SPECIAL REPORT. tax notes. Navigating an OPR Disciplinary Proceeding. By Rita A. Cavanagh and Paul B. Hynes Jr. I. Introduction

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1 Navigating an OPR Disciplinary Proceeding By Rita A. Cavanagh and Paul B. Hynes Jr. Rita A. Cavanagh is a partner and Paul B. Hynes Jr. is an associate with Latham & Watkins LLP. Cavanagh was with the Treasury Department s Office of Tax Policy when the first major revisions to Circular 230 since 1994 were promulgated. The authors have concluded and have pending matters before the IRS Office of Professional Responsibility (OPR). The standards of practice under Circular 230 have been subject to considerable commentary, but less has been written about the process that occurs once a practitioner comes under investigation by OPR. Although Circular 230 does not address the informal administrative process that precedes formal adjudication with OPR, there are several considerations that practitioners should be aware of when determining whether and how to negotiate a resolution with OPR. Formal adjudication with OPR is a disciplinary proceeding governed by the rules of administrative adjudication with features of a tax penalty dispute. Since OPR began to publish decisions rendered by administrative law judges and the appellate authority, a body of administrative precedent has emerged that provides insight into procedural and legal issues, including evidentiary issues and the definition of willfulness under Circular 230. This report describes the process, examines several of those issues, and highlights important aspects of the published decisions to date. Copyright 2010 Rita A. Cavanagh and Paul B. Hynes Jr. All rights reserved. SPECIAL REPORT tax notes B. Mediation IV. Appeal Rights A. Administrative Appeal B. Judicial Appeal V. Professional and Reputational Considerations A. State Licensing Board and Other Referrals B. Reputational Concerns C. Considerations for a Practitioner s Firm. 799 VI. Conclusion I. Introduction Much ink has been spilled on the standards of practice before the IRS, which are set forth in 31 CFR part 10, commonly known as Circular This is because Circular 230 has been revised several times in the past decade in response to marketed tax shelters and because enforcement has increased. Considerably less ink has been spilled on the process that a practitioner confronts once he comes under investigation. The Circular 230 rules address the legal process that ensues once a case proceeds to formal adjudication, but they do not address the informal administrative process that precedes it. This absence of rules presents both a burden and an opportunity for counsel representing practitioners before the IRS Office of Professional Responsibility (OPR). 2 Likewise, there are risks and opportunities in a formal proceeding, because it is not a judicial setting governed by judicial practice and procedure. Rather, it is administrative adjudication before an administrative law judge (ALJ), with appeal to a single individual, the so-called appellate authority, who is appointed by the IRS chief counsel. 3 Judicial process is available only after a final agency decision, and the scope of judicial review is limited. Table of Contents I. Introduction II. Administrative Investigation and Resolution A. The Process Begins With an Allegation Letter B. Obtain the Administrative File at the Outset C. Negotiating a Resolution III. Administrative Adjudication A. Formal Adjudication Is Not Like Tax Litigation In 1884 Treasury was statutorily authorized to promulgate rules and regulations governing practice before the agency. 23 Stat. 236, (July 7, 1884). In 1886 rules and regulations were first promulgated in the form of a department circular denominated Circular 13. See Internal Revenue Record and Customs Journal, vol. 32, no. 7 (Feb. 18, 1886). The rules were redenominated Circular 94 in 1890 (see Internal Revenue Record and Customs Journal, vol. 36, no. 42 (Oct. 20, 1890)), and Circular 230 in See 3 C.B. 408 (1921). 2 OPR is officially part of Treasury, but is located in the IRS National Office building and its director reports to the IRS Commissioner. 3 Under a series of delegation orders, the authority to review decisions by the ALJ is delegated from the Treasury secretary to the general counsel and from the general counsel to the IRS chief (Footnote continued on next page.) TAX NOTES, May 17,

2 Further, although the administrative adjudication resembles a judicial process, there are significant differences. Most importantly, it is not a tax dispute, but rather a disciplinary proceeding governed by the rules of administrative adjudication that also in some respects resembles a tax penalty dispute. And despite some recent losses, 4 the cases OPR brings as it works through its current caseload and refines its enforcement and litigation strategies 5 will presumably have received close scrutiny and be cases that OPR is dedicated to pursue. Of particular concern to practitioners, recent decisions have raised issues concerning the appropriate standard of willfulness that OPR must demonstrate to establish most Circular 230 violations. 6 And in several ALJ decisions that have been appealed, the sanction imposed has been amended by the appellate authority, thus raising questions about the propriety of that action. As a result of OPR s determination to publish decisions rendered by ALJs and the appellate authority, 7 a nascent body of administrative precedent is emerging that provides some insight into the process and addresses some critical legal issues of which federal tax practitioners should be aware. This report describes the process, examines several of those considerations, and highlights important aspects of the published decisions to date. counsel, who is authorized under Delegation Order 9 (Jan. 19, 2001) to redelegate that authority. The current delegate is an assistant division counsel for tax litigation in the IRS Small- Business/Self-Employed Division. See IRS Office of Chief Counsel Notice CC (June 29, 2009), Doc , 2009 TNT See Director, OPR v. Sykes, No (Jan. 29, 2009) (rejecting allegations of lack of due diligence in connection with short form opinions addressing the basis of preferred stock in a leasing transaction); Director, OPR v. Panitz, No (June 15, 2009) (rejecting allegations of false or misleading statements made regarding offer in compromise submissions). 