Stephen M. Brecher, Weiser LLP Lawrence Hill, Dewey & LeBoeuf LLP

1. Institute of International Bankers June 2008 Annual Tax Seminar Interplay of Developments in the §6694 Tax Return Preparer Rules and Circular 230: Should In-House Tax Professionals Care About These? Stephen M. Brecher, Weiser LLP Lawrence Hill, Dewey & LeBoeuf LLP Diana L. Wollman, Sullivan & Cromwell LLP Moderator: Howard Sacarob, Royal Bank of Canada

2. Today’s Agenda • Chronology • Big Picture of §6694 • Who is a Preparer • Defenses Available to Preparers • Circular 230 Preparer-Developments • Applying 6694 and C230 to In-House Persons • Responsibility for Facts and Law • Some More About MLTN • LMSB Procedures for §6694 Cases

3. §6694-Related Chronology • 5/25/07: §§6694 and 7701(a)(36) amended, effective 5/25/07. • 6/11/07: Notice 2007-54 • provides §6694 transitional rules for tax returns due on or before 12/31/07. • 12/31/07: Notices 2008-11, -12, and -13 • provide §6694 interim rules that apply until Final Regs. are issued. • These 3 Notices are the rules in effect NOW – they incorporate by reference much of the current Regs. • 6/16/08: Prop. Regs. under the new §§6694 and 7701(a)(36) • Proposed to be effective for returns prepared and advice rendered after these Prop. Regs. are finalized and in no event earlier than 12/31/08. • We will refer to these throughout, but will not cover them in detail because they are not in effect this year.

4. §6694-Related Chronology cont’d • 4/11/08: Chief Counsel Notice CC-2008-013 • States that until final §6694 Regs are issued, Chief Counsel attorneys must consult with Office of Associate Chief Counsel (Procedure and Administration) on any issues under §6694. • IRS explanation for this: IRS says it wants to have a single place for examiners to go for guidance on the new rules. • 4/13/08: LMSB Memorandum LMSB-04-0308-009 introduces LMSB Procedures for Tax Return Preparer Penalty Cases. • Full of surprises • Surprises that will be of interest to preparers and taxpayers that use preparers. • Possibly coming up before the end of 2008: • Final §§6694 and 7701(a)(36) Regs. • Maybe also new Regulations under §§6662, 6664, 6707 and 6708 and C230 §10.34.

5. The Big Picture of §6694 (as amended May ‘07) • A “tax return preparer” of any tax return must pay a monetary penalty if • a position on that tax return resulted in a tax understatement, and • the preparer knew (or reasonably should have known) of that position; • unless one of the §6694 defenses applies. • We will discuss these defenses in a moment. • §6694 monetary penalty • 50% of “the income derived by the preparer from the preparation of the return”, or • if greater, $1000 ($5000 if preparer was “willful or reckless”). • Other possible consequences of violating §6694: • Automatic referral to OPR (for it to investigate a possible C230 violation). • IRM 4.11.55.4.2.2.1 (in IRM prior to May ’07). • C230 possible sanctions: censure, suspension, disbarment and/or monetary penalties. • Prop. Regs. Preamble said this IRM provision will be changed. • Possible discipline by state licensing authority. • Possible harm to professional reputation.

6. Who is a “Tax Return Preparer”

7. Who is a “Tax Return Preparer” IRC Definition of Tax Return Preparer (§7701(a)(36)) • “Any person who prepares for compensation, or who employs one or more persons to prepare for compensation, any return of tax imposed by” title 26. • “The preparation of a substantial portion of a return … shall be treated as if it were the preparation of such return”. The existing Regulations (still in effect today) add a lot more detail ….

8. When is an Advice-Giver a “Tax Return Preparer”? • Person who only gives advice is a “preparer” if • the advice is given after the underlying events have occurred, • the advice is “directly relevant to the determination of the existence, characterization, or amount of an entry”, and • the entry is a “substantial portion” of the return. • There is no requirement • that the taxpayer have, in fact, relied upon this advice in determining how to complete that entry; or • that the advice-giver expected the taxpayer to rely upon the advice in determining how to complete that entry. • Some changes in Prop. Regs.: • How to determine whether “substantial portion”, and • “after underlying events” – new 5% rule.

