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accounting firm to avoid an accuracy-
related penalty.
The court noted that the regulations
under 6664 provide that "neither
reliance on the advice of a profession-
al tax adviser nor reliance on facts that,
unknown to the taxpayer, are incorrect
necessarily demonstrates or indicates
reasonable cause or good faith."
In reaching its opinion, the accounting
firm had set financial ratios the compa-
ny would need to maintain to show that
it could satisfy its obligations under the
indemnity agreement. The firm found
very little guidance in the tax law, other
than some advance ruling parameters
contained in an obsolete, 10-year-old
revenue procedure.
The court found the revenue procedure
"irrelevant" and chastised the account-
ing firm for basing its opinion "on such
dubious legal reasoning." The court
was also influenced by the fact that the
contracts and other agreements sup-
porting the transaction did not specifi-
cally require the company to maintain
the financial ratios recommended by
the accounting firm.
The court also looked at whether the
accounting firm had a conflict of inter-
est that rendered its advice unreli-
able. It noted that "Courts have
repeatedly held that it is unreason-
able for a taxpayer to rely on a tax
adviser actively involved in planning
the transaction and tainted by an
inherent conflict of interest."
The company argued that it had every
reason to trust the accounting firm's
judgment because of its long-term rela-
tionship with the firm. The court ruled
that the firm "crossed over the line from
trusted adviser for prior accounting
purposes to advocate for a position
with no authority that was based on an
opinion with a high price tag."
The court found a variety of conflicts:
The accounting firm researched and
drafted the tax opinion.
It "audited" the company's assets to
determine that they complied with the
assumptions used in the opinion.
It made legal assumptions separate
from the tax assumptions. For exam-
ple, it reviewed state law to determine
if entities were properly formed.
It was intricately involved in drafting
key agreements.
It issued an opinion on a transaction
it helped plan.
The court seems to have been offend-
ed by the size and nature of the fee for
the opinion letter. The company paid
the accounting firm $800,000, which
was not based on hourly billing rates.
While not entirely clear from the facts
presented, the court also believed that
the fee was contingent on the compa-
ny executing the transaction.
The court was also troubled by the num-
ber of times the accounting firm used
the phrase "it appears" when interpret-
ing tax authorities. For example, when
the opinion letter stated "it appears that
such regulations adopt an all or nothing
approach," the court admonished that
the accounting firm "had no basis for
that conclusion other than [its] interpre-
tation of the regulations."
One wonders whether the court
expects an opinion letter to be free of
any expressed opinions.
Significance of the Case
Under the analysis presented by the
court, most accounting firms have an
inherent conflict of interest with their
long-term clients. The client relies on
the accounting firm to assist with struc-
turing transactions. That fact alone
tends to put the firm in the position of
rendering tax advice on a transaction
the firm was involved in structuring.
Although the court cited a number of
cases in support of its "participation in
the structure leads to conflict of inter-
est" conclusion, virtually all of those
cases involved actively promoted tax
shelters. In those cases, taxpayers
who invested in the shelters were pre-
cluded from claiming reliance on a tax
adviser who was retained by the pro-
moter or who was involved in the struc-
ture and promotion of the shelter.
Most clients choose the Tax Court
because their case is heard without the
cost of first paying the tax and then
suing for a refund. Unfortunately, Canal
Corporation
is now precedent in the
Tax Court.
Most commentators have focused on
the issues the court took with the sub-
stance of the accounting firm's opin-
ion. But suppose the court had found
the opinion well-reasoned, but still
disagreed with the conclusion. And
suppose the court had found the fee
paid to the accounting firm reason-
able in amount.
Under the conflict of interest theory, at
least as interpreted by this court, the
company would still have been unable
to rely on advice provided by that tax
adviser to invoke the reasonable
cause exception to the accuracy-relat-
ed penalty.
One last question to consider is
whether the court thought the conflict
existed with the individual who wrote
the opinion letter or with the entire firm.
It appears the conflict existed with the
firm but since I have no basis for this
conclusion other than my interpretation
of the case, I suppose the court would
find that I am basing my advice on
unreasonable assumptions.
advocacy community education
22
CSCPA Past
President Michael
R. Redemske, CPA
is an instructor in
residence at the
University of
Connecticut, where
he teaches federal income taxation
and personal financial planning.
He can be reached via email at
Michael.Redemske@business.uconn.edu.
Reliance on Accountant Fails to Forestall Tax Penalty
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