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William & Mary Annual Tax Conference Conferences, Events, and Lectures

1995

Ethical Issues in Tax PracticeRobert I. Brauer

James P. Holden

Copyright c 1995 by the authors. This article is brought to you by the William & Mary Law School Scholarship Repository.https://scholarship.law.wm.edu/tax

Repository CitationBrauer, Robert I. and Holden, James P., "Ethical Issues in Tax Practice" (1995). William & Mary Annual Tax Conference. 292.https://scholarship.law.wm.edu/tax/292

WILLIAM AND MARY TAX CONFERENCE

December 2, 1995

ETHICAL ISSUES IN TAX PRACTICE

Robert I. Brauer

James P. Holden!

I. SOURCES OF PRACTICE STANDARDS FOR TAX PRACTITIONERS.

A. THE NATURE OF PRACTICE STANDARDS. Practice standardsare ethical principles that guide the tax practitionerin balancing duty to client with duty to "system."

B. WHERE DO WE FIND TAX PRACTICE STANDARDS? Tax practicestandards come from three sources: standards set byprofessional organizations, civil penalties set forthin the Internal Revenue Code, and the Federalregulations known popularly as "Circular 230."

1. Standards Set by Professional Organizations.

a. Both the American Bar Association ("ABA") andthe American Institute of Certified PublicAccountants ("AICPA") define standards fortheir members. The ABA Model Rules ofProfessional Conduct also serve as the basisfor standards set by most court systems,including the United States Tax Court (Rule201(a)).

b. ABA and AICPA committees issueinterpretations of their standards forparticular factual situations.

c. Other professional organizations, such as theNational Association of Enrolled Agents andthe National Society of Public Accountantsalso issue standards for their members.

2. Internal Revenue Code Civil Penalty Provisions.These include the income tax return preparerpenalty under section 6694 and the aiding andabetting penalty under section 6701.

*/L This outline was prepared by Mr. Holden, and it does notnecessarily reflect the views of Mr. Brauer.

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3. Federal regulations known as "Circular 230" (31CFR Part 10) establish standards for those whopractice before the Internal Revenue Service.

C. TAX RETURN ACCURACY STANDARDS.

1. Tax return accuracy standards have beenestablished for both taxpayers and taxpractitioners.

2. These standards are fundamental to tax practice,and we turn to them before considering otherstandards.

3. we commence with the tax return accuracyobligation of the client taxpayer beforedescribing the accuracy required of thepractitioner. This order is chosen on the theorythat the practitioner cannot effectively assistthe client unless the practitioner understandsfully the client's own accuracy obligation underthe tax law.

4. Following that, we return to the accuracyobligation of the tax practitioner.

II. THE TAX RETURN ACCURACY OBLIGATION OF THE TAXPAYER CLIENT:THE TAXPAYER ACCURACY PENALTY.

A. THE FOUR COMPONENTS OF THE TAXPAYER ACCURACY PENALTY.A 20% penalty is imposed on any taxpayer whose returnshows an underpayment of tax that is attributable toone or more of the following four components.

1. Negligence. Negligence occurs if a tax returnposition lacks reasonable basis or if the taxpayerdoes not make a reasonable attempt to comply withthe tax law. Reg. S 1.6662-3(b).

a. A taxpayer acts reasonably if the taxpayer ingood faith relies on the advice of a taxprofessional. Chamberlain v. Commissioner,No. 94-40806 (5th Cir. 9/27/95).

2. Disregard of rules or regulations. Disregardincludes any careless, reckless, or intentionaldisregard of the Code, temporary or permanentregulations, revenue rulings, or notices (otherthan notices of proposed rulemaking). Reg. S1.6662-3(b)(2). A position contrary to a revenueruling or notice does not disregard the ruling ornotice if the position has a "realisticpossibility of being sustained on its merits," aterm that we define below.

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3. Substantial understatement of income tax. Asubstantial understatement of income tax occurswhere an income tax underpayment exceeds thegreater of ten percent of the tax due or $5,000($10,000 for corporation) and the position givingrise to the underpayment is not supported by"substantial authority." Section 6662(d).

a. There is substantial authority for a positionif the weight of authorities supporting theposition is substantial in relation to theweight of authorities supporting a contraryposition. Reg. S 1.6662-4(d)(2).