5 The director of OPR is reported to have said that when she was appointed to the position in March 2009, there was a backlog of approximately 700 cases that were more than a year old. Of those cases, 75 percent involved compliance issues. She further said that cases involving a hearing before an ALJ were being reviewed to determine if they can be resolved in different ways. Jeremiah Coder, OPR Finding Creative Ways to Handle Case Backlog, Hawkins Says, Tax Notes, Oct. 5, 2009, p. 49, Doc , 2009 TNT See Director, OPR v. Gonzalez, No (decision on appeal, Dec. 9, 2009); Director, OPR v. Kilduff, No (decision on appeal, Jan. 20, 2010). 7 Under section 10.72(d) of Circular 230, OPR now publishes all disciplinary decisions on its website, available at Decisions dating back to 2007 are available. 8 In some circumstances, the tax practitioner may instead receive a so-called soft letter or preallegation letter. OPR is (Footnote continued in next column.) II. Administrative Investigation and Resolution A. The Process Begins With an Allegation Letter A practitioner under scrutiny by OPR may be unaware of an investigation or referral to OPR until he receives an allegation letter. 8 The letter will summarize the allegations against the practitioner and the Circular 230 provisions that he has purportedly violated. Sometimes the practitioner has advance notice of a potential referral for example, if it has arisen out of a preparer or promoter penalty investigation by the IRS of which the practitioner is aware, and the practitioner has been informed of a referral (or an intended referral) to OPR. But even then, the precise allegations may be set forth for the first time in the allegation letter. It is important to realize that by the time an allegation letter is sent, OPR has made a preliminary determination that the allegations have merit. 9 Referrals are first reviewed by an OPR enforcement attorney, who sends an allegation letter if she concludes the allegations should be pursued. 10 If the matter is not resolved after a response is received from the practitioner or his representative, the case file is presented to a panel of OPR attorneys for additional review. 11 Keep in mind that although the majority of OPR matters involve relatively straightforward compliance failures, the more difficult cases may involve allegations arising from complex transactions, client engagements, or interactions with the IRS. For example, Sykes involved opinions rendered for a leasing transaction and Panitz involved submissions made in connection with offers in compromise. Also, OPR attorneys and Treasury General developing several types of soft letters for situations (generally involving compliance issues, such as a failure to file one s own tax returns) in which OPR provides the practitioner an opportunity to become compliant or if the practitioner has voluntarily come into compliance, OPR notifies the practitioner that it is aware of the prior noncompliance and sets forth conditions for future compliance. See Coder, supra note 5. In noncompliance (or conduct) cases, OPR has developed a preallegation letter to notify a practitioner that it has received a complaint and to request that the practitioner respond with any exculpatory or mitigating evidence. Jeremiah Coder, OPR Director Discusses Updates to Disciplinary Process, Tax Notes, Feb. 1, 2010, p. 605, Doc , 2010 TNT Historically, if OPR concluded that the allegations would not be pursued, the file was closed but retained by OPR without notice to the practitioner of the referral or closure of the matter. This procedure has been criticized, and the current director announced an intention to revise it to notify the practitioner of the referral and of OPR s decision not to proceed, and to permit the practitioner an opportunity to make a submission for the record. See Coder, supra note 5. Until that policy is implemented, if a practitioner learns of a referral, an inquiry should be made to learn whether prior referrals are in OPR s files in order to respond, if warranted, to that earlier referral. If such an inquiry is denied, a practitioner may file a Freedom of Information Act request with OPR for records of the prior referral. See PMTA (June 9, 2009), Doc , 2009 TNT (concluding that in response to a FOIA request, OPR should disclose prior practitioner misconduct reports that it did not pursue). 10 See IRS Publication 4693, Office of Professional Responsibility Brochure ( Who We Are; What We Do ), available at There are two enforcement branches. Branch 1 considers enforcement actions for attorneys, CPAs, and enrolled agents. Branch 2 covers enrolled actuaries, retirement plan agents, and appraisers. 11 Id. 790 TAX NOTES, May 17, 2010

3 Legal Services (GLS) attorneys who handle cases that proceed to formal adjudication are inevitably less familiar than private practitioners with the prevalent professional practices in different areas of tax practice. Nonetheless, because the issues have received review before the allegation letter, the practitioner is not starting with a clean slate when negotiating with OPR. Equally important, because there are no formal rules governing OPR s administrative consideration of a matter before the filing of a complaint, there are important strategic considerations from the outset, such as whether to meet with OPR, make a formal submission, or proceed directly to formal adjudication. The rules say only that OPR may confer with the practitioner concerning allegations of misconduct irrespective of whether a proceeding has been instituted. 12 Counsel should be involved early to obtain an understanding of the facts, to learn about any background investigation of which the practitioner is aware (for example, whether the referral likely came from a revenue agent, the client, or a third party), and to advise on those initial strategic decisions. Precisely because there is no preset procedure for dealing with OPR at this stage, counsel has an opportunity to be flexible in his approach in negotiating with OPR to achieve an early resolution of the investigation before it proceeds to a formal hearing CFR section 10.61(a). 