1.6694-2(c)(iii) disclosure

(iii) Requirements for advice . For purposes of satisfying the disclosure standards of paragraphs (c)(3)(i) and (ii) of this section, each return position for which there is a reasonable basis but for which the tax return preparer does not have a reasonable belief that the position would more likely than not be sustained on the merits must be addressed by the tax return preparer. The advice to the taxpayer with respect to each position, therefore, must be particular to the taxpayer and tailored to the taxpayer's facts and circumstances. The tax return preparer is required to contemporaneously document the fact that the advice was provided. There is no general pro forma language or special format required for a tax return preparer to comply with these rules. No form of a general boilerplate disclaimer, however, is sufficient to satisfy these standards. A tax return preparer may choose to comply with the documentation standard in one document covering each position, or in multiple documents covering all of the positions.

The above is a quotation from the proposed regulations dealing with "reasonable basis" disclosures. The return preparer must justify EACH POSITION taken.

IMPORTANT! the return preparer must DOCUMENT advice given and relied upon. Obviously, this means that advice given by a tax attorney or some other tax advisor must be in writing and cite the relevant technical authority as applied to the relevant facts. The legal memorandum must provide an analysis of the authority cited. One cannot just say that they have an oral opinion from a tax expert. The IRS wants to see and evaluate the "document" or memorandum received.

Although this is the only place in the proposed regulations where the word "document" is used, it stands to reason that all positions taken should be document whether or not the position is disclosed and whether or not the tax return preparer relies on the advice of a tax professional.

The documentation of the technical analysis is imortant for another reason other than avoiding the 6694 penalty. The return preparer will also want to supply "substantial authority" to avoid the negligence penalty. Although the "reasonable basis" standard is lower than the "substantial authority" standard, as a matter of wise tax practice, all disclosed positions should meet the "substantial authority" standard to avoid a negligence penalty for a client. This higher standard will also justify the need for your client to pay for the expert technical opinion letter.

It is a strange "trap" for the drafters of the proposed regulations to draft a disclosure rule to avoid the 6694 penalty that is insufficient to negate the client's negligence penalty.

I also read the above quoted language as a message to return preparers to have all disclosed or undisclosed positions supported with a legal memeorandum. Obviously, one would want to do this only for problematical positions or positions that are factually and legally complex. One has to have a sense of the issue and supply written technical support for those issues that could be challanged in an audit examination. For example, we know that the IRS will likely challange home office expenses or travel and entertainment expenses, etc. Those are the positions that should be supported by the statute, regulations, case law, IRM and other authority.
Otherwise, you rund the risk of the section 6694 penalty.

All of the positions taken or discussed in this blog are open for discussion by adding comment to these blogs. Otherwise, you can contact ab@irstaxattorney.com for a discussion of this or any other provision in the proposed regulations.

Please understand that when the 2008 tax returns are filed, you will want to make sure that the tax returns are not selected for audit. Otherwise, you can expect that the disclosed positions will be identfied by the IRS for audit examination. It will be far less expensive for your client to pay for the effort needed to submit a position that is fully documented based on the facts and the law and thereby reduce the risk for audit examination