What is a Tax Opinion Letter?
The Internal Revenue Service and the U.S. Treasury department have declared war on the widely used tax opinion letters in their effort to combat abusive tax shelters. But tax opinion letters are also used in many legitimate transactions, and are prepared by tax attorneys for any business or personal transaction that might lead to significant tax consequences. The opinion letters are typically used to assure investors that a transaction is legitimate. Often tax issues associated with proposed transactions are complex, and the lack of certainty is what prompts people to obtain a tax opinion letter. These documents are designed to justify a tax position, avert an audit, legitimize tax minimization strategy, and avoid possible accuracy or negligence penalties.
The Treasury Department established Circular 230, which calls for any written advice concerning a plan or arrangement, the significant or principal purpose of which is to avoid or evade tax, to meet a number of requirements as to its content and presentation. If the tax opinion letter does not meet the requirements, the clients will not be able to rely on it to avoid IRS penalties should they be audited with an adverse result.
Circular 230 requires tax advisers to warn clients explicitly what protections, if any, a tax opinion letter offers. Still, in some instances where tax shelters are involved, investors will not be able to shift blame for using sham shelters to their advisors — nor would companies be protected from huge penalties if the IRS deems the shelters to be invalid.
The IRS has been concerned that some practitioners might be providing opinions based on unrealistic factual assumptions or without considering important legal doctrines. A good tax opinion letter should be clear and concise. Unfortunately, many such opinion letters are overstated and ambiguous, and don’t address all the elements of the transaction involved.
What makes a good tax opinion letter?
A good tax opinion letter will discuss technical issues along with factual details, and provide a substantive legal analysis. There should be ample case law cited from Tax Court cases and other authorities to support the conclusions of the letter. To some degree, the opinion should discuss the reasons against the tax position as well as the reasons for it, in balanced fashion. Certificates, declarations, and other documentation should accompany the opinion letter to strengthen the assertions made and fill in any gaps.
The overriding motivation of clients in seeking an opinion letter is to have their tax position upheld. Clients want an opinion that is as strong as possible. One of the reasons is that clients want penalty protection. Yet any discussion of penalties presupposes that the substantive position has failed or at that it might be attacked.
Tax opinions, especially if prepared early, can help shape the transaction or position, help with information return issues, help direct the return preparer, and help in tax controversies. An opinion should be prepared early, for it may be problematic in filing a tax return before a written opinion is issued.
A legal opinion is a sensitive document. An opinion should be drafted with the assumption that in the event of an audit, the document will ultimately wind up in the hands of the IRS.
