Regulating Tax Lawyering

2.  Regulating Tax Lawyering


Lawyers often think of the legal profession’s uniqueness as inhering in – or reflecting – the profession’s self-regulated nature and its monopoly on certain services, such as representing clients in courts. Yet, for tax lawyers, matters are quite different. Whereas most lawyers are subject to regulation only by the state authorities where they are admitted and the federal courts in which they practice, Congress has enacted parts of the Internal Revenue Code to prescribe tax lawyering standards. Tax lawyers may be subject to both civil and criminal penalties as a result of their tax advice. The Treasury Secretary exercises authority over tax lawyers through the Director of the Office of Professional Responsibility (the “OPR”) and Circular 230.  CPAs who “practice tax” are also subject to the OPR and Circular 230.  Unlike most other lawyers, tax lawyers share their profession with non-lawyers and are regulated by non-lawyers.


2.1.    Regulating Tax Lawyering through the IRC


A taxpayer has the right to structure his affairs so as to minimize his tax liabilities. This is the right to avoid unnecessary taxation, that is, taxes that he is not obligated to pay. However, a taxpayer commits a felony if he willfully attempts to evade or defeat taxes that he is obligated to pay. Under IRC § 7201 such a taxpayer may be fined $100,000 and imprisoned for up to five years. Of course, lawyers may not engage in assisting clients in any criminal behavior, including tax evasion. Model Rule 1.2(d). But where is the line between legal tax avoidance (for which tax lawyers are well-paid) and criminal tax evasion (which can land both the client and tax lawyer in prison)? Generally, criminal tax evasion requires that the taxpayer knew her obligations under the tax law, but intentionally did not fulfill those obligations. In other words, ignorance of the tax law is a defense to criminal conviction. See, e.g., United States v. Harris, 942 F.2d. 1125 (7th Cir. 1991) (mistresses who received payments but argued exclusion as “gifts” were not criminally liable for tax evasion as the prevailing legal standard was too unclear to establish willful evasion). A civil fraud penalty may also apply. IRC § 6663.


Willfully filing a return that the taxpayer does not believe is true and correct as to every material matter is a felony punishable by up to $100,000 and imprisonment for up to three years. IRC § 7206(a)(1). So is aiding or assisting anyone in doing so:


IRC § 7206. Fraud and false statements


Any person who–


* * *


(2) Aid or assistance.–Willfully aids or assists in, or procures, counsels, or advises the preparation or presentation under, or in connection with any matter arising under, the internal revenue laws, of a return, affidavit, claim, or other document, which is fraudulent or is false as to any material matter, whether or not such falsity or fraud is with the knowledge or consent of the person authorized or required to present such return, affidavit, claim, or document; […]


* * *


shall be guilty of a felony and, upon conviction thereof, shall be fined not more than $100,000 ($500,000 in the case of a corporation), or imprisoned not more than 3 years, or both, together with the costs of prosecution.


Notes and Questions


10.  Note that § 6701 provides a civil penalty for aiding and abetting a tax liability understatement that is very similar to the §  7206(a)(2) criminal penalty.


11.  A lawyer who prepares tax-related documents that are “fraudulent” or “false as to any material matter” may be committing a felony under § 7206(a)(2). The false statement need not be material to calculating the tax liability. U.S. v. Abbas, 504 F.2d 123 (9th Cir. 1974), certiorari denied 95 S. Ct. 1990, 421 U.S. 988, 44 L. Ed.2d 477 (1975). Of course, if the return is audited and the falsity discovered, no tax will be successfully evaded. However, success in evasion is not relevant. U.S. v. Borgis, 182 F.2d 274 (7th Cir. 1950). Note that § 7206(a)(2) applies to “any person,” not only a preparer of the return. For example, an engineer who prepared a fraudulent report about coal reserves, knowing that the report would be used in claiming undue tax benefits, violated § 7206(a)(2). U.S. v. Nealy, 729 F.2d 961 (4th Cir. 1984).


12.  Laura is a second year associate in the tax department of a large law firm. A corporate client was involved in a merger. It was essential for the best tax consequences that the merger be completed on July 1, as this was the first day of the fiscal year for the parties involved. For two months prior to this deadline, Laura, along with many of the other lawyers involved, worked 80 hour weeks. The deal seemed to be completed as planned. However, over the July 4th holiday, the junior partner supervising Laura asked her into his office. He told her that several documents that should have been executed on July 1 had not been. He instructed Laura to prepare the documents with a July 1 date, and that he would send the documents by courier to the client for immediate execution. If Laura knows that the documents will be used in preparing the client’s tax returns, is she committing a § 7206(a)(2) felony if she follows the instructions? Would she be subject to the IRC § 6701 civil penalty if she follows the instructions? What if Laura is unsure how these particular documents relate to the tax return? What if she asks the partner, and he tells her that it is a good question but not to worry about it? What if, instead of telling her not to worry about it, he explains that the documents are very useful for “housekeeping” purposes but not essential to the tax treatment and not a material matter for tax purposes? Does Model Rule 5.2 apply? Would complying with the Model Rules protect Laura from criminal prosecution? Being convicted under § 7206(a)(2) may lead to being permanently disbarred by the Secretary of the Treasury (and the state bar). See the Washburn case, below.


13.  There are multiple IRC sections that impose criminal sanctions. Review IRC §§ 7201- 17. There are also criminal provisions elsewhere in federal law that may apply when tax lawyers assist their clients in crossing the line from tax avoidance into tax evasion, such as conspiracy to defraud the United States (18 U.S.C. § 371 (2006)) or making false statements to the federal government (18 U.S.C. § 1001 (2006)). The mailing of a fraudulent tax return may be a mail fraud felony (18 U.S.C. §§ 1341, 1343 (2006)), which may be a predicate crime for prosecution under the RICO Act (18 U.S.C. §§ 1341- 51). At what point does advising a client on minimizing taxes become a conspiracy between the lawyer and client to defraud the federal government of its property? Would it be a prudent office procedure to avoid mailing tax returns on behalf of clients?


While the criminal penalties and civil fraud penalties for tax evasion raise many interesting issues, most taxpayers do not willfully evade their tax liabilities or commit fraud. In fact, American taxpayers willfully pay the taxes they owe at a rate that is very high compared to others in the world (about 85%). Most American taxpayers want to “get it right,” it seems. But given the complexities of tax law, they may not be able to do so. The tax law is a strict liability law: taxpayers owe what they owe, regardless of their knowledge or intention. When a client turns to a tax lawyer for advice, the client should be able to rely on the advice, expecting it to be accurate.


IRC § 6694(a) is prominent in regulating the advice tax lawyers give in connection with tax return preparation. It sets a relatively high standard for the advice, and it imposes a penalty on a tax return preparer if there is an “unreasonable position” on the return that results in an understatement of tax liability.


§ 6694. Understatement of taxpayer’s liability by tax return preparer


(a) Understatement due to unreasonable positions.


      (1) In general.–If a tax return preparer–


(A) prepares any return or claim of refund with respect to which any part of an understatement of liability is due to a position described in paragraph (2), and


(B) knew (or reasonably should have known) of the position, such tax return preparer shall pay a penalty with respect to each such return or claim in an amount equal to the greater of $1,000 or 50 percent of the income derived (or to be derived) by the tax return preparer with respect to the return or claim.


(2) Unreasonable position.—


(A) In general.–Except as otherwise provided in this paragraph, a position is described in this paragraph unless there is or was substantial authority for the position.