(1) There may be substantial authority formore than one position.

(2) The standard is objective and thus thetaxpayer's belief about the accuracy ofthe position is not relevant.

(3) Authorities that may be considered inevaluating the presence of substantialauthority include essentially allgovernment-issued material but do notinclude privately-issued material suchas treatises, legal periodicals, andopinions of tax professionals.

(4) If there exists no authority with regardto a position, substantial authority mayrest on a well-reasoned construction ofthe applicable statutory provision.

b. Determining the existence of substantialauthority in highly factual cases can bedifficult.

(1) In Osteen v. Commissioner, 95 TNT 168-46(11th Cir. 8/24/95), the Tax Court heldthat the taxpayers did not conduct theirhorse breeding business for profit anddenied claimed loss deductions. It alsoimposed the substantial understatementpenalty on grounds that the claimeddeductions were not supported bysubstantial authority.

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(2) The appeals court affirmed on thesubstantive tax issue but reversed onthe penalty issue. It held thatsubstantial authority exists if alower-court decision in favor of thetaxpayers would have been affirmed asnot clearly erroneous. The appealscourt concluded that there was evidenceboth ways, and the Tax Court could thushave found for the taxpayers. Had itdone so, its decision would have beenaffirmed as not clearly erroneous.This, said the appeals court, issufficient to establish substantialauthority.

c. If a substantial understatement arises byvirtue of a tax shelter, special rules apply.Reg. S 1.6662-4(g).

(1) A tax shelter includes any plan orarrangement having as its principalpurpose the avoidance of Federal incometax. Reg. S 1.6662-4(g)(2), (3).

(2) A noncorporate taxpayer may avoid thepenalty by showing that there wassubstantial authority for the positionand by establishing that the taxpayerreasonably believed that the positiontaken on the return was more likely thannot proper. The taxpayer may establishthe required reasonable belief throughpersonal analysis of authorities orreliance on the opinion of aprofessional tax advisor. Reg. S1.6662-4(g).

(3) A corporate taxpayer does not have thisoption. Its tax shelter underpaymentsare subject to penalty unless relief isavailable under the reasonable cause andgood faith exception of section 6664(c),discussed below. Reg. S1.6662-4(g)(1)(ii).

4. Valuation misstatement. There are severalvaluation misstatement penalties that apply whereincome, pension, and estate or gift tax valuationsexceed stated threshold limits. Section6662(e),(f), and (g).

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B. AVOIDING THE PENALTY BY MAKING ADEQUATE DISCLOSURE.

1. Effect of adeauate disclosure. The taxpayer mayavoid some components of the accuracy penalty bymaking adequate disclosure on a Form 8275 (a Form8275-R must be used if a regulation has beendisregarded).

2. Reasonable basis reguired. Disclosure is noteffective unless there exists a "reasonable basis"for the position. Reg. S 1.6662-1.

a. The precise meaning of "reasonable basis" inthis context is unclear.

b. While the regulations assert that thereasonable basis standard is "significantlyhigher than the not frivolous standard," theyreserve the actual definition of the term forfuture resolution. Reg. S 1.6662-3(b)(3).

3. The negliQence component. Negligence generallyoccurs only where a taxpayer acts withoutreasonable basis, and-thus disclosure is noteffective as a defense against this component ofthe accuracy penalty. Reg. SS 1.6662-1,1.6662-7(b).

4. The disreQard component. The disregard componentof the accuracy penalty may be avoided bydisclosure so long as the taxpayer keeps adequatebooks and records and properly substantiatesitems. However, if a regulation is disregarded,disclosure will not be operative unless thetaxpayer is engaged in a good faith challenge tothe validity of the regulation. Reg. S1.6662-3(c)(1).

5. The substantial understatement component. Thesubstantial understatement component of theaccuracy penalty may be avoided by disclosureexcept that disclosure will not be effective if(1) the position-relates to a "tax shelter," or(2) the taxpayer failed to maintain adequate booksand records or to substantiate items. Reg. S1.6662-4(e).

