Contingent Fee Tax Advice Restrictions
The IRS has the authority to regulate the practice of taxpayer representatives before the IRS as provided under 31 U.S.C. section 330(a)(1). And pursuant to the applicable regulations known as Circular 230, the IRS proscribes that a practitioner cannot charge a contingent fee for services rendered in connection with any matter before the IRS, with three exceptions (as noted below). See 31 CFR, Subtitle A, Part 10 (Circular 230).
Circular 230 defines “contingent fee” as any fee that is based, in whole or in part, on whether a position taken on a tax return or other filing avoids challenge by the IRS or is sustained either by the IRS or in litigation. A contingent fee includes a fee that is based on a percentage of the refund reported on a return or on a percentage of the taxes saved or otherwise depends on the specific tax result attained. See Circular 230, section 10.27(c)(1).
A contingent fee also includes any fee arrangement in which the practitioner will reimburse the client for all or a portion of the client’s fee if a position taken on a tax return or other filing is challenged by the IRS or is not sustained. This extends to reimbursement pursuant to an indemnity agreement, a guarantee, rescission rights, or any other arrangement with a similar effect
In Circular 230 (See 31 CFR, Subtitle A, Part 10 (Circular 230)) the IRS says that a practitioner cannot charge a contingent fee for services rendered in connection with any matter before the IRS. See Circular 230, section 10.27(b)(1).
But Circular 230 recognizes three exceptions:
1. Under section 10.27(b)(2), a contingent fee may be charged in connection with the IRS’s examination of or challenge to:
a. an original tax return; or
b. an amended return or claim for refund or credit when the amended return or claim for refund or credit was filed within 120 days of the taxpayer’s receiving a written notice of the examination of, or a written challenge to, the original tax return
2. Under section 10.27(b)(3), a contingent fee may be charged in connection with a claim for credit or refund filed solely in connection with the determination of statutory interest or penalties assessed by the IRS.
3. Under section 10.27(b)(4), a contingent fee may be charged for services rendered in connection with any judicial proceeding arising under the Internal Revenue Code.
In Loving, the district court held Section 330(a) expressly limits the regulatory authority of the Secretary of the Treasury to "the practice of representatives of persons before the Department of the Treasury." See Loving v. IRS, 742 F.3d 1013 (D.C.Cir.2014); see also 31 U.S.C. 330(a)(1). To fall under Section 330, the regulated conduct must be "practice" and must be undertaken by a "representative."
As the Loving court held, two terms "Representative" and "Practice" in the Section 330(a) provision are key:
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(1) "Representative"
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As to the meaning of the term "representative," Loving held a "representative" is traditionally one "with authority to bind others." Loving, 742 F.3d at 1016.
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Tax-return preparers neither "possess legal authority to act on the taxpayer's behalf" nor can they "legally bind the taxpayer by acting on the taxpayer's behalf." Loving, 742 F.3d at 1017. As a result, taxpreparers are not per se agents.
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The Loving court defined "tax return preparers" to expressly include those preparing refund claims.
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However, CPAs preparing and filing such claims before possessing any power of attorney possesses no "legal authority to act on behalf of taxpayers." Loving, 742 F.3d at 1017.
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In Loving's words, these individuals merely "assist" the taxpayer. Thus, Section 330's use of the term "representative" excludes refund claim preparers, just as it did tax-return preparers in Loving.
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(2) "Practice"
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As the Loving court explained, "practice . . . before the Department of the Treasury," like practice before any agency or court, "ordinarily refers to practice during an investigation, adversarial hearing, or other adjudicative proceeding." Loving, 742 F.3d at 1018.
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The process of filing an Ordinary Refund Claim—again, before any back-and-forth with the IRS—is similar to the process of filing a tax return in that both take place prior to any type of adversarial assessment of the taxpayer's liability.
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If a "tax-return preparer do[es] not practice before the IRS when [he] simply assist[s] in the preparation of someone else's tax return," then a CPA hardly "practices" before the IRS when he simply prepares and files a taxpayer's refund claim, before being designated as the taxpayer's representative and before the commencement of an audit or appeal. Loving, 742 F.3d at 1018.
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Following Loving, the Court therefore concludes that the plain text of Section 330 excludes preparers and filers of Ordinary Refund Claims from the scope of the IRS's regulatory authority.
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But see Recent IRS Position Publication - "Practice Before the IRS"
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“Practice before the IRS” comprehends all matters connected with a presentation to the IRS, or any of its officers or employees, relating to a taxpayer’s rights, privileges, or liabilities under laws or regulations administered by the IRS.
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Such presentations include, but are not limited to,
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preparing documents;
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filing documents;
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corresponding and communicating with the IRS; and
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rendering oral and 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.
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See IRS Link: What does “practice before the IRS” entail?
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In Loving, preparing and signing tax returns is not practice before the IRS. Therefore, the IRS cannot regulate tax return preparers.
After the D.C. Circuit’s decision in Loving, another district court (Ridgely) also reiterated that Circular 230 could regulate only “practice” before the IRS. See Ridgely v. Lew, 55 F. Supp.3d 89 (D.D.C. 2014). The Ridgely district court held that a CPA’s preparation of an ordinary refund claim, prior to holding any power of attorney, is vested with no legal authority to act on behalf of the taxpayer. As such, the CPA is not a representative, which means that preparing the refund claim is not practice before the IRS.
Furthermore, recently in Sexton, the Sexton court held the IRS Office of Professional Responsibility (OPR) has no authority or jurisdiction over a disbarred attorney/tax preparer or his tax preparation practice and cannot regulate his provision of tax advice a federal district court in Nevada. See Sexton v. Hawkins, 2:13-cv-00893-RFB-VCF (D. Nev. 3/17/17). The court granted the tax preparer’s motion for a permanent injunction against the IRS from seeking to assert authority or jurisdiction over his tax preparation activities.
Nevertheless, as noted above, the IRS has argued that there is an alternative grant of authority in 31 U.S.C. section 330(e), which refers to the regulation of written advice “with respect to any entity, transaction plan or arrangement, or other plan or arrangement, which is of a type which the Secretary determines as having a potential for tax avoidance or evasion.” As such original return tax preparation falls under the purview of Circular 230 and restrictions on contingency fee arrangements.
Conclusion
In general, amending federal returns to claim the R&D credit in exchange for a contingency percent of any refunds may face challenges by the IRS as a permitted contingency fee arrangement. Although there is argument to contend that the preparation of original refund claims does not amount to representing a taxpayer / company in a matter before the IRS, thus section 10.27(b)(1) prohibiting contingent fees not apply, there is still risk of further scrutiny by the IRS and possible non-compliance with Circular 230 restrictions.
Note, the cited district court cases above (Loving, Ridgley, Sexton) addressing contingency fee restrictions per Circular 230 are U.S. District Court decisions which are not binding on any courts outside the district, but can be persuasive. See U.S. Federal Tax Law Hierarchy Quick Reference Chart. Moreover, there may be further restrictions applicable to allowable contingent fees pursuant to state law applicability and should be carefully investigated prior to entering such agreements Therefore, until more substantive legal precedence is established, or the Office of Professional Responsibility revises Circular 230 to address the invalidation of the registered return preparer and "practice before the IRS" as addressed in Loving, the most conservative approach would be to consider contingency fee arrangements pursuant to the three exceptions noted under Circular 230.