Comments on Monetary Penalties under Circular 230



AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS

Comments on Notice 2007-39

Disciplinary Actions under Section 822

of the American Jobs Creation Act of 2004

Developed by:

AICPA Tax Practice Responsibilities Committee

AICPA Approved by:

Tax Executive Committee

Submitted to the Internal Revenue Service

CC:PA:LPD:PR (Notice 2007-39)

1111 Constitution Avenue, N.W., Washington, DC. 20224

August 22, 2007

AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS

Comments on Notice 2007-39

Disciplinary Actions under Section 822

of the American Jobs Creation Act of 2004

Notice 2007-39 (Notice) provides preliminary guidance to practitioners, employers, firms and other entities that may be subject to monetary penalties under 31 U.S.C. section 330, as amended by Section 822 of the American Jobs Creation Act of 2004 (Act). This Notice also invited comments from the public regarding rules and standards relating to monetary penalties under 31 U.S.C. section 330.

The AICPA has a longstanding track record of establishing high professional standards for our CPA members, including the AICPA Code of Professional Conduct and our enforceable Statements on Standards for Tax Services. These standards provide meaningful guidance to CPA members in the performance of their professional responsibilities. These standards also provide the foundation for many states’ ethical rules for CPAs which, as a practical matter, extends the application of our rules to many CPAs regardless of AICPA membership. We believe the AICPA's focus on professional standards contributes to the public awareness of the professionalism that is associated with CPAs, as well as the AICPA.

Accordingly, we respectfully submit the following comments.

EXECUTIVE SUMMARY

The guidance contained in the Notice is part of the ongoing efforts by the Treasury Department and the IRS to generally enhance standards of federal tax practice for all tax practitioners. Although we support these efforts and goals, we believe that some aspects of this guidance regarding monetary penalties should be changed and other aspects should be clarified.

COMMENTS

A. Comments Requested by the IRS

1. Appropriate Factors to Consider when Determining Whether a Monetary Penalty Is Appropriate

Congress intended to add monetary penalties to the previously available sanctions which may be imposed upon practitioners, such as suspension or disbarment from practice before the Treasury Department or censure. It did not intend to create a separate penalty regime. As such, we believe the tiered approach of current Section 10.52 of Treasury Department Circular 230 provides the appropriate initial factors to consider when determining whether a monetary penalty is appropriate. Section 10.52 delineates two categories of actionable behavior: (1) willfully violating any provision of Circular 230 (other than Section 10.33); or (2) recklessly or through gross incompetence (as defined in Section 10.51(l)) violating Sections 10.34, 10.35, 10.36 or 10.37.

As with the other sanctions that existed before the Act, monetary penalties should be considered for the types of behaviors that endanger the integrity of our tax system and the orderly administration of that system.

The factors to consider in determining whether a monetary penalty is appropriate depend on the facts and circumstances of the prohibited conduct. However, although not determinative, the following are examples of additional factors to be considered in determining whether a monetary penalty is appropriate:

a. The extent to which compliance with Circular 230 or the orderly administration of Circular 230 would be appropriately enhanced by using monetary penalties instead of, or in addition to, the other available sanctions of private reprimand, censure, suspension or disbarment from practice before the IRS;

b. The extent to which a monetary penalty might be disproportionate to the misconduct;

c. The nature and extent of resources assigned by a firm towards training in professional practice matters and promoting compliance with relevant professional responsibilities;

d. The existence of policies and procedures furthering professional conduct of practitioners in a firm, and to administer and enforce compliance;

e. The extent of a firm or entity's compliance with Section 10.36 of Circular 230;

f. Whether prompt action was taken to correct the noncompliance after the prohibited conduct was discovered;

g. Measures taken to prevent a recurrence of a similar misconduct in the future;

h. The extent of injury to the client, public, or tax administration;

i. The frequency of the misconduct;

j. The duration of the misconduct; and

k. The extent to which the conduct was intentional.

