David A. Handler, partner in the Chicago office of Kirkland & Ellis LLP, reports that on Sept. 23, 2007, the Treasury Department issued proposed amendments to Circular 230 that essentially say, “Yes, this applies to you. And your advice better meet a pretty high standard.”

This tightening of the Circular 230 noose is scheduled to take effect in 2008.

Specifically, the amendments clarify that Circular 230 applies to any practitioner who practices before the Internal Revenue Service. And be warned: any written tax advice by a practitioner (for example, an attorney or certified public accountant) is considered practice “before the IRS” — even though it may not involve any contact with the Service or preparation of any tax returns by the practitioner.

Also, the Treasury Department issued proposed amendments to Sections 10.34(a) and 10.34(e) of Circular 230, which address the standards applicable to a practitioner who prepares a return or who advises a client to take a position on a tax return. Under the proposed amendments, the practitioner must satisfy one of two standards:

  1. The practitioner must have “a reasonable belief that the tax treatment of a position taken on the return is more likely than not the proper tax treatment.” This is satisfied if the practitioner analyzes the pertinent facts and authorities and, based on that analysis, reasonably concludes, in good faith, that there is greater than a 50 percent likelihood that the position would be upheld if the IRS were to challenge it. The practitioner may consider the authorities referenced in Treasury Regulations Section 1.6662-4(d)(3)(iii) (dealing with the penalty for the substantial understatement of income tax), which includes private letter rulings, cases and revenue rulings.

  2. The position must have a “reasonable basis and it must be adequately disclosed” to the IRS, which is satisfied if the position is reasonably based on the same authorities. The regulations state that “reasonable basis is a relatively high standard of tax reporting, that is, significantly higher than not frivolous or not patently improper. The reasonable basis standard is not satisfied by a return position that is merely arguable or that is merely a colorable claim.” Thus, although this is a lower standard than “more likely than not,” it requires actual and adequate disclosure of the tax position to the IRS.

Before this proposed amendment, the “reasonable basis” standard was satisfied if the position had a one-in-three chance of being sustained.

Under the current version of Section 10.34, a non-signing practitioner (that is to say, a practitioner who gives written tax advice but does not prepare the tax return) can qualify for a lower, not-frivolous standard by advising the client about the opportunity to avoid penalties through disclosure. Under the proposed amendment, a non-signing advisor is subject to the new standards, and therefore can qualify for the lower reasonable basis standard only if disclosure is in fact made.

As a result, any practitioner giving written tax advice, even if that person does not prepare the tax returns, should ensure his advice satisfies the tougher “more likely than not” standard, unless he's confident the position will be disclosed to the IRS (in which case the advice must satisfy the less stringent reasonable basis test.)

The changes to Sections 10.34(a) and 10.34(e) are applicable to returns filed or advice provided on or after the date that final regulations adopting the changes are published in the Federal Register, but no earlier than Jan. 1, 2008.