Private Letter Rulings and Tax Opinions

In certain transactions involving a lot of money, the tax law may be unclear. Consequently, there could be large differences in tax liability depending on how the IRS treats the transaction. To remove uncertainty, a taxpayer, usually a business, will request a private letter ruling to remove any uncertainty regarding the transaction. If the IRS does issue a private letter ruling, it will be bound by the ruling, but only for that specific taxpayer. Rulings are generally sought for proposed transactions where the tax liability is high and the law is uncertain, such as a tax-free reorganization under the complex rules of IRC §355. If the letter ruling request is denied, it does not say anything about the legality of the tax issue, but it also does not remove uncertainty.

A letter ruling applies the tax law to the specific set of facts of a given transaction of the taxpayer requesting the ruling. Letter rulings are made public, but confidential information is redacted. Rulings can be expensive: 2013 fees, for instance, range from $150 for simple requests to $50,000 for pre-filing agreements. A ruling for a specific transaction costs $18,000, but typically ranges up to $30,000.

Because letter rulings are only written for specific taxpayers, they have no precedential value. However, published letter rulings on transactions similar to the proposed transaction can indicate the likelihood that a proposed letter ruling will be approved. Additionally, the taxpayer can rely on the rulings to argue against the assessment of substantial understatement penalties.

Rulings are only issued on proposed transactions or completed transactions for which no tax return has been filed yet. By contrast, a Technical Advice Memorandum is similar to a letter ruling but differs in that the return has already been filed and is under audit.

An approved private letter ruling must be attached to the tax return.

No Rules List

The IRS frequently publishes revenue procedures that list subjects on which the IRS will not issue a ruling. Additionally, the IRS will not generally issue a ruling for novel or complex tax matters. Since private rulings must conform to the tax code, no private rulings will be issued on anything that will be published in a Revenue Ruling, Revenue Procedure, or as a Treasury Regulation. Likewise, if the tax code already provides a clear answer, then the IRS will not issue a “comfort ruling”.

Pre-Ruling Conference

Because of the substantial cost of not only paying for the ruling, but also the need to hire professionals to request the ruling, most taxpayers perform due diligence to ascertain whether the ruling is likely the be granted. A request for a private letter ruling is usually preceded by a short memo that states the relevant facts, the issues involving the uncertainty, and the specific ruling that is being requested, so that it can be discussed with business executives and lawyers, to assess the likelihood that it will be granted. One factor to consider is whether there is a similar letter ruling favorable to another taxpayer, since it indicates that the ruling will likely be approved, especially if it is the same type of transaction under similar sets of facts. By the same token, an unfavorable letter ruling similar to the taxpayer's proposed transaction would indicate that a ruling for the taxpayer will not likely be approved.

A pre-ruling conference is conducted because if the ruling request is denied, then the taxpayer may have to pay a substantial fee, which may be avoided if the request is withdrawn, but, then, the IRS will send an audit alert to the field office that covers the jurisdiction of the taxpayer, alerting the field office that a request for the ruling was made, then denied, and that the taxpayer withdrew the request.

A letter ruling will more likely be requested if the request is likely to be granted; otherwise, the taxpayer will probably forgo the request to avoid any fees and to prevent any audit alerts being issued to the field office.

Letter Ruling Request

The IRS issues a revenue procedure annually, detailing what information must be provided in a ruling request, so the latest procedure should be consulted before asking for a ruling. In any case, the following information must be provided:

A request for a Private Letter Ruling must be accompanied by copies of contracts, agreements, deeds, wills, instruments, and any other documents relevant to the transaction. The request must explicitly state all relevant facts, and not simply rely on the submitted documents.

The taxpayer should stipulate what confidential data should be redacted before the ruling is made public. Information that must be provided for the request includes the basis for any position. If the taxpayer is not assuming a certain position, then the tax consequences of the transaction should be stated. Additionally, any opposing evidence should also be presented. All relevant authorities that the taxpayer relied upon should be cited; if the taxpayer could not find any relevant authorities, then the request for the ruling should explicitly say so.

Finally, the taxpayer must sign the request under penalty of perjury.

Tax Opinion

Often, the taxpayer will not want to alert the IRS to a dubious treatment of a transaction. On the other hand, the taxpayer will still want some proof that the treatment was not frivolous, which can incur large tax penalties. In these cases, the taxpayer will formally seek an opinion from an attorney about the legality of the transaction. Tax opinions are generally cheaper and faster than private letter rulings, but they offer less certainty, and therefore, greater risk. A tax opinion will generally be issued within several weeks, while letter rulings will generally take at least 6 months.

A tax opinion (a.k.a. legal opinion) is written by an attorney for a client and subject to the attorney-client privilege and is rarely given to the IRS except when the taxpayer is audited, when the taxpayer needs to provide a basis for the treatment of the transaction. The best time to seek an opinion is before the relevant events, and certainly before the filing of the tax return,, since a tax opinion will only reduce penalties if the taxpayer relied upon the opinion as a reason for proceeding with the transaction.

To present a reasonable basis, the tax opinion should consist of the relevant facts, legal arguments, and authorities regarding the issues. The taxpayer should require that both sides of the arguments of an opinion be presented, since that will show a balanced consideration of the issues, providing evidence for why the sought opinion is valid, which will also help to negate any specious arguments that the IRS may consider that would cause it to reject the opinion. Since the IRS did not issue the opinion, obviously, it will not be binding. All assumptions should be reasonable and explicitly stated.

The opinion should not be given to the accountant who prepares the tax returns; instead, the attorney may direct how to report the item and that it is based on an opinion protected by the attorney-client privilege; otherwise the accountant, not being protected by the attorney-client privilege, may inform, or be compelled to inform, the IRS of the opinion so as to explain what was reported. In certain cases, the attorney writing the opinion can hire the accountant for the specific case, thus bringing the accountant within the attorney-client privilege, although this method is not foolproof.

While a private letter ruling will protect the taxpayer requesting the ruling in regard to the issue, as long as the facts supporting the ruling are relevant and true, the tax opinion will help the taxpayer to avoid penalties and improve the chances of winning any audit concerning the issue, or, at least, of winning a good compromise.