2. Factors that Should Be Considered in Declining to Impose a Monetary Penalty

The Notice allows a monetary penalty to be imposed on a firm for acts of a practitioner having an agency relationship with the firm without consideration of whether the practitioner may have acted outside the scope of this agency. We believe this inappropriately subjects a firm to a strict liability and puts a firm at unfair risk for the acts of a partner or employee acting beyond the established scope of his or her agency relationship with the firm.

We recommend that the IRS decline to impose monetary penalties against a firm for actions outside the scope of the agency relationship. Evaluating behavior by taking into account the applicable scope of agency, based on the facts and circumstances, properly implements the statutory standard that the firm "knew, or reasonably should have known, of such conduct."

We also recommend that when another monetary penalty has been imposed on the same behavior under the authority of another penalty provision, the IRS should decline to impose a further monetary penalty under this provision. For example, it would not be appropriate to impose a Circular 230 monetary penalty if the practitioner or firm has paid or has been assessed a penalty under section 6694 for the same behavior.

Assume a practitioner gave written tax advice that the outcome of a matter was more likely than not the correct treatment, then prepared and signed the taxpayer's return, reflecting the written advice previously rendered, without preparing any disclosure with the return or advising the taxpayer with respect to any disclosure. The IRS asserts that the practitioner did not have a reasonable belief that the position would more likely than not be sustained on its merits, due to recklessness.

Although the IRS may assert monetary penalties under section 6694 or Circular 230, we believe that imposing both penalties at the same time for the same behavior would be a punitive measure that would not improve compliance with Circular 230 or be in furtherance of sound tax administration. Note: Assessing both penalties would result in up to 150 percent of the income derived (or expected to be derived) being subject to penalties, which does not appear to be consistent with Congressional intention.

Finally, there will be instances where it will be difficult to determine the gross income derived (or to be derived) by practitioners, as discussed below. We believe this factor should be taken into account, with the result that monetary penalties against the firm, and not the individual practitioner(s), should be considered until such time as guidance is provided regarding the determination of a practitioner's share of gross income.

3. Mitigating Circumstances that Should Be Considered when Determining the Amount of a Monetary Penalty

The mitigating circumstances that should be considered when determining the amount of a monetary penalty depend on the facts and circumstances of the particular misconduct. Examples include:

a. The nature and extent of training taken by the practitioner, or provided by a firm to practitioners in the relevant areas of ethics and professional responsibility;

b. The adequacy of resources that a practitioner, employer, firm or other entity devotes to promote compliance with relevant ethics and performance of professional responsibilities, taking into account the size of the firm and the nature of its tax practice;

c. The frequency and duration of misconduct by the practitioner, employer, firm or other entity;

d. The extent of injury to the client, public, or tax administration; and

e. Whether prompt action was taken to correct the noncompliance after the prohibited conduct was discovered.

B. Additional Comments on Notice 2007-39

1. Imposing Monetary Penalties in General

We believe that the non-monetary sanctions under Circular 230 generally are sufficient to adequately discipline individual practitioners (employees and partners of a firm) for misconduct. Monetary penalties should, therefore, only be imposed when the misconduct is so serious that any other sanction under Circular 230 is not adequate.

In addition, it would be inappropriate to impose a monetary penalty against a firm where the practitioner acted outside the scope of the agency relationship with the employer relative to the Circular 230 conduct.

2. Special Rule for Larger Engagements

The Notice has a special rule for so-called larger engagements. Under the Notice, if a single prohibited act is an integral part of a larger engagement, the penalty will be imposed up to the gross income derived (or to be derived) from the larger engagement. The Notice includes no guidance on (1) when an engagement is considered to be “larger;” or (2) what constitutes “an integral part of a larger engagement.” This special rule for larger engagements should be reconsidered with the goal of issuing clearer guidance that focuses only on the income derived from the prohibited conduct as required by the Act.