6. The valuation misstatement component. Thevaluation misstatement component of the accuracypenalty may not be avoided by disclosure. Reg. S1.6662-5(a).

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C. AVOIDING THE PENALTY BY ESTABLISHING REASONABLE CAUSEAND GOOD FAITH.

1. The general rule.

a. The accuracy penalty of section 6662 may notbe imposed if the taxpayer establishes thatthere was reasonable cause for theunderpayment and taxpayer acted in goodfaith. Section 6664(c); Reg. S 1.6664-4.

b. The determination of reasonable cause andgood faith is made on the basis of all factsand circumstances, and the most importantfactor is the taxpayer's effort to assess theproper tax liability. Reg. S 1.6664-4(b).

(1) Reliance on such factors as Forms W-2and information returns prepared byothers may establish good faith unlessthose documents are inconsistent withother information that is available tothe taxpayer or with the taxpayer's ownknowledge. Reg. S 1.6664-4(b).

(2) Reasonable reliance in good faith onadvice provided by others (including atax professional) may suffice if thatadvice is based on all pertinent factsand circumstances and is not based onunreasonable assumptions. Reg. S1.6664-4(b),(c).

2. Special tax shelter rule for corporate taxpayers.

a. A corporate taxpayer seeking to avoid penaltywith respect to a tax shelter position mayavoid the penalty by establishing reasonablecause and good faith.

b. Ordinarily, a corporation would defendagainst a penalty by stressing the "legaljustification" that it had for its position.However, the corporation's legaljustification for a tax shelter position willbe considered only if the taxpayer firstsatisfies both an "authority requirement" anda "belief requirement." Reg. S 1.6664-4(e).

(1) The corporate taxpayer satisfies the"authority requirement" by establishingthat there was substantial authority forthe position.

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(2) The corporate taxpayer satisfies the"belief requirement" by establishingthat the taxpayer reasonably believedthat there was a greater than 50-percentlikelihood that the position would besustained if challenged by the IRS.This belief may be based on either thetaxpayer's own research or the opinionof a professional tax advisor.

c. Once these two requirements are satisfied,the corporate taxpayer's "legaljustification" may be considered. Reg. S1.6664-(e)(2).

d. Even if a corporation satisfies all of theabove requirements, including legaljustification, relief from the penalty maynonetheless be denied if the circumstancesindicate an absence of good faith (where, forexample, the taxpayer's participation in theshelter lacked a business purpose, or thetaxpayer claimed benefits that areunreasonable in relation to its investment).Reg. S 1.6664-4(e)(3).

3. NegliQence inconsistent with reasonable cause.While the reasonable cause exception istechnically available to defend against thenegligence component of the accuracy penalty, thatcomponent of the penalty should not have beenproposed in the first instance if the taxpayeracted reasonably. Thus, the reasonable causeexception should not play a role in negligencesituations.

D. SUMMARY OF THE TAXPAYER ACCURACY STANDARD. The factthat a taxpayer who acts reasonably is, by reason ofsection 6664(c), protected from the accuracy penaltysuggests that the accuracy standard for a taxpayer canbe summarized as a requirement that the taxpayer actreasonably with respect to the taxpayer's taxobligations.

III. THE TAX PRACTITIONER'S ACCURACY OBLIGATION.

A. THE REALISTIC POSSIBILITY STANDARD FOR TAX RETURNACCURACY.

1. The Realistic Possibility Standard.

a. The prevailing standard requires thatpractitioners neither sign returns nor advisetaxpayers to adopt tax return positions

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unless those positions have a realisticpossibility of being sustained on the merits.

b. This standard, known as "the realisticpossibility standard," has been adopted inthe professional organization standards, thecivil penalty provisions, and Circular 230.

2. Definition of the Realistic Possibility Standard.Although there is some dispute as to whether thisstandard can properly be expressed in percentageterms, the Service defines the realisticpossibility standard as requiring that areasonable and well-informed person, knowledgeablein the tax law, would, upon analysis, concludethat the position has approximately a one inthree, or greater, likelihood of being sustainedon its merits. Reg. S 1.6694-2(b).

