The Ethics of Tax Lawyering

The Ethics of Tax Lawyering
3rd Edition
Michael Hatfield
2018 CALI eLangdell Press, www.cali.org. Subject to an Attribution-NonCommercial-ShareAlike CC BY-NC-SA
Ethics of Tax Lawyering

Ethics of Tax Lawyering




Michael Hatfield

Professor of Law

University of Washington





March 2015

About the Author

Michael Hatfield is a Professor of Law at University of Washington School of Law.  Previously he was a Professor of Law at Texas Tech University where he served as the Associate Dean for Faculty Development and Research and held the Glenn D. West Research Professorship. Michael has served as a Visiting Professor of Law at the University of Washington School of Law and at the Seattle University School of Law, and worked as an associate at Debevoise & Plimpton in New York, New York and at Simpson, Thacher & Bartlett in New York, New York. From 2010-2012, Michael served as the Glenn D. West Research Professor at Texas Tech University. In 2010, he was awarded the Texas Tech University President's Excellence in Teaching Award, and in 2006, 2008, 2009, 2011, and 2012 he was named the Outstanding Professor of the Year. In 2007 he was awarded the Texas Tech University Alumni Association New Faculty Award. He teaches courses in taxation, ethics, and trusts and estates. His research has been published in the Florida Tax Review, the Northwestern Law Review Colloquy, the NYU Annual Survey of American Law, the Baylor Law Review, the Notre Dame Journal of Ethics and Public Policy, the Lewis & Clark Law Review, the Texas Tech Law Review, Tax Notes and the Johns Hopkins University Press. With Baylor Law School Mills Cox Professor of Law Thomas M. Featherston, Jr. he co-authored Q&A: Wills, Trusts and Estates (2nd. ed., 2008).


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Chapter One
Introducing Legal Ethics for Tax Lawyers

In order to appreciate the ethical complications in which tax lawyers often find themselves, it is essential to appreciate and understand the greater contexts of legal ethics and the tax system. While it is important to begin with this more general discussion of ethics and tax lawyers, it may also be useful to re-read this section after finishing the chapter—to get a view of the forest after inspecting some of the trees.

1.1. Ethics for Lawyers

Ethics is practical reasoning. It is thinking through the most important implications of behavior. For lawyers, ethical reflection involves considering not only the lawyer’s personal values but also the lawyer’s roles as officers in the legal system and as agents and advisors for clients. Organizing and clarifying the layers of obligations and duties implicated in lawyer behavior is the subject matter of legal ethics. The objective is to define a lawyer’s professional responsibilities. It is not an abstract or idealistic exercise. A lawyer with a misunderstanding of her professional responsibilities may find herself disbarred from the practice of law, sued by her former clients, fined and jailed—personally miserable even if she escapes discipline, suit, or criminal punishment.

Many ethical considerations reflect a lawyer’s personal values, such as the choice of practice area or choice of clients. However, legal ethics is not simply the domain of personal values. A great many duties are imposed on lawyers by fiduciary and contract laws, and, of course, each state has its own ethics rules and means of enforcement. Most states have adopted some version of the American Bar Association’s Model Rules of Professional Conduct, and many have followed the ABA’s subsequent amendments (as amended, the “Model Rules.”). While the popular image of a lawyer may be as a courtroom strategist and dramatist focused on winning at any cost, the Model Rules reflect the complex realities of lawyering, prescribing different standards for a lawyer working as an advisor, neutral third party, and advocate, as well as unavoidable duties to third parties, opposing counsel, and the tribunal.

Unfortunately for the practicing lawyer, burdened with thinking through the consequences of her professional behavior, complying with the state ethics rules does not necessarily mean she escapes liability under malpractice standards. Lawyers may be sued by former clients—and even third parties who were never clients—on either tort or contractual grounds where compliance with the state ethics rules may not provide a sufficient defense. Although the different standards used in disciplinary and malpractice claims may appear to be confusing, a prudent lawyer should never close her eyes, rely on untutored intuition, and hope for the best.

Notes and Questions

1. Under the Model Rules, what are the differences between a lawyer acting as an advisor and a lawyer acting as an advocate? Has the state in which you intend to be admitted adopted the ABA Model Rules? The Tax Court has adopted the Model Rules—both their “letter and spirit.”  United States Tax Court Rules of Practice Rule 202(a)(3). What does “spirit” mean? How does one comply with the “spirit” when it is not described in the “letter?” We may speak in these terms in casual conversation, but if you are the lawyer needing to know how to proceed in court, how do you determine if “letter” and “spirit” have different requirements? If the requirements are the same, why mention both? If the requirements are not the same, how do you know? Is your client’s interest relevant in determining the “spirit” of the Model Rules?