(B) Disclosed positions.–If the position was disclosed as provided in section 6662(d)(2)(B)(ii)(I) and is not a position to which subparagraph (C) applies, the position is described in this paragraph unless there is a reasonable basis for the position.


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(3) Reasonable cause exception.–No penalty shall be imposed under this subsection if it is shown that there is reasonable cause for the understatement and the tax return preparer acted in good faith.


IRC § 6694(a)(2)(A) and (B) secure two types of positions from being characterized as “unreasonable.” First are positions for which there is “substantial authority.” Second are positions for which there is a “reasonable basis” and that have been disclosed on IRS Form 8275 or 8275-R. But what does “substantial authority” and “reasonable basis” mean?


“Substantial authority” is often thought to mean “around a 40% chance of success on the merits.”[12] According to IRS Notice 2009-5, “substantial authority” has the same meaning under IRC § 6694 as in §§ 1.6662-4(d)(2), (d)(3) which provides as follows:


(2) Substantial authority standard. The substantial authority standard is an objective standard involving an analysis of the law and application of the law to relevant facts. The substantial authority standard is less stringent than the more likely than not standard (the standard that is met when there is a greater than 50-percent likelihood of the position being upheld), but more stringent than the reasonable basis standard as defined in § 1.6662-3(b)(3). The possibility that a return will not be audited or, if audited, that an item will not be raised on audit, is not relevant in determining whether the substantial authority standard (or the reasonable basis standard) is satisfied.


(3) Determination of whether substantial authority is present –


(i) Evaluation of authorities. There is substantial authority for the tax treatment of an item only if the weight of the authorities supporting the treatment is substantial in relation to the weight of authorities supporting contrary treatment. All authorities relevant to the tax treatment of an item, including the authorities contrary to the treatment, are taken into account in determining whether substantial authority exists …. There may be substantial authority for more than one position with respect to the same item. Because the substantial authority standard is an objective standard, the taxpayer’s belief that there is substantial authority for the tax treatment of an item is not relevant in determining whether there is substantial authority for that treatment.


(ii) Nature of analysis. The weight accorded an authority depends on its relevance and persuasiveness, and the type of document providing the authority. For example, [an] authority that merely states a conclusion ordinarily is less persuasive than one that reaches its conclusion by cogently relating the applicable law to pertinent facts…. For example, a revenue ruling is accorded greater weight than a private letter ruling addressing the same issue. An older [document] must be accorded less weight than a more recent one. Any document described in the preceding sentence that is more than 10 years old generally is accorded very little weight…. There may be substantial authority for the tax treatment of an item despite the absence of certain types of authority. Thus, a taxpayer may have substantial authority for a position that is supported only by a well-reasoned construction of the applicable statutory provision.


(iii) Types of authority. [Generally, the] following are authority for purposes of determining whether there is substantial authority for the tax treatment of an item: Applicable provisions of the Internal Revenue Code and other statutory provisions; proposed, temporary and final regulations construing such statutes; revenue rulings and revenue procedures; tax treaties and regulations thereunder, and Treasury Department and other official explanations of such treaties; court cases; congressional intent as reflected in committee reports, joint explanatory statements of managers included in conference committee reports, and floor statements made prior to enactment by one of a bill’s managers; General Explanations of tax legislation prepared by the Joint Committee on Taxation (the Blue Book); private letter rulings and technical advice memoranda issued after October 31, 1976; actions on decisions and general counsel memoranda issued after March 12, 1981 (as well as general counsel memoranda published in pre-1955 volumes of the Cumulative Bulletin); Internal Revenue Service information or press releases; and notices, announcements and other administrative pronouncements…. Conclusions reached in treatises, legal periodicals, legal opinions or opinions rendered by tax professionals are not authority. The authorities underlying such expressions of opinion where applicable to the facts of a particular case, however, may give rise to substantial authority for the tax treatment of an item…. In the case of court decisions, for example, a district court opinion on an issue is not an authority if overruled or reversed by the United States Court of Appeals for such district. However, a Tax Court opinion is not considered to be overruled or modified by a court of appeals to which a taxpayer does not have a right of appeal, unless the Tax Court adopts the holding of the court of appeal….


A position with a “reasonable basis” is often thought to be one with a 10-20% chance of success on the merits.[13] Though not as high a standard as “substantial authority,” Treasury Regulations § 1.6662-3(b)(3) and § 1.6694-2(d)(2) provide that the “reasonable basis” standard is a relatively high standard of tax reporting, that is, significantly higher than not frivolous or not patently improper. The reasonable basis standard is not satisfied by a return position that is merely arguable or that is merely a colorable claim. If a return position is reasonably based on one or more of the authorities set forth above regarding substantial authority, the return position will generally satisfy the reasonable basis standard even though it may not satisfy the substantiality authority standard.


Notes and Questions


14. Although § 6694 only applies to a tax return preparer, the definition of a “preparer” is broader than may be anticipated. Even if a tax lawyer does not literally prepare the return, she may be deemed to be a preparer by virtue of providing advice about an entry on a return. In general, advice given prior to a transaction does not make a tax lawyer into a preparer, but advice given afterwards may. The distinction between “before” and “after” advice is easy to maintain in theory, but may rarely hold in practice – after all, there are often follow-up questions. Read Treasury Regulations § 301.7701-15.


15.  Laura is a tax lawyer. She provides tax advice to a client in connection with the sale of certain business assets. The client consummates the transaction as advised by Laura. Laura’s total time involved in the transaction is thirty hours. After the transaction is completed, Laura has no additional contact with the client. The client’s CPA prepares its tax return without consulting with Laura. Is Laura a “preparer” of that return? What if the client and the client’s CPA call Laura for a thirty minute follow-up on some of the tax issues so that the CPA will know how to prepare the return? What if the follow up requires fifteen additional hours of work by Laura? What if the client did not consult with Laura prior to the transaction but does so only afterwards?


16.  How does a tax lawyer decide whether a position has a 20% or 40% chance of success if litigated? Why should a tax lawyer ever be able to advise a client to take a position if the chances are that a court would hold against the position? After all, even if, at about 40%, the substantial authority standard is considered a relatively high standard of legal advice, by definition, the chances are still about 60% that it will lose in court. Could there be substantial authority for conflicting positions?


17.  Private letter rulings are not precedential. Why are they considered “authority” for these purposes? What makes a treatise or law journal authoritative?


18.  A position for which there is only a “reasonable basis” will not be considered unreasonable if the position is disclosed to the IRS by attaching Form 8725 to the tax return. Review Form 8275. What is the purpose of Form 8275?


19.  The § 6694(a) penalty applicable is the greater of $1,000 or 50% of the preparer’s fee. Other punishments may also apply. For example, the tax lawyer may be disciplined pursuant to Circular 230, especially if there is a pattern of inappropriate advising. Note also that § 6694(b) imposes a greater penalty if the understatement was due to “willful or reckless conduct” rather than a merely “unreasonable position.” See also Circular 230 § 10.51(13).


20.  Alongside the “substantial authority” and “reasonable basis” standards, there is also protection provided if the preparer had “reasonable cause” and acted in “good faith.” § 6694(a)(3). Treasury Regulations § 1.6694-2(e) detail this exception, emphasizing factors such as whether or not the provision involved was complex or highly technical; whether the error was isolated or part of a pattern; and whether or not the “normal office practice” of the preparer promotes “accuracy and consistency.” This final factor emphasizes the importance of good office practices, such as the routine use of checklists. Even though a tax lawyer makes a mistake, the processes routinely used in the office may turn out to be very important to providing penalty protection.