3. The Professional Organizations.

a. ABA Opinion 85-352 and AICPA Statement No. 1both-adopt "realistic possibility" as the taxreturn accuracy standard for their members.

b. These organizations recognize that a positionneed not meet the realistic possibilitystandard if the position is not frivolous andis adequately disclosed on the return.Similarly, they recognize that a position notmeeting the realistic possibility standardmay be taken or advised in a claim for refundso long as the position is not frivolous.

4. The Income Tax Return Preparer Penalty.

a. The realistic possibility standard governsthe application of the income tax returnpreparer penalty of section 6694(a).

b. Under section 6694(a), a $250 penalty isimposed on the preparer if an income taxreturn understates tax liability and theunderstatement is attributable to a positionthat fails to meet the realistic possibilitystandard.

(1) The penalty does not apply if theposition was adequately disclosed on thereturn and is not frivolous (Reg.§1.6694-2(c)).

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(2) It also does not apply if the preparerestablishes that the understatement wasdue to reasonable cause. (Reg. S1.6694-2(d)).

C. If an income tax return understates liabilityby reason of either (1) a willful attempt bythe preparer to understate liability, or (2)a reckless or intentional disregard of rulesor regulations by the preparer, a $1,000penalty is imposed on the preparer of thatreturn. Section 6694(b).

(1) There is no disclosure option wherethere has been a willful attempt tounderstate liability.

(2) There is, however, a disclosure optionwhere there has been disregard of rulesor regulations. As with the disregardcomponent of the taxpayer accuracypenalty, disclosure is effective where aregulation has been disregarded only ifthe taxpayer is engaged in a good faithchallenge to he validity of theregulation. Reg. S 1.6694-3(e).

(3) There is no stated exception to thesection 6694(b) penalty for reasonablecause, but, if the preparer actedreasonably, the penalty should not havebeen asserted.

5. Circular 230: Realistic Possibility.

a. Circular 230 requires that IRS practitionersobserve the realistic possibility standard.S 10.34. Circular 230 defines the standardin the same manner as do the preparer penaltyregulations noted above, i.e., as requiring aone-in-three probability of prevailing.

b. Circular 230 distinguishes between a signingpractitioner and a nonsigning practitioner(i.e., a practitioner who advises concerninga return position or who prepares part of areturn but does not sign the return).

(1) A practitioner may not sign a returnthat contains a position that does notmeet the realistic possibility standardunless the position is not frivolous andis adequately disclosed on the return.

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(2) A nonsigning practitioner may not advisea position or prepare part of a returncontaining a position unless theposition meets the realistic possibilitystandard or the position is notfrivolous and the practitioner advisesthe taxpayer of the opportunity to avoidan accuracy penalty through adequatedisclosure.

B. THE AIDING AND ABETTING PENALTY APPLICABLE TOPRACTITIONERS.

1. The Penalty. Section 6701 imposes a penalty onany person who assists in the preparation orpresentation of any document knowing (or havingreason to believe) that the document will be usedfor tax purposes and who knows that, if used, thedocument will result in the understatement of thetax liability of another person.

2. Amount. The penalty is $1,000, except that it isincreased to $10,000 if the document relates tothe tax liability of a corporation.

3. Where applicable. This penalty would apply, forexample, to an individual employed by the taxpayerwho assists in the preparation of a document forthe employer, knowing that the document willunderstate the employer's tax liability.

IV. THE ETHICAL OBLIGATION OF CONFIDENTIALITY.

A. THE GENERAL RULE. Virtually all professionalorganizations impose an obligation of confidentialityon members of the profession with respect to clientaffairs. We discuss this ethical obligationprincipally in terms of the standards developed forlawyers because they deal comprehensively with thesubject.

B. ABA MODEL RULE 1.6. This rule states that a lawyershall not reveal information relating to arepresentation of a client without the client's consentexcept where necessary to prevent the client from"committing a criminal act that the lawyer believes islikely to result in imminent death or substantialbodily harm" or to establish a claim or defense in acontroversy between the lawyer and the client.

