The weight of IRS rulings and other documents, and what constitutes “substantial authority”

IRS issues a wide variety of documents every week, some of which is written for release to the public, and others of which are for IRS's internal use but released under the Freedom of Information Act (FOIA). Whether written for internal or public use, IRS administrative pronouncements vary in precedential value and utility. This examines various types of IRS pronouncements, their weight as authority, and their practical use to tax professionals and taxpayers. Part I considers the effect of the Mayo case on their precedential value. Part II, in this article, continues the discussion of different types of IRS documents and also addresses which are “substantial authority” for purposes of the accuracy-related and return preparer penalties.

Private Letter Ruling (“PLR”). A PLR is a written statement issued by the IRS Associate Office to a taxpayer (or the taxpayer's authorized representative) in response to a written inquiry from an individual or organization about its status for tax purposes or the tax effects of its acts or transactions, before the filing of returns or reports that are required by the revenue laws. A request for a private ruling can be withdrawn before the ruling is finalized (e.g., if it becomes apparent that IRS will rule adversely). A PLR is only binding with regard to the requesting taxpayer and may not be cited as precedent that is binding on IRS or relied on by another taxpayer. (See, e.g., Lucky Stores, Inc. & Subsidiaries vs. Com., (1998, CA9) 82 AFTR 2d 98-5815 , stating that “[t]axpayers other than those to whom such ruling or memoranda were issued are not entitled to rely on them.”) In IRS's instructions to personnel on the application of PLRs, it states that they “may not be used as precedents in the dispositions of other cases but may be used as a guide with other research material in formulating an area office position on an issue.” (IRM 4.10.7.2.10)

Because a PLR represents IRS's conclusions as to the particular transaction described in the ruling request, one taxpayer can't rely on a PLR issued to another taxpayer. IRS also isn't prevented by its ruling on a question of law or fact for an earlier year from reaching a different conclusion and applying a contrary ruling for a later year. (American Plywood Assn. v. U.S., (1967, DC WA) 19 AFTR 2d 615 ) A PLR may be modified or revoked retroactively by IRS, unless it is part of a closing agreement.

However, although PLRs are only binding against the requesting taxpayer, they have acquired some status in the courts as to how IRS interprets a certain provision in the absence of contrary authority. For instance, in Roman Companies Inc. v. U.S., (1981, S Ct) 48 AFTR 2d 81-5115 , the Supreme Court pointed to a series of PLRs in one case as evidence of IRS's position; and the Eighth Circuit referred to PLRs as an “instructive tool that we have at our disposal” in ABC Rentals of San Antonio, Inc. v. Commissioner, 81 AFTR 2d 98-1473 . The Court of Federal Claims further suggested in International Business Machine (IBM) Corp. v. U.S., (1965, Cl Ct) 15 AFTR 2d 1526 , that PLRs can potentially be used to demonstrate that the Commissioner has abused his discretion under Code Sec. 7805(b) . PLRs are also an important research resource for practitioners, because they often reveal “cutting edge” planning techniques used by other practitioners and indicate how IRS views them.

Technical Advice Memorandum (“TAM”). In a TAM, IRS's National Office responds to a request for advice on a technical or procedural question. Although the District Director or Chief, Appeals Office determines whether to request technical advice, a taxpayer may ask that the examining or appeals officer get technical advice on an issue. TAMs are cited the same way as PLRs (i.e., by number), and are similar to them in their effect, reliability, and use by practitioners.

Although TAMs are also not precedent that is binding on IRS, courts have approved the use of TAMs for reinforcing a taxpayer's independently viable position and revealing IRS's interpretation of the law. (See Buckeye Power Inc. v. U.S., (1997, Ct Fed Cl) 79 AFTR 2d 97-2794 )

Internal Revenue Manual (“IRM”). The IRM contains the policies, procedures, instructions, and guidelines governing IRS's organization and operations and covers in detailed fashion the daily functions of IRS personnel. It is updated by Manual Supplements. The IRM isn't legally binding because its provisions are directory and not mandatory. It is nonetheless an important research resource to practitioners, e.g., it shows what IRS may be looking for during an audit, or what factors should be considered by an IRS officer in whether to include the value of a dissipated asset in a taxpayer's reasonable collection potential (IRM Part 5.8.5.4(4)).

Guides for auditors. IRS sometimes issues “Market Segment Specialization” (MSSP) and Audit Technique Guides (ATGs) for its field agents and auditors. Some of them cover a specific industry (e.g., for farmers or independent used car dealers), and others are Reference Guides (e.g., the MSSP Reference Guide on Passive Activity Losses). These Guides can't be cited as authority or relied on by taxpayers. Nonetheless, they are valuable to practitioners for planning purposes because they represent IRS's “playbook” on a particular industry or topic.

Other IRS internal documents. None of the following documents may be cited or used as precedent, but all of them are valuable to practitioners in tax planning and controversies because they provide insight into IRS's current thinking on a certain topic.