For example, assume a firm provides several different kinds of federal tax advice to a single client, all relating to a large acquisition the client is undertaking. Under the engagement letter between the firm and the taxpayer, the following tax services are to be provided: transfer pricing documentation studies, mergers and acquisitions structuring advice and advice relating to tax treaties. Three teams of the firm's partners and employees advise on these three categories of issues, reflecting their own specialized practices and experiences. The IRS Office of Professional Responsibility (OPR) believes that prohibited conduct in violation of Circular 230 occurred with respect to the written advice on tax treaties. We believe the Notice should be clarified to indicate that, in such instances, (1) only the gross income reasonably related to the written tax advice on tax treaties should be included; and (2) any gross income related to other aspects of the larger engagement should not be included. Similar problems arise if the engagement is for tax and non-tax services.

3. Determining “Gross Income”

We anticipate significant practical difficulties in determining a practitioner’s share of the gross income attributable to the misconduct. It is, therefore, critical that Treasury clarify how the practitioner’s gross income attributable to the misconduct should be determined in the case of a practitioner who is an employee or partner of a firm.  Measuring the practitioner’s gross income attributable to the misconduct by reference to the fees received by the entity may overstate the income actually earned by the practitioner.  Instead, we recommend the practitioner’s gross income be determined based on an allocation of compensation or partnership income received by the practitioner that is attributable to the misconduct.  While such an allocation may be complex, we believe it will lead to a fairer result.

4. Total Amount of Monetary Sanctions

The statute and Notice are unclear as to the aggregate amount of monetary penalties that may be imposed against a practitioner and his or her firm with respect to a given act of misconduct.  Section 822 states that “[s]uch penalty shall not exceed the gross income derived (or to be derived) from the conduct giving rise to the penalty…”  The Notice states that “The aggregate amount of the monetary penalty (or penalties) imposed by the Secretary for any prohibited conduct may not exceed the gross income derived by the practitioner and the employer, firm, or other entity in connection with such prohibited conduct.” 

We believe that the aggregate amount of the penalties imposed on the practitioner and the firm should not exceed 100% of the fees paid by the client with regard to the misconduct (whether paid by the client to the firm or directly to the practitioner) and that the guidance should make that limitation clear.  For example, if the client pays the firm $8,000 in fees attributable to the misconduct, and also pays $2,000 in fees attributable to the misconduct directly to the practitioner, the aggregate amount of the penalties imposed on the practitioner and the firm should not exceed $10,000.

5. Suggested Change to Example 1

We believe Example 1 is confusing and misleading in that it appears to suggest that the "creation, promotion and marketing" of “tax advantaged strategies” are prohibited activities under Circular 230. Although the IRS may appropriately look at idea creation, marketing or promoting in assessing whether a firm or individual acted properly, such activities in connection with “tax advantaged strategies” are not necessarily prohibited any more than “tax advantaged strategies” are necessarily prohibited. In fact, Sections 10.35(b)(5) and 10.35(e)(2) specifically contemplate the issuance of written "marketed opinions" that comply with Circular 230.

We believe Example 1 should be rewritten to state that OPR has determined that one or more specific violations of Circular 230 occurred in particular situations regarding Strategy X. We suggest the violation be described in detail, such as the reckless failure by Attorney A to exercise appropriate due diligence or in relating the law to the relevant facts when providing written tax advice to a client regarding Strategy X.

6. Procedural Safeguards and Guidance Regarding Procedures

We believe monetary penalties reinforce the need for strong procedural safeguards under Circular 230 (see the AICPA's March 6, 2006 comments on the proposed Circular 230 regulations). In particular, we believe that before any final decision to impose monetary penalties is made, that the affected practitioners and firms have access to a meaningful and independent review of OPR's decision to impose such penalties.

In addition, these additional sanctions on practitioners and firms reinforce the need for the IRS to have well-targeted and consistent guidance on when IRS professionals are to make referrals to OPR.

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