Vices and Virtues of an Objective Reporting Standard

By Dennis J. Ventry Jr. Dennis J. Ventry Jr. is an assistant professor of law at American University Washington College of Law. Comments are welcome at dventry@wcl.american.edu. Copyright 2006 Dennis J. Ventry Jr. All rights reserved. I. Introduction The substantial understatement penalty lay at the heart of the protracted controversy over practice stan- dards in the 1980s. Practitioners objected to Treasury Department efforts to align professional standards with reporting requirements for taxpayers. Proposed amend- ments to Circular 230, released in 1986, would have prohibited practitioners from advising or recommending a reporting position or preparing or signing a tax return unless they could determine that the section 6661 sub- stantial understatement penalty would not apply. 1 Prac- titioners recoiled. Prevailing ethical guidelines of the major professional organizations merely required tax practitioners to render advice in good faith evidenced by a realistic possibility of success if litigated; prevailing guidelines did not require them to insure against poten- tial tax liabilities. 2 Unified and vocal practitioner oppo- sition forced Treasury to twice extend the comment period for its proposed amendments. 3 The apparent impasse belied feverish activity among the protagonists. In many ways, the parties were working toward a compromise. The American Bar Association Tax Section appointed a special task force in the summer of 1987 to undertake a comprehensive review of civil and Treasury Department, Notice of Proposed Rulemaking, Tax Practitioners, 51 Fed. Reg. 29113 (Aug. 14, 1986). For a discussion of the 1986 proposed modifications to Circular 230, see Dennis J. Ventry Jr., ‘‘Filling the Ethical Void: Treasury’s 1986 Circular 230 Proposal,’’ Tax Notes, Aug. 21, 2006, p. 691. American Bar Association Section of Taxation, Committee on Ethics and Professional Responsibility, Formal Opinion 85- 352 (July 7, 1985); American Institute of Certified Public Accoun- tants Federal Taxation Executive Committee, Statements on Responsibilities in Tax Practice No. 1, ‘‘Tax Return Positions’’ (rev. 1988). Treasury Department, Extension of Comment Period, 51 Fed. Reg. 30510 (Aug. 27, 1986); Treasury Department, Solicita- tion for Extended Comments, 51 Fed. Reg. 40340 (Nov. 6, 1986). criminal penalties; 4 in November 1987 IRS Commissioner Lawrence Gibbs established an Executive Task Force on Civil Penalties, comprising IRS employees from offices around the country. 5 Moreover, both houses of Congress were preparing to conduct their own investigations into the penalty regime with a series of high-profile hearings. 6 Those investigations did not proceed independently, but rather involved significant cooperation. The IRS task force, for instance, worked closely with and consulted the ABA Tax Section, the American Institute of Certified Public Accountants Tax Division, the Tax Executives Institute, the National Society of Public Accountants, and the National Association of Enrolled Agents, in addition to other professional, academic, and business groups. The next three installments of Policy and Practice will explore the activity surrounding the penalty system in the late 1980s. This installment examines the love-hate relationship between the substantial understatement penalty and practitioners; the next installment evaluates the remarkable documents produced by the IRS task force on civil penalties; and the third chronicles the politics of penalty reform and congressional hearings on the penalty system. Thereafter, this series on the histori- cal relationship between standards of tax practice and tax compliance — now in its ninth installment — will culminate in a final column that summarizes the ‘‘les- sons’’ of the last 40 years. In the process, it offers several suggestions on the appropriate role and combination of professional guidelines, administrative regulations, and statutory penalties in facilitating compliance and curbing overaggressive reporting activity. II. Hate the Substantial Understatement Penalty Practitioners urged repeal of the section 6661 substan- tial understatement penalty. 7 The rate of the penalty, at 25 ABA Tax Section, Committee on Civil and Criminal Tax Penalties, ‘‘Penalties Study Report’’ (July 28, 1988), reprinted in U.S. Congress, House, Committee on Ways and Means, Subcom- mittee on Oversight, Hearings on ‘‘Review of the Civil Penalty Provisions Contained in the Internal Revenue Code’’ (Mar. 31 and July 28, 1988), at 362. Executive Task Force, Commissioner’s Penalty Study, Inter- nal Revenue Service, ‘‘Report on Civil Tax Penalties’’ (Feb. 21, See, e.g., ‘‘Review of Civil Penalty Provisions Contained in the Internal Revenue Code,’’ supra note 4. In its study on civil and criminal penalties, the ABA Tax Section concluded that the substantial understatement penalty should be eliminated. Meanwhile, the Tax Section recom- mended that a taxpayer’s intentional failure to understate tax owed should be punished under an increased negligence pen- alty. ‘‘Penalties Study Report,’’ supra note 4, at 24. See also Treasury Tax Correspondence, ‘‘TEI Submits Proposals for Civil Penalty Tax Reform,’’ 89 TNT 127-26 (June 19, 1989); Pat Jones, (Footnote continued on next page.) TAX NOTES, September 18, 2006 (C) Tax Analysts 2006. All rights reserved. Tax Analysts does not claim copyright in any public domain or third party content. Vices and Virtues of an Objective Reporting Standard