By Conrad M. Davis, CPA, and Bronwyn R. Gillespie, CPA
In October 2013, we penned an article discussing the Department of the Treasury’s (Treasury) proposed changes to Circular 230. Treasury now has released its finalized regulations that apply to written tax advice provided on or after June 12, 2014. The final regulations modify the standards governing written advice, as expected, and update other provisions. As a result, the steps advised in our previous article are no longer merely optional, and CPA firms without the proper systems, controls, and documentation in place risk the potential for noncompliance.
Commentators and Treasury both agree the final regulations reflect a shift from a rules-based approach to one that is more principles-based. The regulations address several areas that are especially noteworthy.
Competency
As in the proposed regulations, Section 10.35, “Competence,” acknowledges the need for practitioners to possess a certain level of experience and establishes a new standard. The provision identifies “the appropriate level of knowledge, skill, thoroughness, and preparation” as necessary requirements for tax advisers when performing an engagement before the IRS.
Some commenters on the proposed regulations expressed concern over whether this standard would not allow practitioners to become competent by consulting other practitioners with relevant expertise or by learning about governing law through research and study. In the final regulations, the IRS clarifies that practitioners can become competent in a variety of ways, including consulting with experts in the relevant area and studying the relevant law. Whether consultation or research is adequate to make a practitioner competent in a particular situation depends upon the facts and circumstances of that situation.
Principal Authority
Section 10.36, “Procedures to Ensure Compliance,” places the responsibility for compliance with Circular 230 on the individuals who maintain principal authority within a firm. Practitioners with principal authority are charged with taking reasonable steps to ensure that the firm has adequate compliance procedures for all members, associates, and employees. Commenters have pointed out that the proposed rule could allow a firm’s management to comply simply by taking reasonable steps to make sure the firm has adequate procedures in place, even if management does not take any steps to make sure these procedures are properly followed. In response, the final regulations clarify that Section 10.36 requires both the existence and the implementation of adequate procedures.
According to Treasury, if violations occur on a consistent basis, authorized parties are required to deploy specific measures to address the violations. In cases where members in authoritative positions fail to take action, they may be held accountable if willfulness, recklessness, or gross incompetence regarding compliance is demonstrated. Practitioners with principal authority also will bear responsibility for a firm’s compliance with Circular 230 in its entirety. Furthermore, in the absence of a designated principal authority, the IRS may identify one or more individuals responsible for compliance. Fundamentally, Section 10.36 encourages firms to self-regulate, without the excessive burden of a rigid one-size-fits-all approach.
Written Advice
Similar to the proposed regulations, which amended Section 10.37, “Requirements for Written Advice,” replaces the onerous covered opinion provisions of the previous Section 10.35 with principles to which all practitioners must adhere when rendering written advice on a federal tax matter. Commenters agreed that the comprehensive, principles-based approach of these amendments is more straightforward, is simpler, and can be applied to all written tax advice in a less burdensome manner.
The final regulations changed the language from a prohibition against using unreasonable factual and legal assumptions to an admonition to use reasonable factual and legal assumptions. One commentator described this change as shifting the burden of proof of noncompliance from the IRS to the practitioner.
Practitioners also must make reasonable efforts to identify and ascertain the facts relevant to written advice. However, Section 10.37 does not require a practitioner to describe in the written advice the relevant facts (including assumptions and representations), the application of the law to those facts, or the practitioner’s conclusion with respect to the law and the facts. The determination of whether a practitioner has failed to comply with Section 10.37’s requirements is based upon all facts and circumstances, rather than whether each requirement is addressed in the written advice.
The final regulations also clarify that submissions to the government on matters of general policy (for example, comments on proposed Treasury regulations made on a client’s behalf) and continuing education presentations are not considered written advice.
One change that has captured much attention relates to the previously ubiquitous Circular 230 disclaimer. As Treasury notes in the preamble to the regulations, many practitioners routinely use a Circular 230 disclaimer at the conclusion of every email or other writing to remove the communication from the covered opinion rules, regardless of whether the disclaimer is necessary or appropriate – or whether the communication even contains any tax advice. The final regulations do not prohibit the use of an appropriate statement describing any reasonable and accurate limitations of advice rendered to a client, but Karen Hawkins, Director of the Office of Professional Responsibility (OPR), has made clear that practitioners must remove any language indicating that the statement is required under Circular 230 or by the IRS. The OPR will take action against practitioners who continue to use such language.1
Due Diligence
The final regulations also expand Section 10.22, “Diligence as to Accuracy,” to require practitioners to exercise due diligence in verifying the accuracy of information in all IRS matters. A practitioner may not rely on the work product of another employee unless the practitioner has exercised reasonable care in engaging, supervising, training, and evaluating that individual.
Section 10.37 imposes a duty on a practitioner to determine the skills and experience of anyone whose advice is relied upon. Commenters questioned if that provision was too broad, but the IRS noted that relying on another’s advice without considering one’s expertise and qualifications would be inconsistent with the due diligence required in Section 10.22. However, the IRS and Treasury stated that they do not believe this standard imposes an affirmative duty on a practitioner to determine the skills and experience of the other party when the practitioner is already aware of the other person’s background.
Taken as a whole, the final regulations reinforce the importance of sound quality assurance practices. Rather than simply checking all the required boxes, practitioners must demonstrate their competence and due diligence through documentation and establishment of procedures.
Compliance Going Forward
With the regulations already in effect, compliance is now required. Under Section 10.50, the OPR can seek sanctions ranging from censure, suspension, and disbarment to monetary penalties payable by the firm or an individual for failure to comply with this regulation. AICPA sanctions also may result.
In addition to designating principal authority and revising their disclaimers, firms should consider establishing effective internal controls and processes to both demonstrate compliance with Circular 230 (and applicable professional standards) and help provide an affirmative defense in the event of a professional liability claim. Promoting a culture of due diligence, professionalism, and documentation should help to reduce the risk of costly missteps and result in even better service to clients.
Conrad Davis is a partner with Crowe Horwath LLP in the Sacramento, Calif., office. He can be reached at 916.492.5150 or conrad.davis@crowehorwath.com.
Bronwyn Gillespie is with Crowe in the Sacramento office. She can be reached at 916.492.5154 or bronwyn.gillespie@crowehorwath.com.
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