2. Due to the cost of legal advice, tax advice from a lawyer is rarely justified unless a substantial dollar amount is involved. What does that mean about the amount of damages likely to be sought in a tax malpractice suit?

1.2. The Duty to the Tax System

Tax lawyers may be disciplined by the authorities where they are admitted to practice; they also risk malpractice suits for negligence and otherwise failing to fulfill fiduciary or contractual duties to clients or others.  Furthermore, they may be subject to discipline by the Internal Revenue Service (the “IRS”) under extensive written regulations (usually referenced as “Circular 230”).1 Under these regulations, the minimum standard for advice as to an undisclosed tax return position is “substantial authority,”2 which is often described as “around a 40% chance of success on the merits.”3 This standard has no counterpart in the Model Rules, and is much higher than the non-frivolous standard for advocacy under ABA Model Rule 3.1.

Such standards for tax lawyers are often described as the tax lawyer’s “duty to the system.”4 This duty reflects the self-reporting nature of our tax system in which only 1–2% of tax returns are audited. It requires ignoring the low audit rate. Tax advice must be given on the presumption that the issue will be litigated in court rather than gambling that the IRS will never examine the issue (playing “audit roulette,” as it is often called).5  After all, with a 2% audit rate, even the worst tax advice has a 98% chance of “succeeding” (as 98% of tax returns are not audited).

Notes and Questions

3. If 100% of tax returns were thoroughly audited, would it be relevant in terms of tax lawyers’ duty to the system? What would be the duty to the system if returns were never audited?

4. What if criminal defense lawyers had to have “substantial authority” for every legal argument made on behalf of their clients? What are some of the differences between advising as to tax return positions and advising as to criminal defense?

1.3. Sharing the Profession with Non-Lawyers

Tax lawyers share the tax field with Certified Public Accountants (“CPAs”). Federal law authorizes both lawyers and CPAs to represent clients before the IRS,6 where both practice before the IRS and are regulated by the Secretary of the Treasury.7  Further, so long as they pass an examination, Rule 200(a)(3) of the United State Tax Court Rules of Practice authorizes CPAs to represent clients before the Tax Court.

Grace v. Allen

407 S.W.2d 321 (Tex. Civ. App. 1966)

Bateman, Justice. This is a suit to recover the value of accountants’ services performed…. Appellants pled, Inter alia, that appellees were not entitled to recover because their alleged services constituted the unauthorized practice of law…. The trial court rendered judgment for appellees for the total of $12,600, and appellants appeal on two points of error.

The first of these is that the court erred in holding as a matter of law that the services rendered by appellees did not constitute the practice of law…. Appellees contend that their services in question did not constitute the practice of law . . ., and that in any event such services were within the purview of the federal law and Treasury Department regulations; that although not members of the Bar, they were licensed to practice before the Treasury Department, that everything they did was pursuant to and in accordance with that license, and that if their services were proscribed under New York law they were fully authorized by the federal law and Treasury regulations and, therefore, lawful….

There is no substantial dispute as to the facts. Appellees were both licensed public accountants, one of them being certified, and both were admitted to practice before the Treasury Department, although neither of them was a lawyer. Both of them had been employed by the Internal Revenue Service for a number of years before entering private practice. Although the appellees had not prepared the appellants’ income tax returns for the years 1955, 1956, 1957 and 1958, when the Internal Revenue Service assessed additional taxes for those years they were employed to work with appellants' attorneys in New York City in the preparation and presentation of a protest of such assessment. They did so, and it is these services which appellants say constituted the unauthorized practice of law, pointing out that one of the appellees testified that ‘complicated issues’ were involved, that the protest cited numerous cases as authority for the position they were taking, some of which cases had been discussed with the lawyers but some of which had been found as a result of research by the appellee Brown. Appellees had prepared in their office several Forms 872, ‘Consent to Extension of the Statute of Limitations,’ also memoranda used and presented in various conferences, with representatives of the Internal Revenue Service. Appellees conferred frequently with appellants’ attorneys and kept them advised by telephone and mail as to audits by the Internal Revenue Service and the preparation of the protest. The attorneys participated and cooperated in the preparation of the protest and in conferences with the Internal Revenue Service examining agent and conference coordinator. Appellees also prepared a power of attorney authorizing the attorneys to act for appellees in connection with audits of appellants’ tax returns. Appellants employed appellees to prepare and file their Federal and New York State income tax returns for 1960 and their declarations of estimated income tax (Federal and State) for 1961; also to maintain appellants’ proper books and records therefor.