9. Special Rules for defining “Tax Return Preparer” • Employee-rule: employee is never a preparer of his employer’s return. • Employer-of-preparer-rule: a preparer’s employer is also a preparer. • Example: if an S&C lawyer is a preparer, then S&C is also a preparer. • One-preparer-per-firm-rule: if multiple individuals from a single firm are involved, only one is a “preparer”. • Example: three people from S&C assist a client in preparation of return -- only one is the “preparer”. • Changes in Prop. Regs.: one-preparer-per-position-per-Firm • De minimis rule: an individual is not a preparer if the entries “prepared” by him involve (in the aggregate) • (i) less than $2K, or (ii) less than $100K and less than 20% of the gross income shown on the return. • Changes in Prop. Regs.: raised to $10K and $400K

10. When Does a Preparer Have to Sign the Return • §6695: obligates the preparer to sign the return. • If there is more than one preparer, the Regulations make • one into the “Signing Preparer” and • the rest into “Nonsigning Preparer(s)”. • Which one is the “Signing Preparer”? • “the individual preparer who has the primary responsibility as between or among the preparers for the overall substantive accuracy of the preparation of such return.” • There is no specified limit on the number of Nonsigning Preparers.

11. These Rules Result in There Being Five Types of Preparers • Classic Preparer: physically prepares return. • Shadow Preparer: tells someone else how to prepare return (line-by-line). • 1977 Regs put this in as anti-abuse rule. It worked. • Not included in Prop. Regs. • Pure Advisor Preparer: only gives advice, but advice is on a “substantial portion”. • Schedule Preparer: physically prepares a schedule or other attachment to a return (or gives advice on the completion). • so, “prepared” that portion of the return, and it was a “substantial portion”. • Indirect Preparer: • prepares documents that get sent to taxpayers (e.g., information returns, valuation data, etc.) • Taxpayers use the information on these documents to complete their tax returns. • If that information affects a “substantial portion”, this person is a preparer of that tax return. • Prop. Regs. narrow this substantially – a very welcome change. (Prop. §301.7701-15(b)3)(iii).)

12. What are the defenses available to the Preparer when there is an understatement on the tax return?

13. Preparer’s Possible Defenses According to IRC §6694 (1) MLTN: • “there was … a reasonable belief that the position would more likely than notbe sustained on its merits” (>50%). (2) Disclosure & Reasonable Basis: • the position was “disclosed” and had a reasonable basis (~20%). • Reasonable Cause & Good Faith: there was “reasonable cause” for the understatement and the preparer acted “in good faith”. • Applies when a real mistake was made. • A facts and circumstances analysis. • Not a defense that a preparer can “count on”. • Significance of all this: • If return does not include “disclosure”, preparer has a defense he can “count on” only if the position on the return is supported by MLTN.

14. But taxpayers do not always need MLTN • Taxpayers care about possible §6662 substantial understatement penalties (and the §§6662 and 6664 defenses to those penalties). • Taxpayers have 4 possible defenses to §6662 penalties: • substantial authority (~40% chance of success); • RB plus disclosure (on IRS Form 8275); • reasonable cause & good faith (e.g., good faith mistake of fact); • the MLTN defense: the requirements of this defense are • taxpayer reasonably believed position was MLTN to be sustained, and • position is supported by “substantial authority”. • MLTN is the only defense available if there is a “significant purpose of tax avoidance” (or a listed transaction).

15. Preparers MLTN Ø RB plus disclosure Reas Cause & Good Faith (mistake) Taxpayers MLTN Substantial authority RB plus disclosure Reas Cause & Good Faith (mistake) Comparison of Preparer Defenses to Taxpayer Defenses • So, what’s a Preparer to do when there is substantial authority (but not MLTN)? • Substantial authority is enough for the TAXPAYER to avoid §6662 penalties, but not enough for the Preparer to avoid §6694 penalties.

16. Notice 2008-13 solves the Preparer’s dilemma, temporarily • Notice 2008-13: sets out interim rules for applying §6694 until new regulations are issued. • Part G of Notice 2008-13: • sets out special §6694 defenses, which are intended to bridge the gap between the §6694 preparer rules and the §6662/6664 taxpayer rules. • Prop. Regs.: use these same rules, with some improvements.