13 In Sykes, the ALJ commented, it appears that if [the practitioner] had been more forthcoming during OPR s investigation of his conduct in preparing the basis opinions, this complaint might not have been issued. No at 12 n.10. However, the ALJ exonerated the practitioner of any misconduct, and it is hazardous to second-guess a strategic decision to proceed to trial solely on the basis of the foregoing comment. 14 Dustin Stamper, OPR Not Interested in Punishing Foot Faults, Officials Say, Tax Notes, Oct. 22, 2007, p. 318, Doc , 2007 TNT A referral against an attorney, CPA, enrolled agent, or enrolled actuary is made either on Form 8484, Report of Suspected Practitioner Misconduct, or by a letter or similar communication that includes the practitioner s name, address, telephone number, designation, and a detailed description of, and documents supporting, the allegations. OPR, How to File a Complaint Against Attorneys, Certified Public Accountants, Enrolled Agents, and Enrolled Actuaries, available at A referral against an unenrolled preparer is made by a letter or, if tax fraud or abuse is suspected, on Form 3949-A ( Information Referral ). OPR, Making a Complaint Against an Unenrolled Preparer, available at 0,,id=205897,00.html. Form 3949-A requests that the person making the referral provide the practitioner s identifying information, identify the alleged violation, estimate unreported income, briefly describe the facts of the alleged violation, indicate if books and records are available to substantiate the allegations, indicate if the practitioner appears to be dangerous, (Footnote continued in next column.) COMMENTARY / SPECIAL REPORT B. Obtain the Administrative File at the Outset A former director of OPR indicated that roughly half of all OPR referrals come from revenue agents. 14 That statistic has likely not materially changed; the referrals of which we are aware have uniformly been made by revenue agents. 15 But OPR may have only the information underlying the allegations that the revenue agent (or other referral source) has provided. It is critical to arrange with OPR at the outset to receive a copy of all materials in its file and, if necessary, file a FOIA request. We have found OPR to be accommodating in this regard. More troublesome, however, is that the information in OPR s possession may be only a fraction of the information in the underlying IRS administrative file, which may contain exculpatory material. But that information may be tax return information of another party (such as the practitioner s client), the disclosure of which, with some exceptions, is prohibited under section Counsel should discuss with OPR whether access will be granted to the entire file, and if not, consider alternative means of access, such as discovery under section 10.72(d)(3) of Circular 230 if the matter proceeds to adjudication. C. Negotiating a Resolution Given the absence of published procedures regarding the preadjudication stage, the first strategic decision is whether and how to negotiate with OPR. Because a resolution likely will not rest solely with the OPR enforcement attorney, serious thought should be given to a written presentation that can be reviewed by all the OPR decision-makers. The IRS Appeals protest with which tax professionals are familiar is a useful model for this purpose. 1. Settlement considerations. One important question is whether statements to OPR constitute admissions for purposes of any subsequent adjudication. For example, statements made by a taxpayer or authorized representative in a protest to, or in conference with, the IRS Office of Appeals may constitute admissions under Federal Rule of Evidence 801(d)(2) (admissions by party opponent) and may be submitted into evidence against a taxpayer at a trial. 16 OPR has not publicly indicated its views on this issue. Practitioners should be aware that a resolution can be negotiated for either no sanction or for a lesser sanction than what OPR would seek if the matter proceeded to adjudication. OPR s policy has been to seek the maximum sanction it has determined is appropriate if the matter is not resolved informally. There is no published guidance on how OPR evaluates a case for settlement purposes; however, OPR issued interim sanction guidelines effective for settlements occurring after OPR has finalized its investigation. 17 provide the name and address of financial institutions used by the practitioner, and explain how information relating to the allegations was obtained. 16 See, e.g., United States v. Webster, 94-1 U.S.T.C. (CCH) para. 50,008 (D. Md. 1993), Doc , 93 TNT (relying on statements made in the taxpayers protest to find that they acted willfully for purposes of the section 6672 penalty). But see Dow Chemical Co. v. United States, 435 F.3d 594, 611 (6th Cir. 2006), Doc , 2006 TNT 15-11, cert. denied, 549 U.S (2007) (trial court did not abuse its discretion by excluding Dow s protest as evidence of conduct or statements made in compromise negotiations). 17 The guidelines were temporarily removed from the IRS OPR website for updating and will be back on the website (Footnote continued on next page.) TAX NOTES, May 17,

