Tax consultants and their marketers are governed under a different set of rules than Enrolled Agents, Certified Public Accountants, and attorneys, though there may be overlap of regulation amongst the groups. The latter group generally may not charge a contingent fee except in rare cases as prescribed under Circular 230(Opens a new window), the regulations governing practice before the IRS, and under other rules and standards applicable to these professionals. Conversely, some consultants may market their fees as a fraction of savings or with a guarantee that a tax position will be upheld. Taxpayers should be wary, as such an arrangement can trigger added compliance, additional scrutiny, and risk of penalties, negating otherwise valid tax reductions.

Added compliance, hefty penalties

Taxpayers who engage in a “reportable transaction” are subject to additional tax compliance. For instance, taxpayers must file Form 8886 to disclose the transaction and its participants, amongst a plethora of other details. Material Advisors (i.e., promoters) of such transactions are also subject to additional reporting on Form 8918. The penalties under Internal Revenue Code (IRC) Section 6707A for failing to disclose these transactions as required under IRC Section 6011 are steep. Each failure to file Form 8886(Opens a new window) generally results in a penalty between $5,000 to $200,000 depending on (1) any related tax reduction resulting from the transaction; (2) whether the taxpayer is an individual or not; and (3) whether the transaction is a “listed transaction.” Accuracy-related penalties may also apply. The penalties for unfiled Form 8918 (Opens a new window)or related recordkeeping are more complex and potentially more financially damaging. 

Guaranteed tax credits

One type of reportable transaction disclosable on Form 8886 is a transaction with contractual protection. Treasury Reg Section 1.6011-4(b)(4) (Opens a new window)defines transactions with contractual protection as those with fees refundable if a tax consequence is not sustained, or those contingent upon realization of a tax benefit. While this would seem to shut the door on “guaranteed tax credits,” Revenue Procedure 2007-20(Opens a new window) exempted certain tax credits from these reporting requirements such as the Work Opportunity Tax Credit and the Low-Income Housing Tax Credit under IRC Section 51 and Section 42, respectively. Several credits that were in place when this Revenue Procedure was issued such as the Credit for Increasing Research Activity (commonly known as the R&D Credit) are conspicuously absent from this list. 

Further areas of consideration

States may also have their own reportable transaction requirements for transactions with contractual protection and impose their own penalties. Adding to the complexity, certain contracts may propose alternate forms of contingent realization such as an audit guarantee, hourly rates not to exceed a contingent cap, alternate repayment methods, or financial benefits rendered to related parties other than the original stakeholders. 

Takeaways

Taxpayers should carefully evaluate whether factors such as the contingent nature of fees or any type of guarantee related to a tax position trigger additional reporting requirements. Tax credit engagements in particular warrant added scrutiny for additional compliance. Review any such agreements with a trusted tax advisor. 

_{Any advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues. Nor is it sufficient to avoid tax-related penalties. This has been prepared for information purposes and general guidance only and does not constitute legal or professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice specific to, among other things, your individual facts, circumstances and jurisdiction. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its partners, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.}