17. 2008-13: Six Defenses for A Preparer When There is Not MLTN • Signing Preparers • 1. RB plus actual tax return disclosure (Form 8275) • 2. RB plus preparer prepares Form 8275 • 3. Substantial authority (taxpayer’s defense met) plus “6694 Speech” • 4. RB plus two Speeches (“6662 Speech” and “6694 Speech”) • applies if taxpayer has a significant purposes of tax avoidance such that substantial authority is not a taxpayer defense. • Nonsigning Preparers • 1. Advising taxpayer directly: • RB plus “6662 Speech” • 2. Advising another preparer: • RB plus “6694 Speech”

18. Signing Preparers: Options #1 and #2 • 1.RB plus actual disclosure • RB for position • Actual disclosure filed with return • That is usually an IRS Form 8275 • 2.RB plus preparer prepares disclosure • RB for position • Preparer provides the taxpayer with a completed IRS Form 8275 • No requirement that taxpayer files the 8275 • No requirement that preparer say any specific thing to taxpayer.

19. Signing Preparers: Option #3 • 3.Substantial authority plus “6694 Speech” • Substantial authority for position • Taxpayer is eligible for the substantial authority defense • i.e., this is not a significant purpose of tax avoidance transaction or a listed transaction • “6694 Speech”: • preparer advises taxpayer regarding the difference between • the §6662 taxpayer standards and • the §6694 preparer standards. • Preparer contemporaneously documents in his files that this speech was given. • Prop. Regs. change this to a “6662 Speech” specifically tailored to the taxpayer’s facts.

20. Signing Preparers: Option #4 • 4. RB plus two Speeches • Applies when this may be a significant purpose of tax avoidance transaction (such that taxpayer cannot use substantial authority defense) • RB for position • “6662 Speech”: • preparer advises taxpayer regarding the taxpayer §§6662 and 6664 penalty standards • “6694 Speech”: • preparer advises taxpayer regarding the difference between • the taxpayer penalty standards and • the §6694 preparer penalty standards. • Preparer contemporaneously documents in his files that these speeches were given. • Prop. Regs. change this to the “6662 Speech” specifically tailored to the taxpayer’s facts.

21. Recap of 4 Current Methods for Signing Preparer • 1. RB plus actual disclosure • 2. RB plus preparer prepares disclosure • 3. Substantial authority (taxpayer’s defense met) plus “6694 Speech” • 4. RB plus two Speeches (“6662 Speech” and “6694 Speech”) • only if taxpayer has a significant purposes of tax avoidance

22. Nonsigning Preparer when advising taxpayer directly • 1.RB plus “6662 Speech” • RB for position • 6662 Speech: • advice given to the taxpayer includes statement informing taxpayer of any opportunity to avoid §6662 penalties and whether that would require disclosure.

23. Nonsigning Preparerwhen advising another preparer • 2.RB plus “6694 Speech” • RB for position • 6694 Speech: • advice given to the other tax return preparer includes statement that disclosure might be required under §6694

24. Recap of 2 Current Methods for Nonsigning Preparer • 1. Advising taxpayer directly: • RB plus “6662 Speech” • 2. Advising another preparer: • RB plus “6694 Speech” • Prop. Regs.: retain these rules and clarify that RB plus Form 8275 disclosure is also Nonsigning Preparer defense.

25. C230 Developments relating to preparers Background • §10.34(a) of C230 has for many years set forth standards for Signing Preparers and for those advising on return positions. • These standards have for many years been the same as the §6694 standards. • §10.34(a) applies whenever a practitioner “advises a client to take a position on a tax return” or “prepares the portion of a return on which a position is taken”. • In contrast to §6694, there is no requirements that the items prepared or advised on constitute a “substantial portion” of the return. • Advice on a single entry is enough to make §10.34(a) apply. • Rationale: C230 is about “fitness” to practice, whereas §6694 is about trying to prevent inaccurate returns from being filed by imposing some standards on the persons who have the most impact on the return preparation process.

26. C230 Developments relating to preparers • 9/26/07: Final C230 Regulations were issued. • As part of this package, Proposed §10.34(a) was released: • would put into §10.34(a) the new §6694 standards. • Thus, for a practitioner to give any advice on any return position, would need to have MLTN or RB plus disclosure. • This is significant because §10.34(a) applies to any advice on any return position.