4 Although the facts and circumstances of each case must be considered, the guidelines describe generally when a reprimand, censure, suspension, or disbarment is appropriate, and they recommend suspensions of specific lengths for compliance violations (such as a two- to four-month suspension if a form 1040 is late filed at time of OPR contact ). The guidelines also provide a list of mitigating factors (such as measures put into place after the misconduct to prevent future violations ) and aggravating factors (such as failure to respond to OPR ) that OPR considers. Presumably, OPR evaluates a case based on litigation hazards, but the office has not said so, and it is unclear whether OPR follows the informal rule applied in tax cases that a case strongly favoring one of the parties (80 percent or better) should be conceded. One difficult issue for settlement purposes is whether to acknowledge any wrongdoing upfront. OPR appears to evaluate expressions of contrition favorably 18 and may perhaps require them as a price of settlement, but practitioners under investigation are obviously disinclined to make such acknowledgements early in a proceeding. Litigators are usually familiar with this particular minefield, however, and know how to navigate it. Also, OPR has historically maintained that any settlement involving a sanction greater than a private reprimand requires that the identity of the practitioner be made public. This can be a sticking point in settlement negotiations in a case that from the practitioner s standard is strong but not bulletproof. If there is a basis for the allegations, the opportunity for settlement may be enhanced if the practitioner has already taken corrective action or has a proposal for corrective action. 19 The practitioner and his counsel should expect that an informal resolution will involve one or two meetings with the OPR staff assigned to the matter and possibly with a more senior OPR staff member. If counsel believes OPR misunderstands the matter, the question is whether to take it up the chain or proceed to adjudication. Given OPR s resources, however, there are few links in that chain. 20 Former OPR directors expressed a policy of declining to meet with practitioners or their representatives. The current director may follow the same practice. 2. Jurisdictional considerations. Jurisdictional issues must be evaluated early in the case because they may be dispositive or increase the litigation hazards for OPR. A key question is whether OPR has jurisdiction over the client as a practitioner before the IRS. This can be more complicated than sometimes appears, because there is uncertainty regarding the outer boundaries of OPR s jurisdiction. If the allegations relate to the practitioner s conduct in dealings with the IRS, his status as a practitioner is usually clear. But if, for example, the allegations relate to conduct in an advisory role to a client, it is less clear whether OPR has jurisdiction, particularly if the practitioner never filed a Form 2848, Power of Attorney and Declaration of Representative, with the IRS. The current rules clarify that practice before the IRS includes the rendering of advice, and the phrase is defined broadly to comprehend[] all matters connected with a presentation to the Internal Revenue Service... relating to a taxpayer s rights, privileges, or liabilities under laws or regulations administered by the agency. 21 Those presentations include preparing and filing documents, corresponding and communicating with the Internal Revenue Service, rendering written advice with respect to any entity, transaction, plan or arrangement, or other plan or arrangement having a potential for tax avoidance or evasion, and representing a client at conferences, hearings and meetings. 22 There is a question whether practice before the IRS includes the preparation and filing of federal tax returns when no advice is rendered or no other representation before the IRS has occurred. Section of Circular 230 imposes standards on return preparers that are derived from the standards for the section 6694 return preparer penalty, and under section 10.2(a)(4), a presentation includes preparing and filing documents. However, regulations issued in 1958 provided that neither the preparation of tax returns nor the furnishing of information at the request of the [IRS] is considered practice before the Service, and the definition of practice in those regulations has remained largely unchanged. 23 Moreover, OPR has indicated that a suspended or disbarred practitioner may continue to prepare tax returns, suggesting that in OPR s view, the preparation of returns does not by itself constitute practice before the IRS. 24 This presumably will change, of course, when return preparers are regulated under the IRS s contemplated return preparer regulation program. Sykes addressed the jurisdictional issue regarding tax advice for pre-2007 years. The 1996 rules governed the practitioner s conduct. The decision found that the [short form] opinions were intended and were reasonably expected to be a part of the taxpayer s presentation to the IRS in support of its position with respect to the basis of the stock and that [the practitioner s] preparation of those opinions constituted practice before the IRS. 25 sometime this spring. The discussion in the text refers to the interim guidelines that were posted before their removal. 18 Recognition of action or inaction violating Circular 230 and commitment to future compliance is a mitigating factor in OPR s interim sanctions guidelines. 19 Mitigating factors in the interim sanctions guidelines include correction of the violation before contact with the IRS [or] OPR, or correction initiated within a reasonably short period after contact by OPR. 20 The OPR director has said that the office has only 11 staff attorneys. See Jeremiah Coder, OPR Still Getting Input on Paid Preparer Review Process, Tax Notes, Oct. 19, 2009, p. 285, Doc , or2009 TNT CFR section 10.2(a)(4). 22 Id. (emphasis added). The highlighted clause was first set forth in proposed regulations issued in 2006 and was retained in the final regulations issued in 2007, effective for conduct occurring after September 26, See REG , 71 Fed. Reg. 6,421 (Feb. 8, 2006), Doc , 2006 TNT (proposed regulations); T.D. 9359, 72 Fed. Reg. 54,540 (Sept. 26, 2007), Doc , 2007 TNT (final regulations). 23 See 23 Fed. Reg. 9,261, 9,262 (Nov. 29, 1958). 24 See IRS Publication 4693, supra note Sykes, No at TAX NOTES, May 17, 2010