... Field Service Advice (“FSA”) memoranda are prepared by IRS's National Office of the Office of Chief Counsel in response to requests from IRS field personnel for legal guidance, usually with respect to issues relating to a particular taxpayer. FSAs usually contain a statement of issues, facts, legal analysis and conclusions. The primary purpose of FSAs is to ensure that IRS field personnel apply the law correctly and uniformly. Although FSAs aren't considered a “final determination” of IRS's position, even if the case in which it is requested, it is nonetheless highly regarded and the advice is generally taken. (IRM 4.8.8.12.3)

In Schering-Plough Corp v. U.S., (2007, DC NJ) 100 AFTR 2d 2007-6864 , affirmed sub nom Merck & Co., Inc. (2011, CA3) 107 AFTR 2d ¶2011-960 , IRS reversed a position that it had taken in an FSA and applied the reversal prospectively to one taxpayer and retrospectively to another. The adversely affected taxpayer sued for a refund alleging disparate treatment, but the Third Circuit upheld IRS's denial, reasoning that FSAs “are not binding documents” and “are meant as guidance for the team conducting an audit, not as an assurance for the taxpayer being audited.”

... Chief Counsel Advice memoranda consist of written advice issued from any national office component of the IRS Office of Chief Counsel to IRS field personnel. Chief Counsel Advice encompasses advice or instructions that convey legal interpretations or positions of the IRS or the IRS Office of Chief Counsel concerning revenue provisions or laws relating to the assessment and collection of any liability under a revenue provision. RIA publications have described these memoranda in various ways, depending on how they are described in the IRS document, itself. Examples: IRS Legal Memorandum (“ILM”), Service Center Advice (“SCA”), or Chief Counsel Advice, or IRS Technical Assistance (“ITA”).

IRS Publications (“IRS Pubs”). Although IRS Pubs are issued to help taxpayers comply with the tax laws, they are not precedent. Courts have held that IRS isn't bound by the literal language of these publications, that they neither have the force of law nor create any rights, and that they aren't an authoritative source of income tax law. Despite these limitations, IRS Pubs are an important resource because they often explain provisions in greater detail than other forms of guidance. Sometimes, they represent the only IRS guidance on a subject until more formal guidance (e.g., a reg or ruling) is issued on it.

As a practical matter, even though a position taken by IRS in a Pub may not be cited as precedent, it is rare that IRS will contest a position taken by a taxpayer that is identical to that taken by IRS in the document, at least where the facts are substantially identical.

Frequently asked questions (FAQs). FAQs are an increasingly prevalent way for IRS to electronically provide information to the public in a timely manner. For example, FAQs have been recently been posted on IRS's website on topics including the voluntary disclosure initiative and the preparer tax identification number (PTIN) requirements, two relatively new and still-developing areas of law. A couple of explanations for the recent increase in FAQs are that the sheer volume of recent legislation, as well as the temporary nature of much of these law changes, prevent IRS from issuing formal guidance on all topics requiring further explanation.

It is uncertain at this point who exactly writes FAQs or what type of vetting process they are subject to prior to online publication. FAQs are also updated and changed periodically, apparently without any record of what was previously said. Although it is currently unclear what weight a court would give a FAQ, unless the position in the FAQ is contrary to that of “stronger” guidance, FAQs are an important source of information for taxpayers and practitioners.

 RIA observation: According to tax professor Annette Nellen's blog, in response to a question that she submitted to the National Taxpayer Advocate website on the role of FAQs, the response stated that FAQs don't meet the standard of reliance for court cases and that taxpayers “would most likely not be able to avoid penalties based on FAQ reliance.” ( http://21stcenturytaxation.blogspot.com/2011/03/irs-faqs-modern-guidance-or-risky-stuff.html )

Authority of IRS documents for penalty purposes. Under Code Sec. 6662 , a 20% accuracy-related penalty applies to substantial understatements of income tax and underpayments attributable to negligence or disregard of rules or regulations. Except in the case of tax shelters, the penalty tax for substantial understatements is avoided to the extent the understatement is due to the treatment of an item that is based on substantial authority or that was adequately disclosed on the return. The regs say the “substantial authority standard is an objective one involving an analysis of the law and application of the law to relevant facts.” Only the following IRS documents factor into whether there is substantial authority for the tax treatment of an item (some non-IRS documents also are substantial authority, but are not listed below):

Final and temporary regs, and proposed regs not yet superseded;Rev Ruls and Rev Procs;

PLRs, TAMs, AODs, and GCMS after they are released to the public, if they are dated after Dec. 31, '84. ( Notice 90-20, 1990-1 CB 328 ) The regs provide that PLRs and TAMs are authority if issued after Oct. 31, '76, and AODs and GCMs are authority if issued after Mar. 12, '81 or (for GCMs) if published in pre-'55 Cumulative Bulletins; and IRS information or press releases, Notices, Announcements and other administrative pronouncements published in the IRB. ( Reg. § 1.6662-4(d)(3)(iii) )

The 20% penalty for negligence or disregard of rules and regs doesn't apply for a return position that has a reasonable basis. If a return position is reasonably based on one of the IRS authorities listed above, the return position generally will satisfy the reasonable basis standard even though it may not satisfy the substantial authority standard. ( Reg. § 1.6662-3(b)(3) )

The Code Sec. 6694(a) return preparer penalty can also turn on whether the preparer had substantial authority for the position taken. The penalty can apply if the preparer prepares any return or refund claim for which any part of a tax liability understatement is due to an “unreasonable position,” and the preparer knew or should have known of the position, the preparer must pay a penalty for each return or claim equal to the greater of $1,000 or 50% of the income derived (or to be derived) by the preparer with respect to the return or claim. ( Code Sec. 6694(a)(1) ) The penalty can be avoided if the treatment of an item was based on substantial authority, or if the preparer had a reasonable basis and disclosed the position on the return.

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