1. The privileQe distinguished. The ethicalobligation of confidentiality is to bedistinguished from the attorney-client privilege,

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which is a rule of evidence rather than an ethicalrule.

2. The privilege is more durable. Theattorney-client privilege is more durable than theobligation of confidentiality. If appropriatelyclaimed, the privilege can survive a court orderto testify. In contrast, the ethical obligationends whenever the practitioner encounters a legalobligation to make disclosure.

3. The privilege is narrower. The attorney-clientprivilege is narrow and is available for only alimited class of communications. On the otherhand, the ethical obligation is very broad andattaches to all information that the client mightwish be held confidential.

4. The privilege is restricted to lawyers. Theattorney-client privilege is available only forcommunications with lawyers. There is noaccountant-client privilege. United States v.Arthur Young & Co., 104 S.Ct. 495 (1984). Theprivilege for communications with an accountantmay be established if the accountant is retainedby an attorney for purposes of providingassistance to the attorney. Bernardo v.Commissioner, 104 T.C. No. 33 (June 20, 1995).

C. TENSION WHERE THE OBLIGATION OF CONFIDENTIALITYRESTRICTS DISCLOSURE OF CLIENT FRAUD.

1. The problem of client fraud. The broad obligationof confidentiality sometimes creates tensionbecause the practitioner may feel the need to makedisclosure of information where the client acts ina fraudulent or otherwise illegal manner.

2. Guidance from the ABA rules. Some ABA Model Rulesrestrict the lawyer in ways that may impinge onthe obligation of confidentiality.

a. ABA Model Rule 1.2(d) states that a lawyermay not counsel or assist in conduct that iscriminal or fraudulent.

b. Model Rule 1.16(a)(1) states that a lawyermust withdraw from a representation that willresult in a violation of the rules ofprofessional conduct or other law.

c. Model Rule 1.16(b) states that the lawyer maywithdraw if the client persists in a courseof action that the lawyer reasonably believes

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to be criminal or fraudulent or if the clienthas used the lawyer's services to perpetratea crime or fraud.

d. Model Rule 3.3(a)(2) states that a lawyershall not knowingly fail to disclose amaterial fact to a "tribunal" when disclosureis necessary to avoid assisting in a criminalor fraudulent act by the client.

e. Model Rule 4.1(b) states that a lawyer shallnot fail to disclose a material fact to athird person when disclosure is necessary toavoid assisting a criminal or fraudulent actunless disclosure is prohibited by Rule 1.6.

3. Only limited guidance provided. Note that onlyRule 3.3(a)(2) (disclosure to a tribunal)expressly frees the lawyer from the obligation ofconfidentiality established by Rule 1.6. In allother situations, the lawyer is left with the needto. reconcile the obligation of confidentialitywith the social pressure to disclose fraud.

4. Dealing With This Tension In Tax Practice.

a. ABA Opinion 314 provides guidance withrespect to certain aspects of practice beforethe IRS.

(1) Opinion 314 concludes that proceedingsbefore the IRS are adversarial in natureand that the IRS is thus not a"tribunal" within the meaning of Rule3.3(a)(2). Accordingly, there is noduty to disclose client fraud to theIRS, and, in this situation, the duty toclient trumps the duty to system.

(2) Opinion 314 appears to contemplate acontroversy representation before theIRS- It is not clear that the sameresult would follow if the matter were,for example, the processing of a requestfor private letter ruling. Would theService then be viewed as a tribunal?Somewhere in between might lie therepresentation of a taxpayer inconnection with a technical advicerequest that arises out of an ongoingaudit of the taxpayer.

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(3) Opinion 314 also concludes that a lawyerwho represents a client before the IRSmay stress the strong points of theclient's case and is not required todisclose weakness in that case. It alsostates that the lawyer may not misleadthe IRS deliberately and affirmatively,either by misstatements or by permittingthe client to mislead.