5 The current OPR director recently highlighted other questions, such as whether nontax professionals who, for one reason or another, have filed a power of attorney with the IRS (her examples were family law or bankruptcy attorneys) are practitioners subject to OPR s jurisdiction by reason of that filing. 26 It is not always obvious that those professionals are practitioners before the agency, and a determination of jurisdiction depends on the factual context and the professional s role. If OPR s basis for jurisdiction is a filed power of attorney, questions can arise such as whether the power of attorney must be for the matter that is the subject of the allegations (probably not), or whether the conduct that forms the basis of the allegations must have occurred after the power of attorney was filed that is, was the practitioner subject to OPR when the conduct occurred (again probably dependent on the facts). Suppose, for example, that a practitioner advised a client and only later filed a power of attorney to provide the IRS access to documents in the practitioner s possession in an examination of the transaction. Is that power of attorney a basis for OPR jurisdiction over alleged misconduct in the rendering of the opinion? If not, does OPR otherwise have jurisdiction because the allegations relate to the nature of the advice rendered? What if the advice was not tax advice? 27 III. Administrative Adjudication A. Formal Adjudication Is Not Like Tax Litigation A formal proceeding begins with the filing of a complaint by OPR, which in essence will repeat the allegations made in the initial letter of inquiry, unless the allegations were refined during discussions with OPR The maximum sanction will be sought. As previously noted, when OPR files a complaint, it pursues the maximum sanction that it has determined to be appropriate. Although the sanction sought is entitled to some deference, the ALJ can reduce the sanction imposed Coder, supra note 5. The director reportedly said, however, that if the misconduct of those professionals is of a compliance nature such as unfiled tax returns, OPR may enter into a deferred agreement whereby the practitioner becomes and remains compliant for five years without having the agreement made public. Id. This approach, of course, does not resolve the jurisdictional issue but may avoid a jurisdictional challenge. 27 As a historical footnote, before 1966 all practitioners before the IRS had to enroll. With the exception of the highlighted clause in the current definition of practice, i.e., treating written advice as practice before the agency, the definition has remained unchanged since first promulgated in See 6-2 C.B. 392 (1927). 28 It has been reported that approximately 20 to 25 cases each year reach the formal complaint stage, although most are resolved without a hearing. See Jeremiah Coder, IRS Designates New Appeals Reviewer for OPR Cases, July 13, 2009, p. 118, Doc , or2009 TNT See, e.g., Director, OPR v. Yoder, No (May 19, 2008) (OPR sought disbarment, but two-year suspension was imposed instead); Director, OPR v. Friedman, No (July 28, (Footnote continued in next column.) COMMENTARY / SPECIAL REPORT 2. The full effect of the sanction is not clear. It is unclear whether suspension or disbarment from practice before the IRS means only that the practitioner may not represent taxpayers before the IRS or if it also precludes the practitioner from advising taxpayers on tax issues that are not yet in dispute (tax planning). OPR has indicated only that a suspended or disbarred practitioner may not advocate for or represent a taxpayer before the IRS but may continue to prepare tax returns or receive and provide information to the IRS through submission of a Form 8821, Taxpayer Information Authorization. 30 The lack of clarity arises from the ambiguous definition of practice before the IRS, described above. In the event sanctions are imposed, practitioners and their representatives should be clear regarding the professional activities in which the practitioner may not engage during the disciplinary period. The ambiguity is particularly troubling for in-house counsel. The director of OPR recently expressed the view that in-house tax counsel may be subject to discipline by OPR. 31 If in-house counsel is suspended or disbarred, the implications are unclear regarding what employment duties of in-house tax counsel would be affected. Those duties generally involve tax planning, preparing the employer s tax return, 32 and interacting with IRS revenue agents in audits of the employer. It is clear, however, that suspension or disbarment does not preclude the practitioner from practicing in the U.S. Tax Court or other courts, because the courts have supervision over judicial practice. 3. The matter is decided by an ALJ. The hearing occurs before an ALJ, and Treasury, having no ALJs of its own, uses agreements with other federal agencies for the services of their ALJs. 33 Until 2010, OPR matters were heard before ALJs from the National Labor Relations Board. 34 OPR now has contracts with the Environmental Protection Agency, the U.S. Coast Guard, and the U.S. Postal Service. There are several important considerations regarding this ALJ situation. Obviously, the first is that the ALJ does not routinely hear tax cases or necessarily have a tax background. However, at least the matter is before a decision-maker who is not part of the IRS ) (reducing the sanction from an 18-month to 12-month suspension), aff d on appeal (Apr. 2008). 30 See IRS Publication 4693, supra note See Coder, supra note Under section 7701(a)(36)(B)(ii) and reg. section (f)(ix), the preparation of a return for one s employer is not return preparation subject to the return preparer penalty of section 6694, which underlies section of Circular 230. Moreover, OPR has maintained that a practitioner suspended or disbarred from practice before the IRS may continue to prepare tax returns. See IRS Publication 4693, supra note Likewise, disciplinary proceedings before the SEC may be presided over by an ALJ. 17 CFR section OPR has also suggested that Treasury may have to consider reestablishing its own ALJs. See Coder, supra note See Director, OPR v. Francis, No at 17 (decision on appeal, Feb. 4, 2008). ( ALJs are purposely selected from a pool of ALJs at other Federal Agencies and Departments to ensure (Footnote continued on next page.) TAX NOTES, May 17,

