Procedure & Administration
The individual serving as the delegate of the secretary of the Treasury and authorized to decide administrative appeals in Circular 230 cases (the appellate authority) has questioned whether the current approach to determining whether a practitioner has willfully violated Circular 230 is appropriate and has asked parties in subsequent proceedings to address the issue. These comments have generated concerns in the practitioner community in view of the potential severity of Circular 230 sanctions, including suspension or disbarment from practice before the IRS.
This item summarizes the current definition of “willfulness” for purposes of Circular 230 and concludes that the current definition is generally sound. It then recommends that any change to the willfulness standard should result from notice and comment rulemaking rather than a decision by the appellate authority.
Circular 230 is a Treasury regulation prescribing standards of conduct for CPAs, attorneys, enrolled agents, and other practitioners who practice before the IRS (see 31 C.F.R. Part 10). Sanctions for violations of Circular 230 include monetary penalties, public censure, suspension, and disbarment from practice before the IRS. A practitioner accused of a Circular 230 violation usually has a right to a hearing in front of an administrative law judge (ALJ) before any discipline is imposed. Either party may appeal the ALJ’s decision to the appellate authority, since it is authorized to decide administrative appeals in Circular 230 cases. Currently, the appellate authority is an assistant division counsel in the IRS Small Business/Self-Employed Division.
In general, a practitioner may be sanctioned under Circular 230 if he or she is shown to:
- Have willfully violated any Circular 230 requirement under Section 10.52(a)(1);
- Be incompetent or disreputable within the meaning of Section 10.51 (which includes various willful acts and other failures); or
- Have recklessly or with gross incompetence violated Circular 230’s tax return preparation provisions or written tax advice standards under Section 10.52(a)(2).
Circular 230 does not explain when a practitioner is considered to have willfully violated a provision. The general prohibition against willful violations in Section 10.52(a)(1) appears to have been added in 1958. The 1958 amendments, however, did not address what “willfully” was intended to mean (see 23 Fed. Reg. 9261 (November 29, 1958)). The preamble to the 1984 amendments merely described “willfully” as meaning “knowingly” (see 49 Fed. Reg. 6719 (February 23, 1984)).
Current Approach to “Willfulness”
The willfulness standard in Cheek, 498 U.S. 192 (1991), currently applies in assessing whether a practitioner has willfully violated a Circular 230 requirement (see, e.g., Director, Office of Prof. Resp. v. