Proposed Changes to Circular 230 Classify Some Contingent Fees As Disreputable Conduct

(Parker Tax Publishing December 2024)

The IRS issued proposed regulations that amend the rules in Circular 230 governing practice before the IRS. The proposed regulations (1) eliminate provisions related to registered tax return preparers, (2) classify the use of certain contingent fee arrangements by practitioners as disreputable conduct, and (3) establish new standards for appraisals and the disqualification of appraisers. REG-116610-20.

Background

The regulations under 31 U.S.C. 330 relating to the regulation of practice before the IRS are codified in 31 CFR Part 10 and reprinted as Treasury Department Circular No. 230 (Circular 230). Circular 230, which contains Sections 10.0 through 10.93 relating to governing practice before the IRS, has been amended periodically since it was first published in 1921.

Prior to 2011, individual tax return preparers were generally not subject to Circular 230 unless the tax return preparer was an attorney, certified public accountant (CPA), enrolled agent (EA), or other type of practitioner identified in Circular 230.

In 2011, the IRS published final regulations in T.D. 9527 to establish qualifications for tax return preparers, which required them to become registered tax return preparers subject to the requirements under Circular 230 and describing the allowable scope of a registered tax return preparer's practice before the IRS (2011 amendments). The 2011 amendments were challenged in Loving v. IRS, 917 F.Supp. 2d 67 (D.D.C. 2013), aff'd 2014 PTC 73 (D.C. Cir. 2014). In that case, tax return preparers argued that the IRS did not have authority to regulate tax return preparation because return preparation was not practice before the IRS. The district court agreed, holding that under 31 U.S.C. Section 330(a), practice before the IRS is limited to representing taxpayers before the IRS by assisting them in presenting their cases. The D.C. Circuit affirmed, explaining that, while tax return preparers assist taxpayers, they do not represent taxpayers before the IRS or formally act as their agent.

Contingent Fees

In 2007, the IRS issued final regulations in T.D. 9359 that amended the rules in Section 10.27 of Circular 230 regarding charging contingent fees (2007 amendments). The 2007 amendments amended the exceptions to the general prohibition on contingent fees, which prohibited practitioners from charging contingent fees for original returns, to permit practitioners to charge a contingent fee for services rendered in connection with the IRS's examination of, or challenge to, (1) an original tax return or (2) 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 or a written challenge to the original tax return.

The IRS subsequently clarified the 2007 amendments in Notice 2008-43 to provide that a practitioner may charge a contingent fee for services rendered in connection with the IRS's examination of, or challenge to, an amended return or claim for refund or credit filed (1) before the taxpayer received a written notice of examination of, or a written challenge to, the original tax return or (2) no later than 120 days after the receipt of such written notice or written challenge. Notice 2008-43 also provided an exception that allows practitioners to charge a contingent fee with respect to whistleblower claims under Code Sec. 7623. Current Section 10.27 also permits practitioners to charge contingent fees in connection with the determination of statutory interest and penalties and for services rendered in connection with judicial proceedings arising under the Code. Current Section 10.27 prohibits contingent fee arrangements for services rendered in connection with any other matter before the IRS, including the preparation of original returns, amended returns, and claims for refund or credit.

In 2009, the IRS published proposed regulations in REG-113289-08 proposing modifications to the rules relating to contingent fees under Circular 230 (2009 proposed regulations). The 2009 proposed regulations have not been finalized.

In Ridgely v. Lew, 2014 PTC 356 (D. D.C. 2014), a district court held that preparing and filing ordinary refund claims, like preparing original tax returns, did not involve representing taxpayers or practice before the IRS. Thus, the court concluded that the IRS cannot prohibit charging contingent fees for ordinary refund claims based on its authority to regulate practice before the IRS.

REG-116610-20

On December 20, the IRS issued proposed regulations in REG-116610-20 that amend Circular 230 by eliminating provisions related to registered tax return preparers or that imposed standards on tax return preparation that are unrelated to representation before the Treasury Department and the IRS. The IRS explained that, as a result of the decision and injunction order in Loving, the 2011 amendments that relate to registered tax return preparers are no longer enforceable. Therefore, the proposed regulations eliminate rules regarding registered tax return preparers under current Sections. 10.3 through 10.6.