6 Disciplinary proceedings generally do not involve complex technical tax issues. However, because a nontax specialist is the decision-maker, counsel should consider the manner in which the case is presented so that the ALJ understands the nature of the practice area, the practitioner s role in the transaction, and the standards of conduct and ethical rules that bind practitioners for example, the different ethical duties imposed on tax advisers in their advisory versus advocacy roles. It is therefore perhaps unfortunate that the ALJs used by OPR rotate among federal agencies, because the body of experience built up by ALJs in one agency may not be fully transferred to ALJs in another agency through their published opinions. 4. The rules of administrative adjudication apply. The procedural and evidentiary rules in Circular 230 reflect administrative adjudicatory practice rather than judicial practice. Thus, for example, the Federal Rules of Evidence do not apply. 36 This means that hearsay evidence is admissible. Hearings are conducted in accordance with section 556 of the Administrative Procedure Act (APA). 37 Also, section 10.70(b) of Circular 230 enumerates the powers of the ALJ, and a notable omission is subpoena power. 38 The ALJ does have explicit authority to adopt rules of procedure as needed and to take any other measures that are necessary or appropriate for the conduct of the proceedings. 39 None of the published cases have addressed the ALJ s subpoena power, and it is unclear whether the general grant of authority encompasses that power. 40 Another question is the deference that may be given to OPR s interpretation of its own rules. This is no different in principle from the deference issues that arise in connection with published tax guidance under Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984), or other deference standards. But a number of important Circular 230 rules (for example, section 10.22, governing due diligence) are relatively that one person with important functions in the overall Circular 230 proceedings is, in both fact and perception, totally independent of the Internal Revenue Service. ) CFR section 10.73(a) CFR section 10.72(a)(3)(ii). 38 By contrast, for example, section 18 of D.C. Bar Rule XI, which governs disciplinary proceedings before the D.C. Bar, authorizes the issuance of subpoenas to compel testimony. The rules for disciplinary proceedings before the SEC also provide for subpoena power. 17 CFR section Likewise, 35 U.S.C. section 24 provides for the use of subpoenas in any contested case in the Patent and Trademark Office, although the rules governing disciplinary proceedings before that office also state that subpoenas shall not be admitted into the record or considered unless leave to proceed under 35 U.S.C. section 24 was previously authorized by the hearing officer. 37 CFR section CFR section 10.70(b)(4), (9). 40 APA section 556(c)(2) provides that subject to published rules of the agency and within its powers, employees presiding at hearings may... issue subpoenas authorized by law. The question is whether a subpoena issued in connection with an OPR proceeding is authorized by law. terse, and there is no large body of public law on how they apply in particular contexts. Precedent from comparable ethical rules, rule commentaries, bar opinions, and the like may be helpful in applying the rules, but are not binding. For example, section of Circular 230, which governs conflicts of interest, is modeled after American Bar Association Model Rule 1.7. That rule contains significant commentary to guide its application, and ABA Model Rule 1.0 contains definitions of relevant terms, such as informed consent. Expert testimony on accepted professional ethics in particular contexts may also prove helpful. The Circular 230 rules allow for expert testimony. 41 Several decisions have addressed the utility of that testimony and the relationship of state bar ethical rules to Circular 230. In Sykes, for example, expert testimony was heard on the use of short-form opinions in leasing transactions. 42 In Francis the appellate authority ruled that the ALJ s decision not to permit expert testimony on the standards of practice in federal tax collection procedures (and to instead allow an offer of proof on how the expert would have testified) did not so prejudice [the practitioner s] case as to constitute reversible error. 43 However, the appellate authority found that the ALJ s understanding of the matters at issue may have been improved if the expert had been permitted to testify and if the ALJ had considered the expert s proposed testimony in issuing his decision. 44 In Panitz factual testimony was heard on the process for submitting OICs, the review process undertaken by the revenue officer, the IRS s expectations in terms of the information to be provided, and the general practice of the practitioner s firm in preparing and submitting those offers. However, the ALJ rejected a proffer of expert testimony on professional ethics, presumably because the ALJ believed the testimony would not be helpful on the question presented OPR cases resemble tax penalty cases. a. OPR has the burden of proof. As is true for the IRS in some tax penalty cases, OPR bears the burden of proof on the misconduct. That burden must be satisfied under one of two standards, depending on the severity of the sanction sought. 46 The standard is a preponderance of the evidence if the sanction sought by OPR is a suspension of less than six months, and it is a clear and convincing evidence standard if a more severe sanction is sought. 47 In Sykes the ALJ applied the well-established standard for clear and convincing evidence: a degree of proof which will produce in the mind of the trier of fact a firm belief as to the allegations sought to be established. 48 b. For most violations, OPR must prove willfulness. With the exception of alleged misconduct under sections 10.34, 10.35, 10.36, and of Circular 230, OPR must CFR section 10.72(c)(3). 42 Sykes, No at Francis, No at 13-14, 17 (decision on appeal). 44 Id. at Panitz, No at 1 n CFR section 10.76(b). 47 Id. 48 Sykes, No at 5; see also Panitz, No at 10 n TAX NOTES, May 17, 2010

7 prove that the misconduct was willful. 49 The published cases have consistently applied the voluntary, intentional violation of a known legal duty standard articulated in United States v. Pomponio, 429 U.S. 10, 12 (1976). 50 This standard does not require a finding of bad faith on the part of the practitioner. 51 In Panitz, however, although agreeing that willfulness does not require a showing of malicious intent or bad faith, the decision amplified that willfulness requires more than a showing of careless disregard for the truth and that the evidence did not show an attempt to falsify information... or to mislead the IRS about the existence of the funds held by the attorney. 52 The decision said that willfulness cannot be established by mere omission or failure to disclose information but must be evidenced by conduct from which an intent to deceive or mislead may be inferred. 53 The decision drew a fine line between malicious intent/bad faith and a knowing submission of false or misleading information. The Panitz decision did not accept OPR s contention that the Pomponio standard, which arises from a criminal tax provision, is higher than that required under Circular 230, nor did it accept that under some state disciplinary rules, willfulness requires only a showing of a general purpose or willingness to commit the act or permit the omission. 54 The decision noted that like the Pomponio standard, the specific state disciplinary standard relied on by OPR derived from the relevant state penal code, and the penal code itself required a showing of intentional conduct. 55 In Francis the appellate authority disagreed with the ALJ s statement in Panitz that state disciplinary precedents, rather than federal tax law, provided the applicable definition of willfulness. 56 However, in the more recent Gonzalez decision, the appellate authority questioned in dicta whether the criminal standard in Pomponio is appropriate for determining CFR section 10.52(a). Interestingly, the appellate authority in Francis indicated that had the sanction been a private reprimand, OPR would not have been required to prove willfulness. Francis, No at 2 n.3 (decision on appeal) ( hence I disagree with the ALJ s statement that only some sections of Treasury Circular 230 require [OPR] to prove that practitioner conduct was willful, at least if the sanction to be imposed is censure, suspension or disbarment ). No authority was cited for that assertion, although it presumably rests on the view that the remedy of a private reprimand is appropriate only for conduct that does not rise to the level of willful misconduct; for example, for negligent or reckless misconduct. But if the misconduct is not willful, it is unclear why any sanction, even a private reprimand, can be imposed under Circular 230, although the sanction has long been in use. 50 See, e.g., Director, OPR v. Banister, No at 42 (decision on appeal, June 25, 2004). 51 See, e.g., Director, OPR v. DeLiberty, No at 2 (Sept. 11, 2007) (willfulness does not require a showing of malicious intent or bad purpose, but only that the practitioner purposefully disregarded or was indifferent to his obligation ). 52 Panitz, No at Id. at Id. at 11 n Id. 56 Francis, No at 2 n.3 (decision on appeal). COMMENTARY / SPECIAL REPORT willfulness under Circular The appellate authority reasoned that the term willful in the State Bar of California s Rules of Professional Conduct has been defined as a purpose or willingness to commit the act, or make the omission referred to, but does not require any intent to violate law, or to injure another, or to acquire any advantage. 58 The appellate authority invited the parties in future cases to brief what the appropriate definition for willfulness should be under Treasury Circular The same question was raised by the appellate authority in Kilduff. 60 The principal distinction between criminal and civil willfulness is presumably the availability of the so-called Cheek defense that the practitioner did not know of the legal duty he is charged with violating. Otherwise, the standards are fairly similar. 61 Several decisions on appeal have considered when and to what extent the Cheek defense may be appropriate. In Cheek v. United States, the Supreme Court held that willfulness requires the Government to prove that the law imposed a duty on the defendant, that the defendant knew of this duty, and that he voluntarily and intentionally violated that duty. 62 For matters of statutory construction under the code, the Court found that by imposing a willfulness standard, Congress intended to depart from the common-law rule, which presumed knowledge of the law, to a rule requiring proof of knowledge (and thus specific intent). However, for issues involving the constitutionality of the code, the Court found that the common-law rule of presumption continued to apply. 63 In Banister the appellate authority acknowledged the applicability of Cheek in determining willfulness, but also 57 Director, OPR v. Gonzalez, No at 5 (decision on appeal, Dec. 9, 2009). Before addressing willfulness, the appellate authority held that the practitioner s appeal should be dismissed as untimely. Id. at Id. at 5 (quoting Richard A. Phillips v. State Bar of California, 782 P.2d 587, 591 (Cal. 1989)). 59 Id. 60 Kilduff, No at 5 (decision on appeal). 61 The willfulness standard in section 6672 responsible person penalty cases means the intentional preference of other creditors over payment of unpaid withholding taxes to the United States. Intentional has been held to mean with knowledge or reckless disregard of the withholding and payment obligation. See, e.g., Plett v. United States, 185 F.3d 216, 219 (4th Cir. 1999), Doc , 1999 TNT ; United States v. Pomponio, 635 F.2d 293, 298 n.5 (4th Cir. 1980). Regarding the civil tax fraud penalty, the willfulness standard means fraud with an intent to evade tax. See Mitchell v. Commissioner, 118 F.2d 308, 310 (5th Cir. 1941); see also Parks v. Commissioner, 94 T.C. 654, 664 (1990) (the IRS must establish the requisite fraudulent intent, and the intent to conceal or mislead may be inferred from a pattern of conduct ) U.S. 192, 201 (1991). 63 The defendant in Cheek, charged with evading income taxes in violation of section 7203 of the Internal Revenue Code of 1954, challenged a jury instruction that an honest but unreasonable belief is not a defense and does not negate willfulness. 498 U.S. at The Supreme Court held that the jury should have considered the defendant s asserted belief that his wages were not income subject to tax, but not his belief that the tax laws were unconstitutional. Id. at TAX NOTES, May 17,