(4) Under Opinion 314, where a client hasmade misstatements to the IRS, thelawyer must counsel the client tocorrect them, and may, if the clientrefuses, have a duty to withdraw. Thelawyer may not, however, disclose themisstatement without the client'spermission.

b. ABA Opinion 92-366, which deals with a nontaxsituation, holds that a lawyer must withdrawfrom any representation where the client isengaged in an ongoing fraud if the lawyer'spresence assists in that fraud.

(1) The withdrawing lawyer may disavow anyof the lawyer's work product that may beused by the client to further thecontinuing fraud even if that act mayhave the collateral effect of disclosingclient confidences. This is known as a"noisy withdrawal." In this situation,involving ongoing fraudulent activity,duty to the system trumps duty to theclient.

(2) Continuing fraud seems to require morethan a-past fraudulent act. If thatwere not so, any prior fraudulent actwould justify a noisy withdrawal. Thus,the concept of continuing fraud appearsto suggest new criminal activity, asdistinguished from efforts to avoiddetection of prior fraudulent conduct.If, however, those efforts produce anindependent criminal activity, such as afalse statement (see 18 U.S.C. S 1001),a continuing fraud might be present.

(3) If the client has committed a fraud thatis not a continuing one, the lawyer maywithdraw but may not disavow his or herwork product.

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C. ABA Opinion 93-375 further elucidates theseprinciples in the context of a regulatoryagency examination of a client. Although theagency involved in the opinion was not theIRS, the same results would seem to follow inan IRS examination. Under the opinion:

(1) The lawyer has a duty not to misleadagency officials but has no duty todisclose weaknesses in the client's caseor to reveal confidential information.

(2) The lawyer must conduct herself in a waythat does not assist in fraud by theclient on the agency.

(3) If the client has a duty to discloseinformation to the agency, the lawyershould counsel the client to make thatdisclosure. If the client fails to doso, the lawyer need not withdraw.

(4) If the client makes a misrepresentationto the agency in the presence of thelawyer, the lawyer is not required tomake a "noisy withdrawal" but isobligated to counsel the client inprivate to correct themisrepresentation. If the clientrefuses, the lawyer may have theobligation to "climb the corporateladder" (i.e., to counsel the client'ssuperior if the client is an employee)to secure a different result. Thelawyer may also be required under ModelRule 1.16(b) to consider withdrawal.

(5) If the lawyer does not withdraw and isasked directly by an agencyrepresentative about the subject of themisrepresentation, the lawyer's onlypermissible option is to decline torespond, regardless of the negativeinference that may be drawn from thataction. The lawyer should caution theclient in advance of any such meetingabout this possibility and the riskspresented by allowing the lawyer tocontinue to function in this "impairedstate."

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D. CIRCULAR 230 AND THE OBLIGATION OF CONFIDENTIALITY.

1. Practitioner must advise client of omission. If apractitioner discovers that a client has notcomplied with the tax law or has made an error inany document, the practitioner is required toadvise the client promptly of that fact. S 10.21.

2. Practitioner disclosure not directed. Circular. 230 does not require or permit disclosure of the

omission by the practitioner.

E. CAUTION CONCERNING DIFFERENT RULES IN DIFFERENTJURISDICTIONS.

1. ABA Rules are advisory only. The ABA Model Rulesand opinions interpreting the rules have nooperative effect unless and until they are adoptedby admitting courts.

2. Variations in different jurisdictions. Some ofthe ABA Model Rules regarding confidentiality,disclosure, and withdrawal have been adopted inwidely varying forms among the various states.

a. In some states, the obligation ofconfidentiality has been downgraded bypermitting the lawyer to make a noisywithdrawal even in the absence of continuingfraud.

b. Still other states condition the obligationof confidentiality by permitting the lawyerto make disclosures that are necessary toprevent financial fraud by a client.

3. Local knowledqe is essential. For these reasons,it is imperative that a lawyer consult the form inwhich the rules have been adopted in his or herparticular state.

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V. THE DUTY OF LOYALTY -- AVOIDING CONFLICT OF INTEREST.

A. CONFLICT OF INTEREST. ABA Model Rule 1.7 and Circular230 S 10.29 both require that a lawyer avoidrepresentation of conflicting interests. This rulerelates to present clients and prior clients, and itgenerally precludes a lawyer from representing a clientin a proceeding where the lawyer will be an essentialwitness.

