The IRS is taking a tough line on tax cheats.

Among the most significant changes in the tax rule book is the Treasury Department’s revised Circular 230, which is likely to have a profound effect on corporate tax strategies. Circular 230 imposes a new, more-stringent set of rules on attorneys, accountants, and other professionals who provide tax advice. The circular became effective in mid-2005. The new rules cover not only formal written tax opinions, but also virtually any written communication that contains advice regarding tax-minimizing transactions. Although the impetus behind the new rules was to combat abusive tax shelters, the revised rules were drafted so broadly that they could be applied to many ordinary transactions.

Strict New Standards

Under existing tax law, if a taxpayer files an incorrect tax return, penalties can be avoided if the taxpayer can prove there was “reasonable cause” for making the error. Historically, taxpayers often claimed the reasonable-cause exemption by saying they had relied on the guidance of a tax adviser or lawyer. Circular 230 sets new, stricter standards of due diligence for any opinions that tax advisers give clients regarding listed transactions, which may include arrangements that have no real economic purpose other than dodging taxes.

For the first time, advisers can bar clients from using their opinions to support a reasonable-cause exception. That shifts the legal responsibility for tax position to the taxpayer and heightens the risks of aggressive tax strategies. (In-house tax advisers are not covered by this rule.)

Corporate tax executives, including Best Buy’s Tilton, say the new requirements have boosted their workload substantially, though it may lessen somewhat as executives become more familiar with the forms. Even the IRS is finding M-3 a bit overwhelming. Commissioner Nolan concedes the agency is currently “getting systems up to speed” in order to properly mine all the new data that is pouring into the agency. The IRS recently delayed M-3 filing requirements for property, life, and casualty insurance companies until they file returns for tax years ending on or after December 31, 2006. S-corporations and limited liability partnerships will not be required to file the M-3 until 2006.

The IRS has also been lagging on a task of critical importance to corporate tax executives: guidance on new rules. The agency issued guidance on only 60 percent of the 349 items it identified as priorities in 2005 (it had set its goal at 75 percent). One issue that concerned corporate taxpayers last year was the lack of clarification on the repatriation provision of the 2004 American Jobs Creation Act, which affects companies with foreign units. The program allows a special one-time dividends-received deduction on the repatriation of certain earnings of foreign operations.

The new law is extraordinarily complicated. Because it expired at the end of 2005, corporate taxpayers were eager to get guidance early so they could devise repatriation plans. The IRS issued some guidance, but many tax executives were left waiting anxiously for months for more-explicit directions from the agency. That meant they had to scramble to take advantage of the program or forgo it entirely.


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