8 distinguished the case because it involved a criminal proceeding and an ordinary taxpayer, not an experienced tax professional. 64 In cases in which the appellate authority has considered the Cheek defense, it has ruled that the defense did not apply because (1) the charges did not involve an interpretation of the code 65 ; (2) the practitioner s subjective belief did not relate to what the law was, but rather to what he believed the law should have been 66 ; or (3) evidence established that the practitioner was aware of the legal duty imposed on him. 67 Thus, as a practical matter, the distinctions among the criminal and civil standards of willfulness may not mean much in the majority of OPR cases. It is difficult to imagine a scenario in which the Cheek defense would be available to an experienced tax professional held to knowledge of the tax laws. c. Recklessness or gross incompetence is the standard for violations of the opinion and return preparation standards. The standard of misconduct that warrants sanctions under sections through 10.37, which relate to return preparation and other submissions, 68 written advice, 69 and the obligations of firms, 70 is recklessness or gross incompetence. Section 10.51(a)(13) defines reckless misconduct (regarding opinion rendering) as a highly unreasonable omission or misrepresentation involving an extreme departure from the standards of ordinary care. Gross incompetence is defined to include conduct that reflects gross indifference, preparation which is grossly inadequate under the circumstances, and a consistent failure to perform obligations to the client. 71 A pattern of conduct is one of the factors that will be considered in determining whether a practitioner acted recklessly or with gross incompetence. 72 In sum, a single or sporadic act of negligence, unless egregious, should not justify sanctions under sections through of Circular Typical trial presentation. In the published cases to date, OPR has principally relied on IRS witnesses (for example, revenue agents) or cross-examination of the practitioner s witnesses as its trial strategy. In simple cases, this may be sufficient, but it can present risks to OPR in more complex cases. In Sykes, for example, the practitioner presented both fact and expert witness testimony. In contrast, OPR did not present any witnesses with any direct knowledge of the lease stripping transactions involved here, the interaction between [the practitioner and the client], or the preparation of the basis opinions it alleges constitute disreputable conduct. 64 Banister, No at (decision on appeal). 65 See, e.g., Director, OPR v. Moose, No at 4 (decision on appeal, Mar. 16, 2009); Director, OPR v. Friedman, No at 8 (decision on appeal, Apr. 2008). 66 See Director, OPR v. Jones, No at 6 (decision on appeal, Oct. 12, 2007). 67 See DeLiberty, No at 7 (decision on appeal) CFR section CFR sections and CFR section CFR section 10.51(a)(13). 72 Id. Rather, it chose to rely on the opinions, which it apparently contends speak for themselves and establish misconduct on the practitioner s part. 73 The ALJ concluded, to the contrary, that the evidence in the record does not support that view. 74 Further, at several junctures in the opinion, the ALJ commented on OPR s failure to put on witnesses from the client, a large hedge fund, to attest to whether there were issues of which they were unaware because those issues were not discussed in the practitioner s short-form opinions. 75 In Panitz OPR presented testimony by the revenue agents and the then-acting director of OPR regarding their conclusions on why OICs prepared by the practitioner had not been truthful and forthcoming. 76 However, OPR unsuccessfully proffered expert testimony on professional ethics, presumably regarding the supervisory responsibilities of attorneys. 77 Although no reasons are set forth in the decision, the ALJ apparently concluded that the factual issue would not be aided by expert testimony. The ALJ found the practitioner s testimony that his supervision was general rather than specific to be credible, and OPR did not present any contrary testimony by the supervised attorney. 78 The decision noted the absence of such testimony and that the supervised attorney was no longer with the practitioner s firm or practicing law. 79 Although she made no explicit inferences from these facts, the ALJ was left with a credible fact witness in the practitioner and no contrary testimony. Readers of the decision may wonder whether the ALJ suspected that OPR had proceeded against the supervising attorney because the real culprit, if there was one, was beyond its disciplinary reach by reason of exiting the profession. 7. Other considerations. Counsel also must be cognizant of any prior proceedings relating to the underlying transaction and whether they addressed the quality of the practitioner s work product. In Sykes, for example, the taxpayer had lost the underlying tax case in district court on the merits, but in the OPR proceeding the ALJ did not credit comments from the district judge regarding the lack of persuasive value in the tax adviser s opinions: There is no indication that [the district court judge] was aware of the due diligence undertaken by [the practitioner] but not a part of the short form opinions. 80 Published opinions, trial or deposition testimony, or documents in other court proceedings must be evaluated for any potential effect on the OPR proceeding. B. Mediation Circular 230 makes no explicit provision for mediation in the formal administrative adjudication, but the ALJ is empowered to hold or provide for the holding of 73 Sykes, No at Id. 75 Id. at Panitz, No at 3-4 n Id. at 1 n Id. at 12 n Id. at Sykes, No at n TAX NOTES, May 17, 2010