2.2.    Regulating Tax Lawyering through Circular 230


Consider the following sections of Circular 230:


§ 10.2 Definitions.


(a) As used in this part, except where the text provides otherwise–


* * *


(4) Practice before the Internal Revenue Service comprehends all matters connected with a presentation to the Internal Revenue Service or any of its officers or employees relating to a taxpayer’s rights, privileges, or liabilities under laws or regulations administered by the Internal Revenue Service. Such presentations include, but are not limited to, preparing and filing documents, corresponding and communicating with the Internal Revenue Service, rendering written advice with respect to any entity, transaction, plan or arrangement, or other plan or arrangement having a potential for tax avoidance or evasion, and representing a client at conferences, hearings and meetings.


 * * *


§ 10.3 Who may practice.


(a) Attorneys. Any attorney who is not currently under suspension or disbarment from practice before the Internal Revenue Service may practice before the Internal Revenue Service….


(b) Certified public accountants. Any certified public accountant who is not currently under suspension or disbarment from practice before the Internal Revenue Service may practice before the Internal Revenue Service….


* * *


§ 10.20 Information to be furnished.


(a) To the Internal Revenue Service.


(1) A practitioner must, on a proper and lawful request by a duly authorized officer or employee of the Internal Revenue Service, promptly submit records or information in any matter before the Internal Revenue Service unless the practitioner believes in good faith and on reasonable grounds that the records or information are privileged.


(2) Where the requested records or information are not in the possession of, or subject to the control of, the practitioner or the practitioner’s client, the practitioner must promptly notify the requesting Internal Revenue Service officer or employee and the practitioner must provide any information that the practitioner has regarding the identity of any person who the practitioner believes may have possession or control of the requested records or information….


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§ 10.21 Knowledge of client’s omission.


A practitioner who, having been retained by a client with respect to a matter administered by the Internal Revenue Service, knows that the client has not complied with the revenue laws of the United States or has made an error in or omission from any return, document, affidavit, or other paper which the client submitted or executed under the revenue laws of the United States, must advise the client promptly of the fact of such noncompliance, error, or omission. The practitioner must advise the client of the consequences as provided under the Code and regulations of such noncompliance, error, or omission.


§ 10.22 Diligence as to accuracy.


(a) In general. A practitioner must exercise due diligence–


(1) In preparing or assisting in the preparation of, approving, and filing tax returns, documents, affidavits, and other papers relating to Internal Revenue Service matters;


(2) In determining the correctness of oral or written representations made by the practitioner to the Department of the Treasury; and


(3) In determining the correctness of oral or written representations made by the practitioner to clients with reference to any matter administered by the Internal Revenue Service.


* * *


§ 10.27 Fees.


(a) In general. A practitioner may not charge an unconscionable fee in connection with any matter before the Internal Revenue Service.


(b) Contingent fees—


(1) Except as provided in paragraphs (b)(2), (3), and (4) of this section, a practitioner may not charge a contingent fee for services rendered in connection with any matter before the Internal Revenue Service.


(2) A practitioner may charge a contingent fee for services rendered in connection with the Service’s examination of, or challenge to–


(i) An original tax return; or


(ii) An amended return or claim for refund or credit where the amended return or claim for refund or credit was filed within 120 days of the taxpayer receiving a written notice of the examination of, or a written challenge to the original tax return.


(3) A practitioner may charge a contingent fee for services rendered in connection with a claim for credit or refund filed solely in connection with the determination of statutory interest or penalties assessed by the Internal Revenue Service.


(4) A practitioner may charge a contingent fee for services rendered in connection with any judicial proceeding arising under the Internal Revenue Code.


(c) Definitions. For purposes of this section–


(1) Contingent fee is any fee that is based, in whole or in part, on whether or not a position taken on a tax return or other filing avoids challenge by the Internal Revenue Service or is sustained either by the Internal Revenue Service or in litigation. A contingent fee includes a fee that is based on a percentage of the refund reported on a return, that is based on a percentage of the taxes saved, or that otherwise depends on the specific result attained. A contingent fee also includes any fee arrangement in which the practitioner will reimburse the client for all or a portion of the client’s fee in the event that a position taken on a tax return or other filing is challenged by the Internal Revenue Service or is not sustained, whether pursuant to an indemnity agreement, a guarantee, rescission rights, or any other arrangement with a similar effect.


(2) Matter before the Internal Revenue Service includes tax planning and advice, preparing or filing or assisting in preparing or filing returns or claims for refund or credit, and all matters connected with a presentation to the Internal Revenue Service or any of its officers or employees relating to a taxpayer’s rights, privileges, or liabilities under laws or regulations administered by the Internal Revenue Service. Such presentations include, but are not limited to, preparing and filing documents, corresponding and communicating with the Internal Revenue Service, rendering written advice with respect to any entity, transaction, plan or arrangement, and representing a client at conferences, hearings, and meetings.


§ 10.29 Conflicting interests.


(a) Except as provided by paragraph (b) of this section, a practitioner shall not represent a client before the Internal Revenue Service if the representation involves a conflict of interest. A conflict of interest exists if–


(1) The representation of one client will be directly adverse to another client; or


(2) There is a significant risk that the representation of one or more clients will be materially limited by the practitioner’s responsibilities to another client, a former client or a third person, or by a personal interest of the practitioner.


(b) Notwithstanding the existence of a conflict of interest under paragraph (a) of this section, the practitioner may represent a client if–


(1) The practitioner reasonably believes that the practitioner will be able to provide competent and diligent representation to each affected client;


(2) The representation is not prohibited by law; and


(3) Each affected client waives the conflict of interest and gives informed consent, confirmed in writing by each affected client, at the time the existence of the conflict of interest is known by the practitioner. The confirmation may be made within a reasonable period after the informed consent, but in no event later than 30 days.


(c) Copies of the written consents must be retained by the practitioner for at least 36 months from the date of the conclusion of the representation of the affected clients, and the written consents must be provided to any officer or employee of the Internal Revenue Service on request.


* * *


§ 10.34 Standards with respect to tax returns and documents, affidavits and other papers.


(a) Tax returns.


(1) A practitioner may not willfully, recklessly, or through gross incompetence —




(ii) Advise a client to take a position on a tax return or claim for refund, or prepare a portion of a tax return or claim for refund containing a position, that —


(A) Lacks a reasonable basis;


(B) Is an unreasonable position as described in section 6694(a)(2) of the Code (including the related regulations and other published guidance) [i.e., an undisclosed position without substantial authority, ed.]; or


(C) Is a willful attempt by the practitioner to understate the liability for tax or a reckless or intentional disregard of rules or regulations by the practitioner as described in section 6694(b)(2) of the Code (including the related regulations and other published guidance).


(2) A pattern of conduct is a factor that will be taken into account in determining whether a practitioner acted willfully, recklessly, or through gross incompetence.




(d) Relying on information furnished by clients. A practitioner advising a client to take a position on a tax return, document, affidavit or other paper submitted to the Internal Revenue Service, or preparing or signing a tax return as a preparer, generally may rely in good faith without verification upon information furnished by the client. The practitioner may not, however, ignore the implications of information furnished to, or actually known by, the practitioner, and must make reasonable inquiries if the information as furnished appears to be incorrect, inconsistent with an important fact or another factual assumption, or incomplete.




