Penalty Protection Opinions and Advisor Conflicts of Interest

Abstract

This article considers when a taxpayer should not be able to rely on a tax opinion to avoid penalties when the tax advisor rendering the opinion has an apparent conflict of interest. The article has three parts. The first part describes the statutory and regulatory standards for taxpayers seeking to rely on tax advice to avoid penalties. The second part of the article describes the cases where a taxpayer has sought to rely on the opinion of a tax advisor with a conflict of interest. Those cases involve three types of situations: (1) tax advisors acting as promoters or brokers of a tax shelter; (2) tax advisors with referral arrangements with tax shelter promoters; and (3) tax advisors that are developers or implementers of a tax strategy. The third part of the article proposes a framework for analyzing how a conflict of interest may affect the reliability of a tax advisor's opinion. It first argues that the analysis should not apply a per se rule, but rather should determine reasonableness and good faith from the perspective of what the taxpayer knew or should have known of the tax advisor's conflict and how the conflict may have affected the reliability of the opinion. In the absence of a per se rule, a court first should consider whether a conflict is relevant to the reliability of the opinion. If the conflict is relevant, the court should consider both (1) the inducement that the apparent conflict may have created to distort the advice (temptation), and (2) the advisor's apparent response to such inducement (resistance). These two variables can be used to create a framework where the level of apparent temptation is compared to the level of apparent resistance. Thus, for example, a court should be more vigilant in case involving a high level of apparent temptation and a low level of apparent resistance, than in a case involving a low level of apparent temptation and a high level of apparent resistance. Finally, the article explores common forms of temptation that tax advisors face when advising on tax-motivated transactions, and considers the circumstances when an advisor's response to those temptations can make an opinion unreliable.