Administrative Law Judge Finds Against IRS Office of Professional Responsibility in Tax Practitioner Case Pertaining to Written Tax Opinions

Posted in Articles & Publications on July 30, 2009 | Share

Over the last few years the IRS’s Office of Professional Responsibility (“OPR” or “the Office”) has lived up to its promise of investigating tax practitioners that have been allegedly engaged in questionable conduct related to their advising clients on tax advantaged transactions and preparing tax opinions.  Recently, the practitioner community gained some insight into what OPR, as well as the administrative tribunal charged with reviewing OPR decision, considers disreputable conduct as a result of the publication of the decision in OPR v. John M. Sykes, Complaint No. 2006-1 (Jan. 29, 2009).  In the decision released on May 18, 2009,  Administrative Law Judge (“ALJ”) Richard A. Scully (“ALJ Scully) held that a prominent tax attorney involved in writing five short-form tax opinions on leasing  transactions that were later determined by a federal court to be tax shelters, did not violate his due diligence obligations under Circular 230’s § 10.22. 31 C.F.R. § 10.22.  

The complaint issued by the OPR in this case was against one of the tax advisors mentioned in theLong Term Capital Holdings v. U.S., 94 AFTR 2d 2004-5666.  In its complaint, the OPR relied on Circular 230’s § 10.22, which requires practitioners to exercise due diligence as to accuracy, as opposed to Circular 230’s newer provisions, that went into effect in June of 2005.  The use of Circular 230’s § 10.22 is significant and should serve as a wake-up call to tax practitioners.  Most Recently, practitioners have been focusing on the new sections of Circular 230 that specifically relate to tax advantaged transactions and have neglected the older regulations that have been around for many years and are broader in scope.

The Sykes Case

John M. Sykes is a well-respected New York City tax attorney with over 80 years experience.  Sykes provided legal advice to a large hedge fund concerning its tax basis in a “lease stripping” transaction in order to claim losses for federal income tax purposes.  The advice was in the form of a “short-form” opinion—a written legal opinion that contains facts and conclusions but not detailed legal analysis.  Based on Sykes’ short-form opinion, a large hedge fund claimed a basis with a net capital loss.  However, the IRS disallowed this basis as a “sham transaction” lacking a non-tax business purpose.  

Based on his use of short-form opinions, the Office issued Sykes a complaint, requesting his suspension from practice before the IRS.  The Office alleged that Sykes failed to exercise due diligence for his client as required by Circular 230’s § 10.22 because his short-form opinions failed to adequately analyze and advise his clients on relevant facts and law affecting the transaction.  The Office based the due diligence claim on allegations that in his short-form opinion, Sykes: (1) did not analyze IRS Notice 95-93 (“the Notice”) which details IRS policy to challenge losses claimed in a lease stripping transaction; (2) analyzed neither the “substance-over-form” doctrine nor the economic substance of the transaction; and (3) failed to inquire into the legal opinions regarding the transaction.  The complaint also alleged that because Sykes failed to exercise due diligence, he willfully engaged in disreputable conduct pursuant to Circular 230’s § 10.51.

In response, Sykes asserted that at the time he wrote the short-form opinion, it was the accepted practice in the profession.  Sykes attested that he had issued short-form opinions in the past without client complaint.  At the time he issued his short-form opinion, Sykes was unaware of any Circular 230 requirement that required lengthy in-depth legal analysis.  In further support of his  use of the short-form opinion, Sykes raised that Circular 230 was revised in 2004 to require opinions to “relate the applicable law (including potentially applicable judicial doctrines) to the relevant facts.” 31 C.F.R. § 10.35(c)(2).  Sykes argued that the IRS would not have amended Circular 230, including § 10.35, if it were already included within the scope of Circular 230’s due diligence standard.  Additionally, Sykes acknowledged that he was aware of the Notice regarding lease stripping transactions, and asserted that he orally informed the hedge fund’s tax director of the Notice.

In his opinion, ALJ Scully dismissed the complaint against Sykes, holding that the Office failed to prove by clear and convincing evidence that Sykes failed to exercise due diligence.  ALJ Scully rejected the Office’s argument that short-form opinions were per se insufficient, acknowledging that their use at the time was the accepted form of practice.  ALJ Scully also considered Circular 230’s revisions and agreed with Sykes’ argument that if “due diligence” required an in-depth analysis of applicable law and judicial doctrine, the IRS would not have amended Circular 230 in 2004.  Further, ALJ Scully substantiated his holding by noting that Treasury Regulation § 1.6664-4(c), which insulates taxpayers from penalty for relying on tax opinions, does not require such opinions to have a particular form.  ALJ Scully recognized that  Sykes had been aware of the IRS Notice and analyzed the law prior to writing an opinion.  Further, based on the evidence present, the ALJ ruled that Sykes made sufficient inquires into the facts and assumptions for his opinion.  Consequently, ALJ Scully found that OPR did not prove by clear and convincing evidence that Sykes failed to exercise due diligence.                   