§ 10.33 Best practices for tax advisors.


(a) Best practices. Tax advisors should provide clients with the highest quality representation concerning Federal tax issues by adhering to best practices in providing advice and in preparing or assisting in the preparation of a submission to the Internal Revenue Service. In addition to compliance with the standards of practice provided elsewhere in this part, best practices include the following:


(1) Communicating clearly with the client regarding the terms of the engagement. For example, the advisor should determine the client’s expected purpose for and use of the advice and should have a clear understanding with the client regarding the form and scope of the advice or assistance to be rendered.


(2) Establishing the facts, determining which facts are relevant, evaluating the reasonableness of any assumptions or representations, relating the applicable law (including potentially applicable judicial doctrines) to the relevant facts, and arriving at a conclusion supported by the law and the facts.


(3) Advising the client regarding the import of the conclusions reached, including, for example, whether a taxpayer may avoid accuracy-related penalties under the Internal Revenue Code if a taxpayer acts in reliance on the advice.


(4) Acting fairly and with integrity in practice before the Internal Revenue Service.


(b) Procedures to ensure best practices for tax advisors. Tax advisors with responsibility for overseeing a firm’s practice of providing advice concerning Federal tax issues or of preparing or assisting in the preparation of submissions to the Internal Revenue Service should take reasonable steps to ensure that the firm’s procedures for all members, associates, and employees are consistent with the best practices set forth in paragraph (a) of this section.


* * *


§ 10.37 Requirements for other written advice.


(a) Requirements. A practitioner must not give written advice (including electronic communications) concerning one or more Federal tax issues if the practitioner bases the written advice on unreasonable factual or legal assumptions (including assumptions as to future events), unreasonably relies upon representations, statements, findings or agreements of the taxpayer or any other person, does not consider all relevant facts that the practitioner knows or should know, or, in evaluating a Federal tax issue, takes into account the possibility that a tax return will not be audited, that an issue will not be raised on audit, or that an issue will be resolved through settlement if raised….


Notes and Questions


21. Leon is a tax lawyer who regularly e-mails his clients. His clients appreciate the convenience. Carla has asked Leon to consider the tax planning possibilities of a particular investment she is considering, and Leon responds in an e-mail advising her of various ways the investment can be planned in order to avoid unnecessary taxes. Is Leon engaged in practice before the IRS? If so, what are the requirements for the advice he is writing in his e-mail? What if Leon does not e-mail Carla but only explains the alternatives in a telephone call, is he subject to Circular 230 with respect to the phone call’s contents?


22.  Laura is a tax lawyer. Her client Cody is an impatient business man; he is always pressing Laura for the “bottom line” and “to get there without a bunch of lawyer time.” Cody has invested in a business that has generated a loss this year. Cody’s CPA wants to avoid the application of the IRC § 469 passive activity loss limit. In order to do so, Cody’s participation in the activity must have been “material,” and the CPA is taking the return position that Colby’s participation was material. The CPA has told Cody that he can be protected from an IRC § 6662 negligence penalty even if the “material participation” return position is not sustained on audit or in litigation, so long as he has written advice from a lawyer. Prompted by his CPA, Cody tells Laura to assume that he spent more than 500 hours actively engaged in the business. This is an essential fact, as, if true, it would mean Cody materially participated and thus is not subject to the passive activity loss limits. Laura does not know whether Cody spent so much time with the business. On the one hand, he is a very busy man involved in many different businesses, but, on the other hand, she knows he is a very hard worker and it is possible that he did. Cody has told Laura not to “rack up the legal fees” on this, but just send him a short e-mail advising him of the tax consequences if the assumption is true. What should Laura do? If she makes the assumption, she may be violating her duties under Circular 230. However, if she spends more time on the issue, trying to document how many hours he spent on the business, she is violating her client’s instructions (and he will not pay for it!). Should she undertake the additional work – but simply not charge Cody for it? Query why the CPA suggested Cody ask Laura for the analysis and did not provide it herself – after all, the CPA would earn a fee for the work. (Is the CPA right about so easily avoiding the negligence penalty? Read Treasury Regulations § 1.6664-4(c).)


23. Review the explanation of “substantial authority” in Treasury Regulations §§ 1.6662-4(d)(2) and (d)(3) (above).  Under Circular 230 § 10.34(a)(2), a tax lawyer may not willfully advise a client to take a position that lacks substantial authority, unless the position is disclosed to the IRS.  As explained above, this is often characterized as a 40% chance of success on the merits.  This is the minimum standard of confidence required for undisclosed positions, and it became the requirement in 2011.  However, in 1985, the ABA Section of Taxation’s Committee on the Standards of Tax Practice issued guidelines that tax advice should have a “realistic possibility” of successful defense in court, meaning a “likelihood of success closely approaching one-third ….”[14]   Thus, the tax section’s minimum standard is lower than that of Circular 230.  Who regulates the tax bar?  Who has the power to discipline tax lawyers?  How much advice is likely to fall below the “substantial authority” standard while remaining above the “realistic possibility” standard?  Note that, after the changes to Circular 230, the penalty standard in the Code and the standard in Circular 230 have been harmonized.  Should a tax lawyer ever be entitled to advise a client to take a position contrary to penalty standards?


24.  While the substantial authority standard might not seem high compared to the realistic possibility standard, compared to a standard that legal advice should be merely non-frivolous, the substantial authority standard seems very high. Advice with even a 5% chance of success in court may not be frivolous, but the realistic possibility standard requires about a 33% chance of success. But, why should a lawyer ever give advice that she believes is more likely than not to fail in court? After all, if the advice has a 40% chance of success, it has a 60% chance of failure. What percentage of success do you think clients expect to “buy” with tax advice from a tax lawyer?


25.  Liz is a tax lawyer who has met with a potential new client, Chris. Chris owns several businesses entities. Chris has not retained Liz. Rather, after reviewing his information, Liz is going to make a presentation to Chris and then he will decide whether or not to hire her. Liz studies the structure of the businesses entities, and she discovers that the structure is very tax inefficient. She concludes that with some straightforward re-structuring she could reduce the overall tax liabilities of the entities by about $30,000 each year. The restructuring is very straightforward, and Liz is surprised that Chris has not done it in the past. She believes it is so straightforward that it will take only about six hours of her time, which at her standard $500 an hour billing rate is $3,000. Liz is very interested in making a good impression on Chris, hoping to win his long-term business. She believes that she can impress him if she “guarantees” her work as part of her presentation to him. She is considering offering to charge him a contingent fee of 10% of the tax savings, which she thinks will be about $3,000. Further, if the IRS successfully challenges the restructuring in the future, she will refund the fee. Ignoring the complications of reasonably defining “tax savings,” is this a type of fee proper?


Circular 230 obligates the lawyer on many issues that are also the subject of state law, such as conflicts of interest, client information, and diligence. The Circular 230 requirements and the state law requirements may not be identical. For example, the conflict waiver requirements under § 10.29 include time periods and signatures that may not be found in state bar rules regarding conflicts of interest. What if the two directly conflict? What if, for example, information required to be disclosed under § 10.20 is prohibited from being disclosed by state bar laws? If it is impossible to comply with both, what is a tax lawyer to do? In some situations, federal regulations pre-empt state law. Does Circular 230? (Model Rule 1.6 allows disclosure of confidential information when necessary to comply with “other law.” Is Circular 230 “other law?”)


