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Bigger isn’t better when it comes to tax advice

Small law firms and accounting firms sometimes feel ‘pushed out’ when it comes to a client’s largest transactions like the sale of a business or estate property. That’s usually not a good thing.

“reliance on a promoter takes the good faith out of good-faith reliance.” – Tax Court Justice Holmes

There’s a powerfully clear and simple lesson to be learned in a Tax Court decision published this month. In RB-1 Investment Partners, Eric Reinhart, Tax Matters Partner v. Commissioner, T.C. Memo. 2018-64 (May 14, 2018). It’s a compelling story of a typical small business that lives through the common cycles of business growth, maturity and eventual sale, along with all the human aspects that accompany the transition. A reading of the case summary makes it clear these people are not tax cheats, but rather just small business owners seeking valuable tax advice. The Tax Court reaffirms and makes it clear that a taxpayer who relies on a tax opinion letter by the seller of the deal cannot avoid the 40% penalty if that advice turns out to be wrong. This is not news. IRS and tax court have been clear on this for many years. This case and the third-party commentary simply reinforce the point.

At first, this conclusion seems to go against what we know about tax law. A taxpayer, acting honestly and in good faith, submits a tax return based on the best available information including tax advice from an impressive professional tax firm. A taxpayer who relies on an opinion letter from a prominent law firm should be able to avoid tax penalties, right? How can a taxpayer go wrong by relying on a 100+ page individually prepared tax opinion letter from a major law firm? We call this defense “good faith reliance” and it normally works well to avoid certain tax penalties. Yet when the tax advice comes to us through the same firm was was selling the tax shelter then that logic fails. It doesn’t take 100 pages of opinion from a law firm to conclude that this deal just smells bad. The taxpayer is liable for the additional taxes, penalties and interest.

The problem could easily be avoided if the taxpayer had sought independent advice BEFORE the deal was completed. But that’s often not how it works. In this case and many others that I’ve seen, the taxpayer does not seek independent advice until later, usually when the tax return needs to be prepared (see page 14 of the Tax Court decision).  As an interesting side note – the tax return preparer avoided liability by mutually agreeing to rely on advice from the law firm but the taxpayer did not avoid liability.

From my personal experience, clients are overly impressed with the powerful presentations, big city accounting and law firms and the highly polished presentations of tax shelter promoters. This is especially true when clients are outside of their comfort zone and normal scope of experience, like the one-time sale of a family business or a valuable family vacation home. I’m accustomed to hearing things like “I know you do a great job with our regular accounting but my rich uncle brought in his big law firm to handle the family business sale so that we don’t have to pay any taxes on it”.

I started my career in tax shelter sales side of the business as a registered Representative for Drexel Burnham Lambert in the middle 1980s. We were experts at overcoming the concerns of the client’s more conservative independent accountant. The advice of specialist tax firm is very likely to overpower the advice of an independent small business CPA like me. It’s always been this way. I’m not inclined to get into a tussle with a much larger firm that often uses implied intimidation tactics to quell the concerns of smaller independent CPAs when it comes to offering advice on these larger transactions. They have a lot at stake. I don’t. But Tax Court reminds taxpayers that if it ‘sounds too good to be true’ then that alone is enough to signal that they can’t rely on the advice provided, no matter how impressive the source.

The important take-home message here is that hooking up with an attractive-looking firm for a ‘one night stand’ may hold emotional appeal but it is not a substitute for prudent thinking and a solid long term relationship with a tax planning professional who is focused only on your best interests.

I read the excellent blog post published this week by Pepperdine Law School Dean Paul L. Caron. It’s worth a read if you are interested in this issue.

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