Know Your Sources: The Importance of the Weight of Authority in Tax Planning
Most individuals prefer simplicity over complexity. Not surprisingly, this premise extends to tax planning.
However, for many wealthy individuals complex tax planning is a reality, if not an outright necessity. As such, when dealing with more complex tax planning, the strength of a tax position or structure relies upon the sources or authorities on which that position or structure is based. It therefore becomes paramount to consider the weight of these authorities when determining a tax plan’s likelihood of success.
The most impactful and binding types of authority are called primary sources. These primary sources are tax law authorities that must be followed and include: the Internal Revenue Code, U.S. Treasury Regulations, Revenue Rulings, and Revenue Procedures. Primary judicial sources include: the Supreme Court of the United States, Courts of Appeal, District Courts, and the U.S. Tax Court. It is important to note that some sources may be primary in some jurisdictions but not binding in others. For example, state law in New York is controlling in New York but not controlling in Florida, although Florida may choose to follow or find New York law persuasive in reaching its decision.
Internal Revenue Service and U.S. Treasury Department issue regulations to provide guidance for new legislation or to address issues that arise from existing Internal Revenue Code sections. Regulations interpret and illuminate direction on complete compliance with the law. The Federal Registrar also publishes these regulations for the guidance of the general public. Regulations can take the form of final regulations, proposed regulations or temporary regulations. Final regulations have the effect of law. Proposed regulations do not have the effect of law until they become finalized. When proposed regulations are published, IRS will solicit comments from practitioners, which they may or may not take into account. These regulations are then either finalized as originally proposed, finalized after changes based on those comments, or not at all. In fact, there are many instances of existing proposed regulations that have never been finalized. It should be noted, while not law, proposed regulations are illustrative of IRS line of thought on any given subject. In addition, there are times when IRS will allow (but not require) taxpayers to rely on proposed regulations at the taxpayer’s discretion. Temporary regulations are effective upon publication; however, they expire after three years and are usually replaced by newly enacted final regulations.
A revenue ruling is an official interpretation by IRS of the Internal Revenue Code, related statutes, tax treaties and regulations. Revenue rulings are controlling law but secondary to subsequent legislation, regulations and court decisions. A revenue ruling embodies an IRS conclusion on how the law should be applied and construed in certain circumstances. The Internal Revenue Bulletin and the Cumulative Bulletin both publish revenue rulings for the information and guidance for taxpayers, tax professionals and IRS personnel.
A revenue procedure is an official statement of procedure that affects the rights or duties of taxpayers and other members of the public under the Internal Revenue Code, related statutes, tax treaties and regulations that should be a matter of public knowledge. Like revenue rulings, the Internal Revenue Bulletin also publishes revenue procedures. The most distinguishing difference between a revenue ruling and a revenue procedure is that while a revenue ruling generally states an IRS position, a revenue procedure provides return filing or other instructions concerning an IRS position. For example, a revenue procedure might specify how those entitled to deduct certain home mortgage interest on a vacation home may calculate the deduction, yet a revenue ruling may show a certain set of circumstances in which that home mortgage interest on the vacation home was deductible and other circumstances in which it was not.
If a primary source is unavailable or not fully illustrative, tax practitioners looks to secondary sources. Although never binding law, they can be quite helpful and persuasive when utilized correctly. Secondary sources include: private letter rulings (PLRs), technical advice memorandums (TAMs), journal and law review articles, treatises and IRS publications.
A PLR is a written statement issued to a taxpayer, which interprets and applies tax laws to the taxpayer’s specific set of facts. IRS issues a PLR to establish with certainty the federal tax consequences of a particular transaction before the transaction is consummated or before the taxpayer’s return is filed. IRS only issues a PLR upon a submitted written request by a taxpayer and is binding on IRS if the taxpayer fully and accurately described the proposed transaction in the request and carries out the described transaction accurately as well. Though a PLR may not be relied upon as precedent by other taxpayers or IRS personnel, it can be a highly persuasive tool when clients find themselves in similarly applicable circumstances. Moreover, due to its highly persuasive nature, it is one of the most utilized types of sources. PLRs are generally made public once personal information is removed that could in any way identify the taxpayer. For very complex transactions, PLRs are often the most useful guidance available.
TAMs are guidance furnished by the Office of Chief Counsel upon the request of an IRS director or an area director appeals in response to technical or procedural questions that develop during a taxpayer’s proceeding. A request for a TAM generally stems from the examination of a taxpayer’s return, consideration of a taxpayer’s claim for a refund or credit or any other matter involving a specific taxpayer under the jurisdiction of the territory manager or the area directors appeals. As opposed to PLRs, TAMs are issued only on closed transactions and provide guidance on the proper interpretation and application of the tax laws. Additionally, TAMs represent the final determination of an IRS attitude concerning a matter but only with respect to that specific issue. Like PLRs, TAMs are highly persuasive in nature when employed correctly when a taxpayer’s circumstances are similar to those at issue in the guidance. TAMs are also made available to the public once personally identifiable information has been removed.
Tax planning is often complicated and relies on what can be equally complicated rules. It is critical not just that these different rules are understood, but also that the weight of authority these different rules have are understood as well. When implemented correctly, the sources discussed provide the strong foundation upon which tax planning is built.