Lou is the senior partner in a tax law firm. What are his responsibilities with respect to the firm’s practices? How would Lou educate himself about what constitutes “best practices?” Recall that Treasury Regulations § 1.6694-2(e) references office procedures that may protect tax lawyers from certain penalties.


Circular 230 establishes disciplinary procedures. Those who practice before the IRS may be reprimanded, suspended, or disbarred. Circular 230 §§ 10.25-.52. If a practitioner is suspended or disbarred, no other practitioner may employ or acceptance assistance from them. Circular § 10.24. Consider that the agency before which the lawyer represents clients is the same agency that is authorized to suspend or disbar him or her from doing so. Is that troubling?


Washburn  v. Shapiro


409 F. Supp. 3 (S.D. Fla. 1976)


FULTON, Chief Judge. On April 16, 1975, plaintiff, Paul C. Washburn, an accountant, filed his complaint in this Court seeking review of the administrative proceedings which resulted in his disbarment from practicing before the Internal Revenue Service…. The defendants are Leslie S. Shapiro, the Director of Practice of the Internal Revenue Service of the United States Department of the Treasury; Richard R. Albrecht, General Counsel for the Department of the Treasury; Kenneth L. Travis, an administrative law judge acting on behalf of the Department of the Treasury; Leonard J. Ralston, a retired administrative law judge, who acted on behalf of the Department of the Treasury; William E. Simon, Secretary of the Department of the Treasury; and the Department of the Treasury which is part of the executive department of the United States government.


On July 12, 1973, in this Court, Paul C. Washburn was convicted of violating 26 U.S.C. § 7206(2) which prohibits willfully and knowingly aiding, assisting, counseling, procuring or advising the preparation or presentation to the Internal Revenue Service of a tax return which is fraudulent or false as to any material matter. This conviction arose from Washburn’s having prepared a joint return for Edward B. McLean, which return Washburn signed for both Mr. McLean and his wife. Washburn, however, had no power of attorney to sign on Mrs. McLean’s behalf, and knew that she had filed a separate return…. On October 10, 1973, the Director of Practice, United States Department of the Treasury, notified plaintiff that he was considering the institution of disbarment proceedings against the plaintiff. These proceedings were instituted on February 14, 1974.


Plaintiff’s attorney moved for a continuance of the disbarment hearing which was set for May 29, 1974 based on the then pending appeal to the Fifth Circuit of the district court’s denial of Washburn’s motion for new trial. The motion for continuance was denied, and the hearing was held as scheduled on May 29, 1974….


In his decision Judge Travis concluded that Washburn’s conviction of an offense under 26 U.S.C. § 7206(2) constituted a conviction of a criminal offense under the revenue laws of the United States for which he might be disbarred or suspended from practice before the Internal Revenue Service. He held that Washburn had been shown to be disreputable within the meaning of 31 C.F.R. § 10.50 in view of his criminal conviction and the conduct supporting it. He ordered the respondent disbarred from further practice before the Internal Revenue Service subject only to the condition that if his conviction were nullified the disbarment would be terminated. The plaintiff appealed that decision and on February 24, 1975, the General Counsel of the Treasury Department issued his decision affirming the initial decision of the administrative law judge. The General Counsel’s decision constitutes the final administrative action in the matter….


Substantive Due Process


Considering the complaint on the merits, defendants contend that the administrative proceedings which resulted in plaintiff’s disbarment were entirely proper, both substantively and procedurally. The Court agrees.


The substantive law governing plaintiff’s disbarment is Section 1026 of Title 31 of the United States Code which provides:


The Secretary of the Treasury may prescribe rules and regulations governing the recognition of agents, attorneys, or other persons representing claimants before his department, and may require of such persons, agents and attorneys, before being recognized as representatives of claimants, that they shall show that they are of good character and in good repute, possessed of the necessary qualifications to enable them to render such claimants valuable service, and otherwise competent to advise and assist such claimants in the presentation of their cases. And such Secretary may after due notice and opportunity for hearing suspend, and disbar from further practice before his department any such person, agent, or attorney shown to be incompetent, disreputable, or who refuses to comply with the said rules and regulations, or who shall with intent to defraud, in any manner willfully and knowingly deceive, mislead, or threaten any claimant or prospective claimant, by word, circular, letter, or by advertisement.


Plaintiff does not challenge the validity of this statute or of the regulations promulgated pursuant thereto as set forth in 31 C.F.R. § 10.50 et seq.


The evidentiary criterion for judicial review of a final decision of an administrative agency is whether there is substantial evidence in the record to support the challenged administrative determination….


It is a matter of record that Paul C. Washburn was convicted of a felony under 26 U.S.C. § 7206(2), that all appeals are exhausted and that the conviction is final. …


The complaint filed by the Director of Practice alleged that the respondent was enrolled to practice and has engaged in practice before the IRS; and that the respondent was subject to disbarment from practice before the IRS 1) by reason of his having been convicted of violating 26 U.S.C. § 7206(2), pursuant to 31 C.F.R. § 10.51(a), and 2) by reason of his having given false or misleading information to the IRS or an officer or an employee thereof in connection with a matter pending before them, knowing such information to be false or misleading, pursuant to 31 C.F.R. § 10.51(b). The respondent filed no answer to the complaint filed by the Director of Practice. 31 C.F.R. s 10.58(c) provides that every allegation in the complaint which is not denied in the answer shall be deemed to be admitted and may be considered as proved. It also provides that failure to file an answer shall constitute an admission of the allegations of the complaint, a waiver of hearing, and the Examiner may make his decision by default.


At the hearing, exhibits were introduced into evidence by the complainant, Director of Practice. No testimony was offered by the complainant or the respondent.


Procedural Due Process


Plaintiff has raised the following arguments in support of his contention that the administrative proceedings violated his right to procedural due process of law:


1. Defendants provided him with inadequate notice of the administrative disbarment proceedings;


2. Defendants failed to give him knowledge of the specific allegations made against him;


3. Plaintiff was denied the right to confront adverse witnesses;


4. Plaintiff was denied the right to question the admissibility of documents submitted by the government at the hearing;


5. Plaintiff’s attorney was compelled to make admissions and statements regarding his client which violated the attorney-client privilege;


6. The burden of proof was unconstitutionally shifted from the prosecuting authority to plaintiff at the hearing;


7. The documents relied on at the hearing were not properly received in evidence;


8. Testimony was received at the hearing by one or more witnesses who were not sworn and or who were not subject to cross examination;


9. There was lack of separation of prosecuting authority and judicial authority;


10. The initial decision was written by a different judge than the judge who presided over the hearing;


11. Plaintiff was required to bear the burden of proving his ‘innocence’ rather than requiring the government to prove his ‘guilt’;


12. The administrative proceedings should have been stayed pending plaintiff’s appeals of his conviction;


13. The complainant failed to identify plaintiff as the same person as the person convicted under 26 U.S.C. § 7206(2); and


14. It was improper for the Treasury Department’s general counsel to act on behalf of the Secretary of the Treasury in rendering the appellate decision affirming the initial decision of the administrative law judge.