B. TAX COURT RULE 24(f). Tax Court Rule 24(f) requires alawyer (1) who was involved in planning or promoting atransaction or operating an entity connected to anissue in a case, (2) who represents more than oneperson with differing interests in a case, or (3) whomay be a witness in a case, to (a) secure informedconsent of the client (but only as to (1) and (2)), (b)withdraw, or (c) take whatever other steps arenecessary to obviate a conflict of interest or otherviolation of the ABA Model Rules.

C. CLIENT WAIVER OF CONFLICT.

1. Client waivers permitted. Generally, affectedclients may waive the protection of the conflictrule and consent to the representation. However,the court ultimately must approve conflictsituations, particularly those involving thelawyer as a witness.

2. Informed client required. Before the client isasked to consent, the client must be fullyinformed of the risks of continued representationof conflicting interests.

3. Lawyer's belief important. Under the ABA rule, alawyer must also reasonably believe that therepresentation will not be adversely affected bythe conflict.

D. CONFLICTS AND FORMER CLIENTS. ABA Model Rule 1.9provides that, unless a former client consents, alawyer may not accept a representation adverse to theinterest of the former client if the subject matter issubstantially related to the former representation.

E. ISSUE CONFLICTS.

1. ABA Formal Opinion 93-377. This opinion dealswith "issue conflicts," i.e., situations in whicha lawyer, already engaged to represent one clienton a matter, accepts representation of a secondclient who seeks a contrary result on the sameissue.

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2. Client consent permitted. Where there issubstantial risk that representation of one clientmay result in a precedent that may undercut thelegal position of the other client, or that theeffectiveness of the representation of one clientwill be materially limited by the representationof the other, disclosure to and consent of bothclients is required.

3. -'Client consent not permitted. If the lawyerbelieves that one representation will be adverselyaffected by the other, the conflict cannot becured by the client's consent. The lawyer mustwithdraw from one of the representations.

VI. THE DUTY OF COMPETENCE.

A. THE GENERAL OBLIGATION OF COMPETENCE. ABA Model Rule1.1 requires that a lawyer provide competentrepresentation to a client.

B. LEVEL OF COMPETENCE REQUIRED. The text of the rulestates that competent representation requires "thelegal knowledge, skill, thoroughness and preparationreasonably necessary for the representation."

VII. THE AMOUNT AND NATURE OF FEES.

A. FEES MUST BE REASONABLE. ABA Model Rule 1.5(a)requires that a lawyer's fee be reasonable. Circular230, S 10.28, prohibits a practitioner from charging anunconscionable fee for any matter before the IRS.

B. CONTINGENT FEES.

1. The ABA Rules. ABA Model Rule 1.5(d) prohibitscontingent fees in certain types of cases but doesnot mention tax cases.

2. The Circular 230 rule. Circular 230, S 10.28prohibits the charging of a contingent fee forpreparation of a return. It allows a contingentfee to be charged for an amended return or a claimfor refund where it is reasonably anticipated thatthe amended return or claim will receivesubstantive attention by the IRS.

VIII.DEALING WITH TAX PRACTICE STANDARDS IN DAY-TO-DAY TAXPRACTICE.

A. SITUATION NO. 1.

1. Your client, a closely held corporation, isconsidering a plan to refinance certain

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outstanding indebtedness. The plan would achievemodest business savings but would alsosubstantially reduce the company's income taxliabilities for several years. The plan wouldrequire that the company take a position on itsreturn that is contrary to a regulation. Thecompany advises you that it has studied theregulation carefully and believes that it is notvalid because it incorrectly interprets thecontrolling statute. The company asks you toreview the matter and advise it with respect toadopting the plan and adopting a tax return withrespect to the plan.

2. You research the matter and learn that severallaw review articles criticize the regulation andquestion its validity. In addition, one Federaldistrict court case held the regulation invalid,but the case was reversed on other grounds by theU.S. court of appeals for that circuit. Yourclient is not located in that particular districtor circuit. Upon finishing your research, youconclude that the taxpayer's proposed positionwould probably lose if it were challenged by theService. However, you believe that the taxpayer'sodds of prevailing are somewhere between 20 and 30percent.

