Tax Blog/Blawg

Nearly all taxpayers will face penalties by the IRS at some point, regardless of their sophistication level and size.  Accordingly, tax practitioners, even those who claim not to get involved in traditional "collection" activities, must understand key aspects of abatement and collection procedures in order to effectively advise their clients.  This is particularly true given that the IRS persists in taking extreme positions in the Tax Court, such as the always-say-never approach, that are contrary to the majority of existing legal authorities.  A recent example is Custom Stairs & ...

We now tackle the third question raised by our original post about Canal Corp. v. Comm’r: when (if at all) should courts defer to the opinion of a reputable tax advisor in deciding whether to uphold an assessment of penalties against a taxpayer?

To be clear, deference in this context does not mean that courts should defer to an advisor’s opinion regarding the substantive merits of a transaction.  If penalties are at issue, the substantive merits (or lack thereof) of a transaction have already been decided.  Instead, deference in this context refers to whether courts should presume that a taxpayer's receipt of an opinion written by a reputable advisor is sufficient to avoid the imposition of penalties on a transaction, notwithstanding a perceived conflict of interest on the advisor's part.

Following up on our earlier post, Deconstructing Canal Corp. v. Commissioner – Part I, we now examine the second question raised by Judge Kroupa’s opinion.  Specifically, where a taxpayer relies on the opinion of an advisor to establish a “reasonable cause and good faith” defense to the imposition of penalties, have the modifications to the penalty preparer rules of Code section 6694 obviated the need for a judicial rule disallowing taxpayer reliance on the opinion of an advisor who has a conflict of interest?

Many practitioners were taken aback by the recent Tax Court decision in Canal Corp. v. Commissioner, where Judge Kroupa issued a stinging opinion that not only recast a leveraged partnership distribution as a disguised sale, but also upheld penalties against the taxpayer for what the judge characterized as the taxpayer’s unreasonable reliance on the opinion of its tax advisor.  Judge Kroupa’s analysis, which should be on the forefront of every tax advisor’s mind, raises a number of interesting, if thorny, questions, including:

• Should a fixed and/or contingent fee arrangement necessarily render tax advice unreliable for purposes of avoiding a substantial understatement penalty under the “reasonable cause and good faith” exception?

• Has the enactment of section 6694 undercut the rationale for prohibiting taxpayers from relying on advisors that have a conflict of interest?

• When (if at all) should courts defer to the opinion of a reputable tax advisor in deciding whether to uphold an assessment of penalties against a taxpayer?

Today, we tackle the first of these three questions.