Defendants contend that the procedural standards required in a ‘fullblown’ hearing set forth in the Administrative Procedure Act, 5 U.S.C. §§ 556 and 557, are not applicable here because 5 U.S.C. § 554 provides that the standards apply only when required by statute. With respect to plaintiff’s disbarment, no such statutory requirement exists. Plaintiff does not contest this. The applicable statute, 31 U.S.C. § 1026, states that the Secretary is required to provide ‘due notice and an opportunity for hearing.’ Thus although a respondent in a disbarment proceeding is not entitled to a ‘full-blown’ hearing, he is entitled to the requisites of elementary fairness-due notice and the opportunity to be heard. The Court has carefully considered each of plaintiff’s allegations of procedural violations and finds them all to be without merit.


Regarding the claim of inadequate notice, the government’s exhibits… at plaintiff’s hearing demonstrated that plaintiff was notified by certified mail of the fact that the Department of the Treasury was giving consideration to plaintiff’s disbarment and that disbarment proceedings had been instituted. …


The Court has reviewed the complaint which was filed by the Director of Practice to institute the disbarment proceedings and finds that the allegations are certainly specific enough to inform the respondent of the nature of the charges against him….


Plaintiff’s argument that he was denied the right to confront adverse witnesses is frivolous as the government called no witnesses at the hearing; its case against plaintiff was established exclusively through documents, principally those establishing plaintiff’s criminal conviction. …


Plaintiff further alleges that defendants denied him the right to question the admissibility of documents submitted by the government in the administrative hearing… [T]his allegation by plaintiff is without legal foundation, for, under 31 C.F.R. § 10.66, he possesses no right to question these documents. …


Plaintiff’s [attorney, Mr. Slinkman alleges] that he was compelled to make admissions and statements regarding his client violative of the attorney-client privilege, evidently, is referring to an exchange wherein Judge Ralston inquired of Mr. Slinkman whether his client was the same person as the Paul C. Washburn convicted of a criminal offense under the revenue laws of the United States…. Since the attorney was not in fact compelled to answer, there was no harm.


Plaintiff alleges that the burden was unconstitutionally shifted from the prosecuting authority to the plaintiff in order to require the plaintiff to prove his innocence. It is undisputed however that plaintiff failed to answer the complaint against him in the administrative proceeding. Although a hearing was not even required because of his failure to answer, a hearing was afforded to him. The Court agrees with defendants’ contention that the ‘shifted burden’ of which plaintiff complains was in fact a ‘second chance’ afforded at the hearing to deny that he had been criminally convicted.


Plaintiff’s allegation that documents which were never received in evidence were used against him in the hearing apparently refers to the motions for continuance and to dismiss filed by plaintiff’s attorney on his behalf during the administrative proceedings. The complainant used these documents to prove that the respondent was the Washburn who had been convicted of violating 26 U.S.C. s 7206(2)…. [C]ommon sense dictates that papers filed on behalf of a litigant are part of the totality of the record of the proceedings….


Plaintiff alleges that testimony was received at his disbarment proceeding by witnesses who were not sworn and/or were not subject to cross examination. [To the extent the allegations refer to the Plaintiff’s attorney being question about his criminal conviction, then] it certainly was harmless error, since the disbarment was justified by the plaintiff’s criminal conviction, which plaintiff effectively admitted.


Plaintiff’s allegation that his constitutional rights were violated by the lack of separation between the prosecuting and judicial authority is unfounded. Section 10.64(a) of the Code of Federal Regulations specifically provides for the appointment of a hearing examiner (now an administrative law judge) to conduct disbarment proceedings according to the procedures set out in the Administrative Procedure Act. It is well settled that pursuant to the doctrine of necessity an administrative agency acting as prosecutor in a particular case may also act as the judicial tribunal and adjudicate the issues before it. …


Plaintiff’s allegation that his disbarment must be overturned because a different administrative law judge presided over his hearing than the one who wrote the initial decision might have merit if the decision to disbar him depended on the credibility and demeanor of witnesses. In plaintiff’s case, however, no witnesses were presented and the decision was founded exclusively on the documents in the record. These documents were, of course, fully available to Administrative Law Judge Travis, who rendered the decision.


Plaintiff next contends that the administrative disbarment proceedings should have been stayed pending his various appeals of his conviction. There is no dispute that the plaintiff’s direct appeal of his conviction was concluded by the time the administrative proceedings commenced. [However,] Judge Travis held that the disbarment would terminate if the conviction upon which it was based were nullified by the result of an indirect appeal to the Supreme Court of the United States, or otherwise. Since the conviction became final on January 13, 1975 when the Supreme Court denied certiorari, any prejudice in failing to wait for the Supreme Court’s disposition of the matter was harmless error.


The issue of non-identification of the plaintiff as the same individual who was convicted of a violation of the revenue laws of the United States has been considered earlier in this opinion. Plaintiff clearly admitted he was the Washburn who had been convicted of violating 26 U.S.C. § 7206(2) by the filing of his motions for continuance and to dismiss, and by failing to answer the complaint filed by the Director of Practice.


Plaintiff’s last procedural contention raises the issue of the propriety of the General Counsel’s acting on behalf of the Secretary of the Treasury Department in rendering the decision on appeal. This contention is also without merit. The first paragraph of the appellate decision sets forth the statutory authorization for such delegation [is found in] Treasury Department Order No. 175-1 (September 13, 1963), and Treasury Department Order No. 190 (revision 10) (January, 1975), which authorizes the General Counsel to perform the function of the Secretary of the Treasury relating to the Office of Director of Practice. Delegation of such authority is entirely proper in these circumstances.…


For all of the foregoing reasons, it is ORDERED and ADJUDGED that [Defendant’s motion to dismiss is granted and Plaintiff’s motion for summary judgment is denied.]


2.3.    Regulating Tax Lawyering through Malpractice Standards


Lawyers are increasingly being sued by unhappy former clients and, in some cases, persons who may not have been clients – or who, at least, the lawyer did not consider to be a client. Most commonly, those suits are premised on the lawyer’s negligence or violation of fiduciary duties to the client (or non-client third parties) or contractual duties between the lawyer and client. Strategies to avoid these suits, or lawyering with an eye on a successful defense strategy in the event of such a suit, can consume the mental and emotional energy of lawyers on a regular basis. Limiting liability, especially for the acts of those with whom one works, is an ongoing concern of lawyers. Many lawyers carry malpractice insurance, which means that complying with the terms of the policy becomes important. Worrying about malpractice suits and the consequent strategies for reducing risk may do far more to regulate lawyering than fear of discipline by the state bar and, for tax lawyers, the Treasury Department.


If a lawyer does not specialize in tax law, how should she handle tax issues?


Horne v. Peckham


97 Cal. App. 3d 404 (1979)


PARAS, Acting Presiding Justice. Defendant, an attorney, appeals from a judgment entered after a jury awarded damages of $64,983.31 against him for legal malpractice in connection with the drafting of a “Clifford Trust” for plaintiffs Roy C. Horne (Horne) and Doris G. Horne, husband and wife. He contends that the judgment should be reversed or in the alternative that another attorney, Thomas J. McIntosh, upon whom he relied for advice, should indemnify him.


In 1960, Horne obtained a patent for processing low grade wood into defect-free material known as “Perfect Plank Plus.” In 1962, he founded a business called “Perfect Plank,” and in 1967 began to produce the patented product. The business was incorporated in 1965, with the Hornes as sole shareholders. Horne anticipated that production of the product might generate substantial income, so he became interested when he read in a newsletter of the tax advantages of a so-called “Clifford Trust.” On July 18, 1967, on the recommendation of Herbert McClanahan, his accountant, he went to defendant and asked him to prepare such a trust, Horne’s three sons to be its beneficiaries.