27. “I am in-house tax practitioner: What do I care about?”

28. Am I subject to §6694? • Am I a §6694 “tax return preparer” of my employer’s returns? • No, you are not a preparer of the returns of your employer • “employer” includes your actual employer and any parent or subsidiary corporation (linked by 50% voting power) of your employer.

29. Am I subject to §6694? • Special partnership rules: • Not a preparer of any return of a partnership in which you are a general partner. • If you are employed by a partnership, you are not a preparer of any return of that partnership or any general partner of that partnership. • If you are an employee of the general partner of a partnership, are you a preparer of the partnership’s return? • Neither current Regs. nor Prop. Regs. address this.

30. Am I subject to C230? • Even if you are not a §6694 preparer, you are subject to C230. • All “practitioners” are subject to C230. • Am I subject to C230 §10.34(a)? • §10.34(a) applies to a preparer obligated to sign the return – that’s not you, because an employee cannot be a Signing Preparer of his employer’s return. • §10.34(a) also applies to a practitioner who “advises a client to take a position on a tax return”. • Does that mean in-house practitioners are exempt from this because their employer is not their “client”? • There is no explicit employee-advising-his-employer exception. • The term “client” is not defined in C230.

31. What other C230 sections might apply to me (in-house)? • Sections that probably don’t apply to in-house practitioner: • §10.21: if you have knowledge that “a client … has made an error or omission from any return, affidavit or other paper” submitted to the IRS, you must • advise the client “promptly” of this fact and of the consequences under the Code and Regs of this error or omission. • §§10.35 and 10.37: rules for giving written advice • Have an explicit exception for employee giving advice to employer. • Sections that probably do apply to in-house practitioner: • §10.22: you must exercise due diligence as to accuracy in assisting in the preparation of tax returns and other documents relating to IRS matters. • §10.51(a)(4): participating in any way in the giving of false or misleading information to Treasury. • §10.51(a)(13): giving a false opinion, knowingly, recklessly, or through gross incompetence.

32. Who is responsible for the accuracy of the facts? • Can my outside advisor rely upon my statement of the facts? • If what I tell him is incorrect and the understatement is caused by the errors in the facts I told him, is that a §6694 defense for him? • Current Rule: preparer may rely upon information furnished by the taxpayer or a third party, without independently verifying it, but the preparer may not ignore the implications of information furnished or known and must make reasonable inquiries of any third party if the information appears to be incorrect or incomplete. • (Not. 2008-13, Section D and Regs. §1.6694-1(e). • Prop. Regs. are very similar. • Nevertheless, will my outside advisor do more factual due diligence? • How much of my time is this going to take up? • Will I have to pay for his additional time?

33. Can one advisor rely on another advisor’s legal conclusions? • If I get an opinion or a schedule prepared by one advisor, can my Preparer rely on that opinion/schedule for his own §6694 defense? • Or will the Preparer insist on repeating the legal and factual research and analysis? • Do I have to pay for that? • Current Rule: preparer may rely upon advice or a schedule prepared by another advisor, without independently verifying it, but the preparer may not ignore the implications of information furnished or known and must make reasonable inquiries if the information appears to be incorrect or incomplete. • (Not. 2008-13, Section E and H (Examples 6 and 7), and Regs. §1.6694-2(d)(5)). • Prop. Regs.: narrow ability to rely on legal conclusions of others.

34. Is Preparer’s Signature All I Need to Avoid Penalties? • If my Classic Preparer is willing to sign the return, does that mean I must have a §§6662/6664 MLTN defense? • The Classic Preparer’s 5 possible defenses are • 1. MTLN • 2. RB plus actual disclosure • 3 . RB plus preparer prepares disclosure • 4. Substantial authority (taxpayer’s defense met) plus “6694 Speech” • 5. RB plus two Speeches (“6662 Speech” and “6694 Speech”) • applies if taxpayer has a significant purposes of tax avoidance such that substantial authority is not a taxpayer defense. • So, Preparer’s willingness to sign return does not always mean Preparer believes position is MLTN.