Amendments to the Rules on Contingent Fees

The proposed regulations eliminate current Section 10.27 of Circular 230, which, among other things, treats the preparation of tax returns and claims for refund or credit as matters before the IRS for which contingent fees may not be charged, and defining certain contingent fee arrangements as disreputable conduct. Specifically, the proposed regulations establish that contingent fee arrangements for services in connection with preparing an original tax return, amended tax return, or claim for refund or credit constitute disreputable conduct subject to sanction. Because the proposed regulations make substantial changes to the regulation of contingent fees under Circular 230, they withdraw the 2009 proposed regulations.

According to the IRS, charging a contingent fee for the preparation of an original return, amended return, or claim for refund or credit prepared prior to the examination of a tax return is disreputable conduct because these circumstances encourage evasion or abuse of federal tax laws by incentivizing practitioners to take unduly aggressive tax positions for their clients, which would increase their clients' reported tax benefits, thus resulting in personal gain for the practitioner. A practitioner with a direct, financial interest in the tax benefits of a client may be incentivized to increase such tax benefits. Therefore, the IRS states that these contingent fee arrangements reflect conduct that is incompatible with ethical practice before the IRS under Circular 230.

Under 31 U.S.C. Sec. 330(c), the IRS has the authority to censure or suspend or disbar from practice before the IRS practitioners who engage in disreputable conduct whether or not the conduct constitutes representation of a client. Unlike the contingent fee standards under current Section 10.27, proposed Section 10.51 is not dependent upon the preparation of a tax return or claim for refund or credit constituting practice before the IRS. The IRS notes that charging contingent fees for preparing tax returns, amended returns, and claims for refund or credit is prohibited under the rules of professional conduct applicable to many accountants. The American Institute for Certified Public Accountants (AICPA) Code of Professional Conduct, for example, acknowledges the disreputable nature of contingent fees and prohibits CPAs from charging contingent fees for the preparation of original returns, amended returns, and ordinary refund claims because of the risk that these contingent fee arrangements would allow a CPA to benefit improperly from an interest in, or relationship with, a client. Many state accountancy board rules also prohibit contingent fee arrangements for preparing an original or amended return or claim for refund or credit.

Appraiser Standards

The proposed regulations incorporate new subpart D, which provides definitions related to appraisers and standards for the disqualification of appraisers. Current Section 10.60(b) provides that proceedings to disqualify appraisers can be instituted whenever a penalty has been assessed against an appraiser under the Code and the IRS determines that the appraiser acted willfully, recklessly, or through gross incompetence with respect to the conduct at issue. The IRS states that this penalty prerequisite limits its ability to respond to misconduct when the misconduct is not covered by a specific penalty, a penalty is not imposed, or a proposed penalty assessment has not yet been made. According to the IRS, an appraiser's conduct may be disreputable or fail to conform to appraisal standards even when the IRS has not assessed a penalty or when no penalty under the Code is applicable. Therefore, the proposed regulations eliminate the penalty prerequisite because it provides an unnecessary barrier to address misconduct.

Other changes to the rules applicable to appraisers include (1) a requirement that appraisals submitted in an IRS administrative proceeding conform to standards promulgated by the International Valuation Standards Council; (2) a provision that appraisers who know or reasonably should know that an appraisal will be used in an administrative proceeding to support a substantial or gross valuation misstatement will be subject to disqualification if they act willfully, recklessly, or through gross incompetence; and (3) a new rule providing that an appraiser who has been assessed a penalty under Code Secs. 6694, 6695A, 6700, or Code Sec. 6701, for which it is determined that the appraiser acted willfully, recklessly, or through gross incompetence may be disqualified for engaging in disreputable conduct, although this assessment is not a prerequisite to disqualification.

In addition, the proposed regulations revise or eliminate provisions that are out of date and incorporate new provisions to better align Circular 230 with the modern practice environment. The scope of the proposed regulations is limited to practice before the IRS. Therefore, the proposed regulations do not alter or supplant other ethical standards applicable to practitioners.

For a discussion of the rules in Circular 230 regulating practice before the IRS, see Parker Tax ¶272,100.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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