Defendant testified he told Horne “…that I had no knowledge of tax matters. I had no expertise in tax matters; that if somebody else could figure out what needed to be done, I could draft the documents.” He said that McClanahan had provided him with “…a couple of pages of translucencies…governing Clifford Trusts,” and he also consulted the two-volume annual set of American Jurisprudence on federal taxation, which included a discussion of Clifford Trusts; he otherwise relied on McClanahan’s judgment.


The original plan was to put the patent, which had 10 more years of life, into the trust. However, on October 11, 1967, Horne told defendant he no longer desired this and asked “…if it wouldn’t be just as good to put in a [non-exclusive] [l]icense…” of the patent rights. Horne testified that he preferred not to put the patent itself into the trust, because the substantial royalties from it would result in more money than should properly be given to his sons.


Defendant testified he told Horne that “…I didn’t know whether…[a license] would be just as good or not, but that we were having a high-priced tax expert come up here like the following day who was undoubtedly going to charge plenty of money for the consultation, and that we should ask him on that point.” The tax expert to whom defendant referred was McIntosh, an attorney from Albany, California, who had been recommended by McClanahan as an expert in deferred compensation and profit-sharing plans. Such plans for Horne’s company were to be discussed at a meeting with McIntosh arranged by McClanahan and scheduled for the next day, October 12. Unknown to defendant, McIntosh had been licensed to practice law less than a year, although he was also a certified public accountant and had worked for two and one-half or three years as a tax accountant.


The meeting of October 12 was attended by Horne, his wife, one son, McClanahan, defendant, and McIntosh. Defendant testified that he asked McIntosh whether it would be just as effective to transfer a license agreement into the contemplated trust as the patent itself, and received an affirmative answer. He further testified that Horne had been talking of a nonexclusive license during the meeting, thus McIntosh should have been aware that such a license was contemplated. However, defendant also testified that no one told McIntosh that the contemplated license would have a five year duration.


Horne testified that he thought the subject of license versus patent arose at that meeting, but he had no independent recollection of it. McIntosh testified that even though at his deposition he thought he recalled such a discussion, he did not recall it at trial.


Sometime after the meeting, defendant drafted the final documents and sent them to McClanahan for approval. He had no further discussions or correspondence with McIntosh. The documents were signed in November 1967, although dated February 1, 1967, the date production of the product began. The first document was an irrevocable trust agreement between the Hornes as trustors and McClanahan, defendant, and one Bill Ryan as trustees for the Horne’s three sons, to terminate in twelve years (1979). The second was a license agreement between Horne and Perfect Plank, granting the corporation a license to produce the patented product for two years with an option to renew for an additional three years, in return for royalty payments determined by production; inter alia, the agreement stated “This license is not exclusive. Licensor retains the right to issue other licenses of the same patent to any other parties whatsoever.” The third document was an assignment to the trustees by Horne of Horne’s rights under the license agreement thus furnishing the trust with a corpus.


The license royalties were paid into the trust until 1970 when the Internal Revenue Service (I.R.S.) audited Horne’s tax returns. Horne was notified of the audit by mail sometime prior to March 18, 1970, and knew within a few days thereafter of a challenge to the favorable tax aspect of the trust. In August 1970, the I.R.S. assessed a deficiency on the ground that the trust did not transfer tax liability for the licensor’s income to the beneficiaries. Horne hired McIntosh to contest the assessment.


After losing at the first administrative level, Horne conceded his tax liability rather than contest it further. On May 12, 1972, he sued defendant for damages for malpractice. On June 18, 1973, defendant filed a cross-complaint for indemnity against McIntosh and his law partnership. After a jury trial, judgment was entered against defendant on the complaint, and in favor of McIntosh on the cross-complaint.


Defendant’s first argument on appeal is that “It is not legal malpractice (negligence) on the part of an attorney general practitioner to draw documents without doing research on a point of law on which there is no appellate decision or statute in point.”


The argument has two parts; first, that the trust documents were in fact valid as a tax shelter, second, that even if invalid, their invalidity is so debatable that he should not be liable for making an error regarding a matter about which reasonable attorneys can disagree. He is wrong on both points. The documents are invalid for their intended purpose, and the invalidity is rather obvious. To demonstrate this, one need go no further than the original Clifford case, from which the name “Clifford Trust” is derived, and the legislation it brought about.


In Helvering v. Clifford (1940) 309 U.S. 331, 60 S. Ct. 554, 84 L.Ed. 788, the United States Supreme Court held that notwithstanding “niceties of the law of trusts or conveyances, or the legal paraphernalia which inventive genius may construct as a refuge from surtaxes,” (309 U.S. at p. 334, 60 S. Ct. at p. 556), the grantor of a trust may be taxed as owner, depending on “an analysis of the terms of the trust and all the circumstances attendant on its creation and operation.” (309 U.S. at p. 335, 60 S. Ct. at p. 556.)


In that case the taxpayer had established an irrevocable five-year trust, with himself as trustee and his wife as beneficiary. The trust corpus consisted of securities owned by the taxpayer. The income was payable to the wife, and the corpus reverted to the taxpayer at the end of five years. The Supreme Court ruled that “…  the short duration of the trust, the fact that the wife was the beneficiary, and the retention of control over the corpus by (the taxpayer)…all lead irresistably to the conclusion that (the taxpayer)…continued to be the owner for purposes of s 22(a) [now § 61(a), defining gross income].” (Ibid.)


On the issue of control, the Clifford court made the following observations, which are directly applicable to this case:


So far as his dominion and control were concerned it seems clear that the trust did not effect any substantial change. In substance his control over the corpus was in all essential respects the same after the trust was created, as before. The wide powers which he retained included for all practical purposes most of the control which he as an individual would have. There were, we may assume, exceptions, such as his disability to make a gift of the corpus to others during the term of the trust and to make loans to himself. But this dilution in his control would seem to be insignificant and immaterial, since control over investment remained.” (Ibid.)


In the present case, the Hornes, by control of the patent and the licensee corporation, also controlled the license. They not only retained the absolute power to control the income from the license agreement by increasing or reducing production of the patented product; they could also cease production entirely, form a new corporation, license it under the patent, and individually receive all future royalties. This would effectively work a termination or revocation of the sole income generating asset of the trust.


Following the Clifford decision, the I.R.S. adopted regulations to implement it, and these formed the basis for sections 671-678 of the Internal Revenue Code’s 1954 revision, 26 United States Code, sections 671-678. Directly applicable to the present case is section 675, which provides:


The grantor shall be treated as the owner of any portion of a trust in respect of which


(4) A power of administration is exercisable in a nonfiduciary capacity by any person without the approval or consent of any person in a fiduciary capacity. For purposes of this paragraph, the term ‘power of administration’ means any one or more of the following powers: (A) a power to vote or direct the voting of stock or other securities of a corporation in which the holdings of the grantor and the trust are significant from the viewpoint of voting control; ….


Since the Hornes have always owned all the stock of the licensee corporation, and since Horne was the sole owner of the patent, clearly the “holdings of the grantor (who holds all of the stock) and the trust (which holds none of the stock) are significant from the viewpoint of voting control” where the sole asset of the trust is a license agreement entirely dependent for royalties (the income to be given favorable tax treatment) upon production of the patented product by the grantor’s corporation. As we have seen, this arrangement permitted the Hornes at any time to render the trust valueless and to divert any income from production of the patented product to themselves or others.


