ABA Formal Opinion 346 and a New Statutory Penalty Regime

By Dennis J. Ventry Jr. Dennis J. Ventry Jr. is a visiting scholar in taxation at the UCLA School of Law and an assistant professor of law at the American University Washington College of Law (beginning fall 2006). Comments are welcome at dventry@wcl.american.edu. Copyright 2006 Dennis J. Ventry Jr. All rights reserved. I. ABA Formal Opinion 346 The American Bar Association released Formal Opin- ion 346 in June 1981, less than one year after the Treasury Department issued proposed amendments to Circular 230. 1 The ABA later withdrew the June release, reissuing Formal Opinion 346 in January 1982. 2 In its final form, Opinion 346 promulgated ethical and disciplinary stan- dards for lawyers rendering opinions on tax shelter investments offered to nonclients. In that way, Opinion 346 differed significantly from ABA Formal Opinion 314, which governed advice to individual clients in the prepa- ration of tax returns. 3 When representing individual clients, the lawyer’s relationship with the IRS was largely adversarial. But when providing a tax shelter opinion the lawyer knows or should know will be relied on by third ABA Committee on Ethics and Professional Responsibility, Formal Opinion 346 (June 1, 1981). For Treasury’s 1980 proposed amendments to Circular 230, see ‘‘Proposed Amendments, Tax Shelters; Practice Before the Internal Revenue Service,’’ 45 Fed. Reg. 58594 (Sept. 4, 1980). ABA Comm. on Ethics and Professional Responsibility, Formal Opinion 346 (Revised) (Jan. 29, 1982). ABA Comm. on Professional Ethics, Formal Opinion 314 (Apr. 27, 1965). Over the years, the ambit of Opinion 314 had broadened to represent prevailing ethical standards ‘‘not only for advice to clients in return preparation, but generally for lawyers in their relationship with the Internal Revenue Service.’’ The Association of the Bar of the City of New York, Special Committee on the Lawyer’s Role in Tax Practice, ‘‘The Lawyer’s Role in Tax Practice,’’ 36 Tax Law. 865 (Summer 1983). For more on Opinion 314 and a detailed discussion of the reasonable basis standard, see Dennis J. Ventry Jr., ‘‘Reasonable Basis and Ethical Standards Before 1980,’’ Tax Notes, May 29, 2006, p. 1047. TAX NOTES, June 12, 2006 persons, the lawyer, according to Opinion 346, ‘‘functions more as an adviser than as an advocate.’’ 4 The guidelines for tax lawyers in Opinion 346 re- sponded directly to the 1980 proposed amendments to Circular 230. While officially restricted to legal opinions on tax shelter investment offerings, Opinion 346 exam- ined the relationship between tax lawyers and the IRS in contexts that extended beyond the tax shelter market- place. In particular, it discussed the tax lawyer as adviser versus advocate, definitional boundaries of tax shelter activity, disciplinary standards and authorities for tax lawyers, due diligence standards applicable to all trans- actional lawyers, and practice standards to follow when opining on the likely success or failure of aggressive tax positions. Opinion 346 also articulated eight ethical prin- ciples to guide tax lawyers. The ethical guidelines were based on various Ethical Considerations of the Model Code and thus were aspirational rather than disciplinary in nature. A. Opinions for 3rd Persons: Adviser vs. Advocate Opinion 346 differentiated between the tax lawyer as advocate and adviser. When representing a client in adversarial proceedings before the IRS, the tax lawyer functioned as an advocate. 5 In rendering a tax shelter opinion to be relied on by third persons, however, the tax lawyer functioned as an adviser. Under normal circum- stances, lawyers did not owe third persons special ethical considerations. But when those third persons had ‘‘an interest in the integrity of the evaluation,’’ the legal duty of the lawyer ‘‘goes beyond the obligations a lawyer normally has to third persons.’’ 6 The tax lawyer’s legal opinion on a tax shelter offering was ‘‘frequently of substantial importance.’’ The shelter promoter depended on the tax lawyer’s opinion in marketing the shelter offering to potential investors, often using the lawyer’s name and firm in connection with sales promotion ef- forts. Nonclient tax shelter investors relied on the law- yer’s opinion in determining whether to invest in a ABA Comm. on Ethics and Professional Responsibility, Op. 346, supra note 2. To establish the lawyer’s role as advocate, Opinion 346 referred to Ethical Consideration 7-22, which stated that ‘‘a litigant or his lawyer may, in good faith and within the framework of the law, take steps to test the correctness of a ruling of a tribunal.’’ That was a particularly odd reference given that Opinion 314 stated unequivocally that the IRS was neither a judicial tribunal nor even a ‘‘quasi-judicial institution.’’ ABA Comm. on Professional Ethics, Op. 314, supra note 3. ABA Comm. on Ethics and Professional Responsibility, Op. 346, supra note 2 (citing to Ethical Consideration 7-3). Remaining citations in this paragraph are from ABA Comm. on Ethics and Professional Responsibility, Op. 346, supra note 2. (C) Tax Analysts 2006. All rights reserved. Tax Analysts does not claim copyright in any public domain or third party content. ABA Formal Opinion 346 and a New Statutory Penalty Regime