To support their position that under New York law the work done by appellees constituted unauthorized law practice, appellants rely wholly on the case of In the Matter of New York County Lawyers Association (Bernard Bercu, Respondent), 273 App. Div. 524, 78 N.Y.S.2d 209, 9 A.L.R.2d 787. In that case . . . the court recognized that an accountant employed to keep a taxpayer’s books or prepare his tax return would be expected and permitted to answer legal questions arising out of and incidental to the accounting work. The court also recognized that the matter of taxation, ‘which permeates almost every phase of modern life, is so inextricably interwoven with nearly every branch of law that one could hardly pick any tax problem and say this is a question of pure taxation or pure tax law wholly unconnected with other legal principles, incidents or ramifications.’ Recognizing the necessity of drawing a line of demarcation between the work of the tax lawyer and that of the tax accountant, the court said, ‘the point at which it must be drawn, at very least, is where the accountant or non-lawyer undertakes to pass upon a legal question apart from the regular pursuit of his calling.’. . .

However, in the case at bar it is not shown that appellants consulted appellees or sought or obtained their opinion on any legal subject that was not incidental to their accounting work. Appellees were preparing the appellants’ 1960 income tax returns and were the regular accountants for appellants. They were also doing accounting work in reviewing and classifying the great volume of papers and records of appellants necessary to the preparation of the protest of the tax assessment and to enable them to discuss with the Revenue Agents the asserted tax liability. It is true that in the preparation of the protest appellees cited numerous cases in support of their position, but this was necessary and incidental to the preparation and presentation of the protest. Moreover, appellees consulted the appellants’ attorneys concerning these authorities and other aspects of the work being done and kept them informed as the work progressed. . . .

It is clear from the record before us that the work performed by appellees, which appellants assert constituted the unauthorized practice of law, was only incidental to their accounting work and was therefore permissible and not unlawful under New York law.

Appellees assert, and appellants do not deny, that the work done by appellees was all within the purview of their licenses to practice before the Treasury Department. It was agreed on the trial that the court might take judicial notice of the federal law and Treasury regulations on the subject. One of those regulations, in part, provides:

Practice before the Internal Revenue Service comprehends all matters connected with presentations to the Internal Revenue Service or any of its officers or employees relating to a client’s rights, privileges, or liabilities under laws or regulations administered by the Internal Revenue Service. Such presentations include the preparation and filing of necessary documents, correspondence with, and communications to the Internal Revenue Service, and the representation of a client at conferences, hearings, and meetings.

Appellees take the position that if there is a conflict between the state law and the federal law, the former must yield, and that, since the regulations referred to were promulgated under sanction of the federal law, they have the force and effect of law. We agree with appellees. The rights conferred by the admission to practice before the Treasury Department are federal rights which cannot be impinged upon by the states in their praiseworthy efforts to protect their citizens from unskilled and unethical practitioners of the law. Sperry v. State of Florida ex rel. Florida Bar, 373 U.S. 379, 83 S. Ct. 1322, 10 L. Ed.2d 428.

This is not to say that the states have surrendered their right to regulate and control the practice of law within their respective boundaries, as was done in the Bercu case. See also Hexter Title & Abstract Co. v. Grievance Committee, 142 Tex. 506, 179 S.W.2d 946, 157 A.L.R. 268. In fact, one of the Treasury regulations referred to (§ 10.39) contains this proviso: ‘And provided further: That nothing in the regulations in this part shall be construed as authorizing persons not members of the Bar to practice law.’ See also Free v. Bland, 369 U.S. 663, 82 S. Ct. 1089, 8 L. Ed.2d 180; Hatfried, Inc. v. Commissioner of Internal Revenue, 3 Cir., 162 F.2d 628; Haywood Lumber & Mining Co. v. Commissioner of Internal Revenue, 2 Cir., 178 F.2d 769; Burton Swartz Land Corp. v. Commissioner of Internal Revenue, 5 Cir., 198 F.2d 558. Appellants' first point is overruled….

Finding no error requiring reversal, we affirm the judgment of the trial court.

Notes and Questions

5. The Grace court cites Sperry v. State of Florida ex rel. Florida Bar, 373 U.S. 379, 83 S. Ct. 1322, 10 L. Ed.2d 428 (1963). The Sperry case involved a practitioner authorized to practice before the U.S. Patent Office, but not authorized to practice law in Florida, which is where he maintained his office. Federal law authorizes non-lawyers to practice before the U.S. Patent Office. May someone who is not admitted to practice law in the state in which he has offices engage in the practice of tax law? How can federal tax issues and state law issues, such as corporate, creditor, and property issues, be separated in any practical sense? For example, if a tax issue requires determination of the nature of an underlying property right under state law, is someone authorized to practice tax entitled to opine as to the underlying state law issue? Or is it that someone authorized to practice tax law is entitled to opine as to the tax law issue, only if someone else, who is authorized to practice state law, has opined on the state law issue? What does Circular 230 § 10.39 mean? As to Circular 230, see below.