If the Clifford decision and section 675 were to be deemed insufficient authority, Commissioner v. Sunnen (1948) 333 U.S. 591, 68 S. Ct. 715, 92 L.Ed. 898, cited by defendant himself, provides (and provided in 1967) further authority to establish the trust’s invalidity as a Clifford Trust…. Defendant attempts to distinguish Sunnen on [two grounds, but] realistically, neither ground is accurate….


In light of the foregoing, it is apparent that there is no merit to defendant’s contention that there was “no appellate decision or statute in point.” Internal Revenue Code section 675 and the Sunnen case were very much in point.




Defendant’s second contention is that “An attorney in general practice does not have a duty to refer his client to a ‘specialist’ or to recommend the ‘assistance of a specialist’ or be guilty of malpractice.”


The court gave a jury instruction which states:


It is the duty of an attorney who is a general practitioner to refer his client to a specialist or recommend the assistance of a specialist if under the circumstances a reasonably careful and skillful practitioner would do so.


If he fails to perform that duty and undertakes to perform professional services without the aid of a specialist, it is his further duty to have the knowledge and skill ordinarily possessed, and exercise the care and skill ordinarily used by specialists in good standing in the same or similar locality and under the same circumstances.


A failure to perform any such duty is negligence.


This instruction is based upon California’s Book of Approved Jury Instructions (BAJI), Instruction No. 6.04, which is found in that work’s section on medical malpractice. Its applicability to legal malpractice presents an issue of first impression. Defendant points out that legal specialties were not officially recognized in California until 1973, and therefore contends that he could not have had a duty in 1967 to refer his client to a specialist or to meet the standard of care of a specialist.


We cannot accept this contention. A California survey in 1968 revealed that two-thirds of the attorneys in the state at that time limited their practice to a very few areas, frequently to one only. (44 Cal.St.B.J. 140 (1969).) Thus, in the words of a leading treatise, the recent debate over Official recognition of specialists must be considered “academic,” for “(t)he reality is that many attorneys have become specialists.” (Mallen and Levitt, Legal Malpractice (1977) § 114, p. 172.) Moreover, “(i)n those jurisdictions which recognize specialties or permit the attorney to make such a designation, taxation is one of the areas of law most commonly acknowledged.” (Id.,  § 268, p. 368.) Taxation also was one of the three specialties initially recognized in California. (See 51 Cal.St.B.J. 549, 555 (1976).)


Defendant himself recognized the existence of tax specialists in 1967 when he advised Horne in 1967 that he was not a tax expert, and that such experts existed. Of course, the fact that the specialty exists does not mean that every tax case must be referred to a specialist. Many tax matters are so generally known that they can well be handled by general practitioners. (See Bucquet v. Livingston (1976) 57 Cal.App.3d 914, 129 Cal. Rptr. 514.) But defendant himself acknowledged his need for expert assistance throughout his testimony, insisting he had no opinion of his own as to the tax consequences of the trust. Under the circumstances he cannot argue persuasively that it was error for the court to give the above quoted instruction.




Defendant’s next contention is that the question of law involved here was one upon which reasonable doubt may be entertained by well-informed lawyers, and therefore he should not be found liable for committing error. He relies upon Lucas v. Hamm (1961) 56 Cal.2d 583, 15 Cal.Rptr. 821, 364 P.2d 685, which held (as restated in Smith v. Lewis (1975) 13 Cal.3d 349, 359, 118 Cal.Rptr. 621, 628, 530 P.2d 589, 596), that “the rule against perpetuities poses such complex and difficult problems for the draftsman that even careful and competent  attorneys occasionally fall prey to its traps.”


But Lucas v. Hamm did not condone failure to do research, and Smith v. Lewis makes it clear that an attorney’s obligation is not satisfied by simply determining that the law on a particular subject is doubtful or debatable: “ [E] ven with respect to an unsettled area of the law,…an attorney assumes an obligation to his client to undertake reasonable research in an effort to ascertain relevant legal principles and to make an informed decision as to a course of conduct based upon an intelligent assessment of the problem.” (Id. at p. 359, 118 Cal. Rptr. at p. 627, 530 P.2d at p. 595.) In other words, an attorney has a duty to avoid involving his client in murky areas of the law if research reveals alternative courses of conduct. At least he should inform his client of uncertainties and let the client make the decision.


In any event, as stated above, there was nothing sufficiently doubtful or difficult about the invalidity of the trust documents in this case to permit invocation of Lucas v. Hamm as controlling precedent.


The judgment is affirmed.


EVANS and REYNOSO, JJ., concur.


Notes and Questions


28.  Carl is involved in a real estate transaction that could easily have been structured to qualify for non-recognition under IRC § 1031. However, his lawyer, Lee, failed to advise him of this possibility. The result is an immediate $400,000 tax liability that otherwise might have been deferred indefinitely. What if Lee thought Carl had a CPA providing him tax advice? What if Lee had written a letter to Carl stating that he would not be responsible for tax advice? What if a provision to that effect was in Lee’s engagement agreement with Carl? Is it ethically appropriate for Lee to attempt to transfer the burden of the tax advice to a CPA? Would it make a difference if he attempted to transfer it to another lawyer? Could he be disciplined by the state bar for attempting to do this? Would this be a reasonable limit on his scope of representation? (Read Model Rule 1.2(c).)  If you were representing Carl in a malpractice suit, what would you argue the damages should be based on? If you were defending Lee, what would you argue about the right measurement of damages?


29.  Lara is a lawyer who has been practicing for a year. She is a solo practitioner. She has no experience in handling tax matters. She is handling her first divorce case, and she is concerned that there may be tax issues. She wants to involve a specialist. Her law school classmate, Ted, is a first year lawyer interested in handling tax matters. She also knows Terry, who is a very experienced tax lawyer. Lara’s client is of very modest means, and the total property involved is of relatively little value. Lara could refer her client to either Ted or Terry. Ted, as a new lawyer, charges a much lower fee than Terry does. In fact, it seems unlikely that her client could afford Terry’s fees. Lara also knows an experienced CPA who would be willing to “help” Lara with the tax issues, but not take primary responsibility. The CPA’s rates are much lower than Ted or Terry’s. What should Lara do? What if she refers the client to Ted, knowing Ted is not very experienced, would she be liable for Ted’s mistakes? What if, as a practical matter, the client cannot afford the tax expertise she needs – but Lara is representing her?


30.  Leo is not a tax lawyer. When tax issues arise, he routinely provides his clients with the names of three tax specialists, suggesting that they interview each of them. He does this in an effort to protect himself from claims by disgruntled former clients that he should be liable for the bad advice of the lawyer to whom he referred them. If a tax issue arises that is so unusual and technical that only one of those tax lawyers is competent, how should Leo handle the referral? Since Leo is not a tax lawyer, how would he recognize that the issue is so unusual and technical that only one of those lawyers is competent? On a more basic level, how does Leo spot all the tax issues that need referral when he is not a tax lawyer?


31.  Model Rules 1.1 requires a lawyer to provide “competent representation.” The comments explain that a “lawyer can provide adequate representation in a wholly novel field through necessary study.” Is that really true? What are the risks of taking a client with the plan of engaging in “necessary study” in order to competently represent the client?


32.  Both lawyers and CPAs practice in the tax field. How do you think assessment of malpractice risks affect the division of the field between the two professions?




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