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Can You Rely on Your Advisor to Avoid Penalties under 6662 after Canal?

What should a tax director do to obtain tax advice that will provide penalty protection? Recently, the Tax Court, in Canal, laid out a list of things that will cause a taxpayer to lose its penalty protection. The Canal decision raises anew the practical question of what a tax director can do to strengthen the company's likelihood of successfully showing reasonable cause and good faith in relying on the advice of its outside service providers. Taxand US looks at the statutes, the regulations and some of the more recent case law to provide a roadmap for tax directors seeking the advice of outside advisors.

In reviewing corporate cases decided before the listed transaction era of the early 2000s, Taxand US found that the reasonable cause and good faith exception inquiry became an examination of a three-part test. For taxpayers to show reasonable cause and good faith, they had to show that:

(1) They provided the return preparer with complete and accurate information;
(2) An incorrect return was a result of the preparer's mistakes; and
(3) The taxpayers believed in good faith that they were relying on the advice of a competent return preparer.

In each instance, the Tax Court determined that the taxpayers could not have relied in good faith on their advisors because they did not provide the advisors with complete and accurate information.

Perhaps the most objective test for determining whether the taxpayer can show actual reliance in good faith was set forth recently by the Tax Court in 106 Ltd. v. Commissioner. In that case, the Tax Court provided another three-part test for determining a taxpayer's actual reliance in good faith. That test looks to three factors to consider:

(1) The taxpayer's business sophistication and experience;
(2) The quality of the opinion letter; and
(3) Whether the advisors upon whom the reliance is placed are promoters.

Taxand US explores recent case law in more detail in the full article

Taxand's Take

At a minimum, tax directors should make sure they provide their advisors with accurate and complete information relating to the advice being sought. While tax directors are not required to get second opinions, they should review carefully the facts, representations, analysis and conclusions drawn in any rendered opinion. This step may already be forced on tax directors by their audit firms - whom we hear inform tax directors that they will have to audit, and come to their own independent conclusion, with respect to any advice received by the company from another advisor.

Tax directors can still rely on the advice of outside advisors for penalty protection, but several precautions should be followed:
  • All relevant facts need to be made available to advisors.
  • The advisors' opinions should be reviewed in depth by the tax director.
  • The tax director should steer clear of any advisor for whom a conflict of interest may be present.
  • A tax director should re-evaluate any of the positions for which outside advice has been rendered as part of the tax provision process.

Your Taxand contact for further queries is:
Gregory Gunderson
T. +1 214 438 8410

Taxand's Take Author