35. 6694 MLTN ≠ Taxpayer 6664 MLTN • Even if preparer doeshave MLTN, that does not mean that the taxpayer satisfies the taxpayer MLTN defense. • Taxpayer’s MLTN defense (§6664) has three components: • Taxpayer “reasonably and actually believes” MLTN. • Preparer’s MLTN defense = preparer reasonably believed MLTN. • Preparer’s belief ≠ taxpayer’s belief. • The position is in fact supported by substantial authority. • There are no other facts or circumstances that show taxpayer does not in good faith believe position is well supported.

36. What if there is no answer that is MLTN? • Tax community has been wringing it hands over what preparers should do when there are multiple alternative positions and NONE of THEM are supported by MLTN. • Example: Corporation buys ceramic coffee mugs for all employees as part of its Green Office program. • Is the expense (i) currently deductible in full?, (ii) depreciable over the useful life of a mug?, or (iii) amortizable over average number of years an employee is retained for? • If your outside advisor tells you that he cannot give you ANY advice in this situation because it would cause him to violate §6694, you do not need to accept that answer. • Go back to the Preparer’s other options (above). • Prop. Regs.: no special rule for this situation.

37. LMSB-04-0308-009 Released 4/13/08New Procedures for Tax Return Preparer Penalty CasesWhy might you care?

38. LMSB-04-0308-009 Part of every taxpayer examination • “During every field examination” of a taxpayer’s return, • it is the IRS examiner’s “responsibility” to determine if any §6694 violations exist and, • if so, to assert penalties. • Explains in detail how the field examiner is supposed to gather information about the preparer during the course of the taxpayer examination. • But, the rule is that the 6694 violation may not be assessed until after the taxpayer audit is closed. • But the 6694 SOL is 3 years from the date the return is filed.

39. LMSB-04-0308-009 • As we go through some of what the LMSB Memorandum provides for, think about the following situation • Preparer has assisted Taxpayer in preparing a return. • Return is being audited and Preparer is assisting Taxpayer in defending the audit. • Can Preparer give unbiased, unconflicted audit defense services to Taxpayer?

40. LMSB-04-0308-009 Gathering info during taxpayer exam • “Each income tax examination is separate and distinct from the [related] return preparer violation case … Therefore, examiners will not propose or discuss conduct penalties per se in the presence of the taxpayer.” • But, the examiner may collect written documentation and oral testimony relating to the potential preparer violation. • “Interviews of the taxpayer should serve a dual purpose: • 1) to further the tax examination and • 2) to identify violations by a tax return preparer.” • “During the initial interview and throughout the examination process, the examiner should ask questions regarding the return preparation as appropriate to the case and issues being developed.”

41. LMSB-04-0308-009 questioning taxpayer during taxpayer exam • “Questions should be tailored to the individual taxpayer and situation.” • “Examples of questions which may be appropriate to a given situation include: • Did you meet with the preparer? • What documentation was provided to the preparer? • Did you receive a copy of the return or claim? • How was the preparer compensated? • Are you aware of any errors, omissions or mistakes on the return under examination? • D id you disclose this transaction on your tax return? Why? Why not? • Were there any concerns about how the transaction was reported? What sort of process is used to address those concerns and on what basis are decisions made? • Was there any discussion regarding potential penalties? • Was there any discussion regarding whether the transaction is subject to disclosure under Revenue Procedure 94-69?”

42. LMSB-04-0308-009 disclosing return info to preparer • “[§6694] penalty files may include copies of tax returns or portions of tax returns prepared by the preparer who is being considered for the penalty. The penalty files may also include other information taken from examination administrative files”. • “Such information may be disclosed to the preparer …if the information relates to the resolution of the penalty issue (IRC 6103(h)(4)).” • “Remember that an examiner may disclose information about the prepared returns because that information relates to the penalty determination, not because the preparer prepared the return or may have had a power of attorney to represent the taxpayer. If there is any information in the penalty file that does not relate to the penalty determination, such as the taxpayer's current address or current employer, that information may not be disclosed to the preparer or the preparer's authorized power of attorney.”

43. LMSB-04-0308-009 • How can a Preparer defend an audit of a tax return he “prepared” if the IRS examiner has a “responsibility” to be simultaneously gathering evidence of a §6694 violation? • What do the in-house practitioners in the audience think? • What do the outside advisors think?