What Constitutes Practice Before the IRS?
In addition to his decision concerning the conduct regarding to the practitioner and the tax opinions, ALJ Scully also dealt with the issue of what constitutes “practice” before the IRS. Specifically, he found that the tax practitioner’s opinions were intended to be part of the taxpayer’s representation to the IRS in support of his position with regard to the basis of the stock.  Sykes at 5.  This finding is significant because prior to the passage of the American Jobs Creation Act (“Jobs Act”) in 2004, it was unclear whether OPR had jurisdiction over tax opinion writers.  Specifically, before the Jobs Act was passed, OPR’s jurisdiction was limited to professionals with the ability to practice before the IRS in combination with actual “proof of practice.”  Basically, proof of practice could be found with the filing of a Form 2848 with the practitioner’s signature on it.  But with the passage of the Jobs Act, the jurisdiction of OPR was vastly expanded to include practitioners who provide written advice to clients,as well as, practitioners who submit documents directly to the IRS or actually make personal appearances before employees of the IRS.  Along with the Jobs Act, this decision in the Sykes case clearly demonstrates what the ALJs will consider as “practice before the IRS.”

ALJ Refuses to Address Statute of Limitations Question?
One issue that ALJ Scully refused to address and that was raised by the practitioner in his answer to the IRS was that this proceeding was time-barred under the statute of limitations provided in 28 U.S.C. § 2462.  See Sykes at 1.  The ALJ’s unwillingness to address this issue in the decision leaves an open question that will continue to fester with practitioners in the tax community.  Most practitioners operate under the assumption that OPR utilizes a statute of limitations period of five years from the date of the alleged misconduct.   However, over the years IRS executives have explained in public forums that the agency may have up to 10 years to bring a complaint against a practitioner. .  Therefore, until an ALJ issues an opinion on the matter or Congress clearly codifies one, the limitation period for OPR to investigate conduct will remain uncertain and will continue to frustrate the practitioner community.

What lessons Can Be Learned from Sykes?
Circular 230’s 2004 and 2005 revisions did not affect Sykes because he wrote his short-form opinion before the revisions went into effect.  However, in the future Circular 230’s revisions could be used by OPR to more vigorously challenge practitioners.  The decision of the ALJ  indicates that Circular 230’s revisions, particularly § 10.35, could be used to impose more stringent requirements on practitioners’ preparation and provision of tax advice. 

Equally important is the ALJ’s rejection of OPR’s sweeping interpretation of Circular 230’s due diligence standard.  The ALJ limited the scope of the due diligence standard, but left open the possibility that similar behavior might be in violation of the due diligence standard under recent revisions to Circular 230. 

What is clear and convincing from this case, however, is that the Office is willing to issue complaints against practitioners who prepare tax opinions, and that the Office is applying a broad standard of due diligence. Whether or how OPR will bring these cases in the future in light of this opinion remains to be seen. 

The main reason the IRS and the OPR agreed to make ALJ decisions public after a final agency decision was to provide a road-map of acceptable behavior for tax practitioners to consider when engaging in certain types of conduct.  This decision particularly achieves its transparency objective and provides tax practitioners who write opinions with insight into how the ALJs will view due diligence obligations and professional activities.  Here, ALJ Scully reviewed the conduct of the tax practitioner from a real world perspective of a tax practitioner, investigating the reasoning behind the practitioners work.  If this case is any indication, ALJs will be specifically reviewing and evaluating all the facts and circumstances as well as all the steps the practitioner had taken before writing his opinion when determining whether he or she exercised sufficient due diligence. 

At the end of the day, the real winners in this case are the individual tax practitioners, the tax community, and the OPR.  This decision demonstrates how effective transparency can be for all the parties involved and serves as an educational road-map for everyone to follow in the coming years.

For more information on this matter, see  Administrative Law Judge Finds Against IRS Office of Professional Responsibility in Tax Practitioner Case Pertaining to Written Tax Opinions or contact Kevin E. Thorn at 202-270-7273 or

Administrative Law Judge Finds Against IRS Office of Professional Responsibility in Tax Practitioner Case Pertaining to Written Tax Opinions is provided as an education service and is not intended to be and should not be construed as legal advice.  Readers with particular needs on specific issues should retain the services of competent counsel. 

American Jobs Creation Act of  2004 (Pub. L. No.  108-357).

ii. Pub. L. No. 108-357 § 822 (2004).

iii  28 U.S.C. § 2462 which imposes a five year statute of limitations for actions initiated by the government to impose a civil fine, penalty or forfeiture on a private citizen.

iv. Jeremiah Coder, Dismissal of OPR Sanction Case Is Instructive, Practitioners Say, Tax Notes, May 20, 2009.

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