6. What do CPAs do? The National Conference of Lawyers and Certified Public Accountants issued a study on the relationship between lawyers and CPAs. Like lawyers, CPAs are licensed to practice by state professional boards. CPAs engage in accounting and auditing, tax and management consulting, and especially in expert examination of financial statements. They develop and analyze data, especially data expressed in monetary or other quantitative forms.8 

7. What do lawyers do? Trying to define the “practice of law” in order to prohibit the unauthorized practice of law has consumed many courts, and few generalizations are useful. Many non-lawyers routinely interpret, apply, and discuss the consequences of the law (e.g., consider bank employees who advise customers on the survivorship rights in accounts). Many non-lawyers routinely prepare legally-binding documents (e.g., consider real estate agents who prepare sales contracts). And many non-lawyers represent others before agencies (e.g., the U.S. Patent Office) and in court (e.g., the U.S. Court of Appeals for Veterans Claims).

8. If CPAs and tax lawyers share the tax field, how is the work divided? Both may prepare tax returns, though, in practice, few tax lawyers specialize in routinely preparing income tax returns for clients. With respect to ascertaining the “probable tax effects of transactions,” the National Conference of Lawyers and Certified Public Accountants (“The Conference”) recognize that both lawyers and CPAs are qualified, but urge CPAs to consult lawyers when there are uncertainties as to the interpretation or application of laws, and urge lawyers to consult CPAs when there are uncertainties as to describing the transaction in money terms or interpreting financial results.9 The Conference identifies preparing legal documents as part of the special training of lawyers, and the preparation of financial statements and similar reports as part of the special training of accountants.10 The Conference recognizes the opportunity for CPAs to represent clients before the Tax Court, but, noting that the client may also pursue remedies in a District Court or the Court of Claims, suggests that a lawyer be consulted when the IRS issues a notice of deficiency.11 

9. The Conference concludes that all matters involving criminal investigations should be referred to lawyers.12 Why?

10. Usually we think of lawyers as having a monopoly on advising clients on legal issues and representing clients in court. However, CPAs are authorized to advise clients on the tax law, and CPAs are authorized to represent clients in Tax Court. We also usually think of lawyers as an independent profession—one that regulates itself. However, tax lawyers, like CPAs, are regulated by the Treasury Department. What is the essence of being a lawyer? Would it make more sense to classify tax lawyers as part of a “tax profession” shared with CPAs? Are tax lawyers and medical malpractice lawyers or criminal defense lawyers members of a shared profession in any meaningful sense?

  • 1 31 U.S.C. § 330 (2012?).
  • 2 Circular 230 § 10.34.
  • 3 Donald B. Tobin, Richard Lavoie, and Richard E. Trogolo, Problems in Tax Ethics 22 (2009). See Jasper L. Cummings, Jr., The Range of Legal Tax Opinions, with Emphasis on the ‘Should’ Opinion, Tax Notes, February 17, 2003, p. 1125, 1128.
  • 4 Tax lawyers are said to have a “duty to the system.” Bernard Wolfman, James P. Holden, and Kenneth L. Harris, Standards of Tax Practice § 101.2 (5th ed., 1999). Professor Deborah Schenk has written that the self-reporting nature of the tax system means that the tax system cannot permit the “absolute adversarial” relationship that lawyers might have in other situations. Deborah H. Schenk, Book Review: Tax Ethics, 95 Harv. L. Rev. 1995, 2004 (1982). The idea that “tax ethics … must be approached from a special perspective”, as a consequence of the self-reporting nature of our tax system, seems the most common argument for tax lawyers’ duty to the system. Id. at 89. See also Anthony C. Infanti, Eyes Wide Shut: Surveying Erosion in the Professional Tax Bar, 22 Va. Tax. Rev. 589, 606 (2003). However, some have criticized this conception of the tax lawyer. See, e.g., David J. Moraine, Loyalty Divided: Duties to Clients and Duties to Others—the Civil Liability of Tax Attorneys Made Possible by the Acceptance of a Duty to the System, 63 Tax Law. 169 (2009).
  • 5

    See, e.g., Treasury Regulations § 1.6662-4(d)(2) (“The possibility that a return will not be audited, or, if audited, that an item will not be raised on audit, is not relevant in determining whether the substantial authority standard (or the reasonable basis standard) is satisfied.”)

  • 6 5 U.S.C. § 500 (2012?).
  • 7 Indeed, under Circular 230 §10.3(c), enrolled agents may also practice before the IRS, but this discussion is limited to tax lawyers and CPAs as these two professions dominate tax planning.
  • 8 National Conference of Lawyers and Certified Public Accountants: A Study of Interprofessional Relationships, 36 Tax Law. 26, 28–29 (1981).
  • 9 Id. at 33–34.
  • 10 Id. at 34.
  • 11 Id. at 34–35.
  • 12 Id. at 35.
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