of disregard of Rev. Rul. or IRS Notice. See Treas. Reg. 1.6662-3(a), (b)(1)
- “There seems to be a continuing sense among practitioners that, as between the two standards [reasonable basis and realistic possibility of being sustained on its merits], realistic possibility is probably slightly higher
- “Reasonable basis” opinion: Higher than “not frivolous” but lower than “substantial authority” (20-30%)
- Substantial understatement penalties for disclosed items. I.R.C. 6662(d)(2)(B)(ii)
- Prevailing interpretation of reasonable basis as requiring something less than a one-in-three chance “may not be totally unassailable.”
- Minimum standard for disclosed non-reportable transactions, etc. tax return positions for tax return preparers. I.R.C. 6694(a)(2)(A); Treas. Reg. 1.6694-2(d)(1), (2). A taxpayer facing a substantial underpayment penalty under I.R.C. § 6662(b)(2) (other than in connection with a tax shelter) can avoid the penalty if he specifically discloses the position and there is a reasonable basis for the claimed treatment.
- A preparer facing a possible preparer penalty under I.R.C. § 6694 (other than in connection with a tax shelter or reportable transaction) can avoid the penalty if the preparer specifically discloses the position and there is a reasonable basis for the claimed treatment.
- For purposes of the negligence disregard penalty of I.R.C. § 6662(b)(1), a taxpayer is not treated as negligent in claiming a position for which there exists a reasonable basis. Treas. Reg. § 1.6662-3(b)(1).
- Disclosed position of disregard of rule or regulation. Treas. Reg. 1.6662-3(c)
- Limited scope opinion. See Circular 230, Sec. 10.34(a)
- Client discussion memorandum. This is consistent with customary practice.
- The regulations suggest that the analysis of whether reasonable basis is satisfied is based on the same types of authorities as those considered for purposes of substantial authority.
- As with “substantial authority,” the operative legal provisions that directly depend on reasonable basis all turn on whether a reasonable basis is actually found to exist, not on the taxpayer’s belief, reasonable or otherwise. Therefore, no opinion at the reasonable basis level can insulate the taxpayer from penalties, although it may assist in establishing “reasonable cause and good faith” (if applicable) and, in any event, can serve to give the taxpayer some comfort that penalties will not apply as long as disclosure is made.
- Not Frivolous
- Lowest level at which there is some modicum of comfort as to a position. “Frivolous” was defined by regulations (no longer in effect) as “patently improper.”
- This is the position the tax practitioner may apply wearing his “advocate” hat.
- The tax practitioner’s arguments must satisfy the “laugh test.”
Opinions may often include qualifiers, particularly in the case of higher levels of confidence, such as “although not free from doubt,” “although no assurance can be given,” or “although not entirely free from doubt.” Rothman suggests that there does not appear to be consistent practice as to the use of such qualifiers or as to what, if anything, they really mean.
Functions of Tax Opinions:
Tax opinions typically serve one or more of the following functions:
- Comfort opinion: Provides the taxpayer with comfort that a transaction the taxpayer is considering entering into will have the expected tax consequences.
- Contractual condition opinion: This opinion is used to effect a particular transaction, with the obligation of one or both parties to close conditioned on the receipt of the opinion that the transaction will have the tax consequences specified in the contract.
- Third-party inducement opinion: This opinion induces the third party to agree to a course of action.
- Disclosure opinion: This opinion gives comfort regarding a person’s duty to disclose.
- Penalty protection opinion: This opinion is intended to permit clients to rely on to avoid possible civil penalties.
- FIN 48 opinion: This opinion provides advice regarding the tax treatment of items for purposes of financial statements. The “more likely than not” standard is required in order to recognize, for financial statement purposes, a tax benefit with respect to which there is some legal or factual uncertainty.
- Reporting opinion: This opinion provides advice regarding the proper tax reporting of a completed transaction.
Penalty Protection Opinion:
The penalty protection opinion must comply with I.R.C. §§ 6662 and 6664 and case law that addresses when a legal opinion will provide a defense to an asserted penalty.
Four types of penalties are most likely to be involved in a penalty protection opinion. The negligence-disregard of rules penalty (I.R.C. § 6662(b)(1)), the substantial understatement penalty (I.R.C. § 6662(b)(2)), the substantial valuation misstatement penalty (I.R.C. § 6662(b)(3)), penalties for understatements of tax from reportable transactions (I.R.C. § 6662A).
Notice 2007-39, providing guidance to practitioners that may be subject to monetary penalties.
Opinion Concerning 501(c)(3) Status:
- Opinion Regarding Disregarded Entity Status: The borrower is an LLC with a single member, which is a 501(c)(3) organization. One firm (“Firm A”) is engaged to be counsel to the borrower. Another firm (“Firm B”) is engaged to be counsel to the 501(c)(3) organization. Firm B expects to give an opinion that the 501(c)(3) organization is an organization described under Section 501(c)(3) of the Code. Should Firm B also be required to give an opinion that the borrower is a disregarded entity for federal income tax purposes such that the 501(c)(3) status “flows through” to the borrower? Most bond counsel would probably require Firm B to provide such opinion, in part because the disregarded status matter is naturally connected to the 501(c)(3) status of the member.
- No Reasonable Possibility: Bond counsel must determine that it would be unreasonable for the court to hold to the contrary. Bond counsel must determine that there is no reasonable possibility that the IRS would not concur or acquiesce in the opinion, if it considered all material legal issues and relevant facts. See “Statement Concerning Standard Applied in Rendering the Federal Income Tax Portion of Bond Opinions,” adopted by the Board of Directors of NABL on November 29, 1993. NABL, 1997 Model Bond Opinion.
- High Degree of Confidence: Bond counsel may render an “unqualified” opinion regarding the validity and tax exemptions of bonds if it is firmly convinced (also characterized as having a “high degree of confidence”) that, under the law in effect on the date of the opinion, the highest court of the relevant jurisdiction, acting reasonably and properly briefed on the issues, would reach the legal conclusions stated in the opinion. NABL, 2003 Model Bond Opinion, p. 7.
- Firmly Convinced: In light of lack of judicial precedent and unique body of Internal Revenue Service administrative guidance, bond counsel may nonetheless give an unqualified opinion with respect to federal income tax matters if it is firmly convinced that, upon due consideration of the material facts and all of the relevant sources of applicable law on federal income tax matters, the Supreme Court would reach the federal income tax conclusions stated in the opinion or the IRS would concur or acquiesce in the federal income tax conclusions stated in the opinion. NABL, 2003 Model Bond Opinion, p. 8.
- Not Unqualified Opinion: An opinion is not “unqualified” if it includes (1) a non-customary assumption, limitation or qualification, (2) a phrase such as “while the matter is not free from doubt” (generally referred to as a “qualified opinion”), or (3) a legal analysis for the opinion (generally referred to as a “reasoned” or “explained” opinion). NABL, 2003 Model Bond Opinion, p. 7.