3. Before reporting back to the taxpayer, you ponderthe situation. If you advise the taxpayer toadopt the proposed return position, what risks doyou face? Are you an income tax return preparer?If so, does that status put you in a position ofrisk? What are those risks? How can they beameliorated? Are your interests consistent withthose of your client? Would adequate disclosureof the return position by your client on thereturn affect your exposure?

4. If the client adopts the position in question withyour advice and concurrence, what risks does theclient face? How can those risks be ameliorated?Is the negligence penalty implicated? Thedisregard penalty? The substantial understatementpenalty? How would adequate disclosure affect theclient's exposure to penalty liability?

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5. Is there an opportunity for the client to escapepenalty risk by reason of the reasonable cause andgood faith exception? What would that require?

6. After digesting this information, you discuss itwith the client. After hearing you out, theclient advises you that it desires to adopt thereturn position in question, that it does notchoose to make adequate disclosure of the positionon the return, and that it wants a written opinionfrom you expressing your professional views. Howdo you respond?

7. The taxpayer asks you to explain the IRSexamination procedure, including the probabilitythat its return may be examined. How do yourespond to this request?

8. The taxpayer files its return, reporting theposition in question. One year later, themanagement of the tax department changes, and anew tax director, who is risk averse, concludesthat the company should not be exposed to anypenalty risks. The tax director consults you andasks if the company can file an amended return,pay any tax attributable to the reversal of theposition in question, and thereby avoid penaltyrisk. How do you advise?

B. SITUATION NO. 2.

1. You have advised a closely-held corporation forsome years with respect to tax matters. Thebusiness was created by the sole shareholder, X,who remains active but is ready to withdraw.There are two officers, A and B, who currentlyhandle most of the business affairs. X wants toretire and sell the business to A and B. Thebusiness is X's principal asset, and its purchasewould be a major commitment for both A and B. Ais a veteran of the business and knows it well.B is X's nephew and, while intelligent and welleducated, is not experienced in business matters.X, A, and B approach you concerning the sale andask that you represent them with respect to thetransaction. Are you prepared to move forwardwith this representation?

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2. The sale transaction is completed, and severalyears later the Service, in auditing thecorporation, questions the tax character of thedeal, proposing adjustments that would increasethe tax liability of the corporation and that of Aand B. You represent the interests of thecorporation as well as A and B before the Service,and the case moves to the Tax Court. In the TaxCourt, the Government moves to disqualify you ascounsel under Tax Court Rule 24(f) on the groundthat you were involved in planning the transactionand on the additional ground that you will be anecessary witness. How should the court rule?

C. SITUATION NO. 3.

1. You represent the sole proprietor of a businessthat is being audited by the Service. You aremaking good progress with the agent on the mattersthat have been raised by the Service. In thecourse of gathering information requested by theagent, you become aware of the fact that theclient neglected to report a capital gain that wasrealized in the year under audit. While there isno doubt that a gain was realized, you concludethat the nonreporting was a result of error ratherthan an intent to evade tax liability. You callthis error to the attention of the client, whoasks you if he is obligated to correct it. Healso asks if he will violate any law by not doingso. Then he asks if you can continue to representhim in the audit if he does not disclose theerror. How do you respond to these questions?

2. The audit proceeds through the protest stage, andyou and your client attend a conference inappeals. There is one large unresolved issue.The appeals officer raises a new point and statesthat, if the facts are of a particular nature, shewould be inclined to find in favor of thetaxpayer. The taxpayer, without consulting withyou, tells the appeals officer that the facts areas described by the appeals officer. Thissurprises you somewhat because you thought thatthe facts were otherwise. However, you remainsilent, and the appeals officer then states thatshe will resolve the case in favor of the

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taxpayer. After leaving the IRS office, youconvey your surprise to the taxpayer, who admitsthat he fabricated his response to the appealsofficer. What do you do? Should you haveintervened when the taxpayer misstated the facts?