Lawyers Wary of New Tax Regulations' Impact on Client Relations

Our thanks to Gloria Norton for this piece.

Some view looming IRS rules as overkill measure that could turn attorneys into snitches. At best, tax attorneys see the latest overhaul of the Internal Revenue Service regulations on tax shelters as inconvenience and overkill -- blasting a shotgun at a mosquito. At worst, they view the changes, slated to go in effect June 20, as a client relations nightmare that could turn attorneys into snitches for the federal government. The revisions are the result of both the Jobs Creation Act of 2004 and changes to Circular 230, the rules that govern attorneys and accountants advising taxpayers on IRS issues. The new rules -- which are designed to crack down on abusive tax shelters -- require law firms and any other tax advisers to create internal advisory committees to ensure compliance. As the deadline for compliance with the new rules looms this month, firms are scrambling to put into place systems to review and regulate the tax advice coming out of their offices. The new rules will require attorneys to report client information more often to the IRS, particularly when giving advice on tax avoidance. Tax avoidance is not illegal. Many high net worth individuals and corporations seek advice from lawyers and other advisers on shelters and other legal ways to avoid paying taxes. But the IRS wants additional information so it can more easily find cases of illegal tax evasion masquerading as legitimate tax shelters. The new rules will require attorneys to put disclaimers on legal opinions they give to clients or instead to perform costly investigations of the facts before rendering an opinion. "They have taken this little pesky problem [of tax shelters] and dropped a nuclear bomb rather than a flyswatter," said Martin Press, a shareholder at Gunster Yoakley in Fort Lauderdale. "My view is that it is the start of the erosion of attorney-client privilege in this country." While not everyone agrees that the new regulations are a threat to attorney-client privilege, many say that frustrated clients will follow the new tax system. Some tax attorneys also say the rules are vague and could cause more problems than they solve, as the firms navigate the most massive overhaul of tax law in over a decade. "I think this may create some tension with your clients," said Donald Duffy, an Akerman Senterfitt shareholder in Miami. "You're going to have to put disclaimers on your opinions. I don't think clients are going to understand it." Much of the attorneys' concern about the new rules has to do with the written opinions tax professionals give to their clients. Individual and corporate clients who seek tax relief often solicit complex written opinions from their advisers. Relying on a written opinion can provide some degree of insulation from IRS censure. But the new regulations limit that ability. Under the new rules, certain types of opinions -- mostly those which the IRS has identified as being potentially linked to tax evasion -- will either have to include a caveat saying that the client cannot rely on the opinion, or the tax adviser will have to conduct an investigation of the client's representations and fully vet the claims before offering an opinion. The latter option would cost the client more money. "When you put something on a letter to a client saying you can't rely on this, it doesn't create the warmest and fuzziest relationship," said Larry A. Campagna, member of the American Bar Association Taxation Section and shareholder at Chamberlain Hrdlicka White Williams & Martin in Houston. "My choice is tell the client that I have to do a full-blown investigation or I have to put this caveat on the letter. There's a lot of paranoia about that process." The changes to the tax law come as the IRS moves toward a tougher stance on enforcement. During the Clinton presidency, the IRS focused more on service, and less on enforcement. Then-IRS Commissioner Charles Rossotti's background was in information technology and management, not accounting. But Rossotti is gone and times have changed. In 2003, Mark Everson was appointed the IRS' new commissioner, and the focus of the agency changed once again. Everson, a former CPA, is nicknamed "The Enforcer" in tax circles. He took office with promises to crackdown on abusive tax shelters used by both corporations and individuals. And the new laws and regulations are what followed. "The idea of a warm, fuzzy IRS didn't work," said Sam Ullman, a partner at Bilzin Sumberg Baena Price & Axelrod in Miami. "Now they are taking people out of service centers and having them do audits. The IRS has concluded that the only way to gain compliance is to be tough." Campagna said the change in direction was part of a usual cycle of crackdowns followed by periods of leniency. However, Campagna said the new rules "have created barriers between tax professionals and their clients that seem excessive and unnecessary." The rules require the tax practitioner, as well as the client, to report the transaction to the IRS. In the past, only corporate entities were required to report tax shelters and other tax avoidance to the IRS. The new rules extend the reporting requirements to individuals and broaden the types of transactions. The tax practitioner also must make the written opinions and client names available to the IRS upon request. This is the section that troubles Press and other tax attorneys. "They are making us into whistle-blowers," said Press, who believes the requirement will apply to attorneys. But that's not entirely clear. Duffy reasons that the new rule will only apply to non-lawyer tax advisers. He said that since the IRS had extended attorney-client type privileges to non-attorneys, the new rules could only narrow them back from non-attorney tax advisers. The ambiguity of that provision is not the only vagueness cited by lawyers and the American Bar Association. The types of legal opinions covered by the new rules are also thought to be unclear by tax practitioners and the ABA. Tax practitioners say that there are many instances when the advice they provide is not entirely about tax avoidance and it is in those instances where the rules are unclear as to whether those opinions are covered. A recent report by the ABA warned tax practitioners about the vagueness of the new rules, but it did not provide attorneys with any guidance on the problems. But the ABA asked the IRS to clarify certain parts of the new rules it considered too ambiguous. The ABA report said the new rules will require lawyers to make "a judgment call about which different practitioners or persons serving in the government may not always agree." "The Final Regulations do not make clear where the line for determining the scope of a transaction should be drawn," according to the ABA report. In the absence of any standardized rules, firms will have to make these determinations on their own. "There are going to be differing interpretations, and that's what scares people the most," Ullman said. "You'll have to ask 'Is this a circumstance in which I have to follow the rules?' The standard isn't exactly clear." "I had hoped the American Bar Association would step into the breach and establish some procedures, and for the IRS to review them," Campagna said. "But each firm is left fending for itself." Press fears the ambiguity and increased regulation might trip up well-meaning tax advisers as well as those promoting abusive tax shelters. "They're going to get the fly," he said. "But they're going to get a lot of other people besides."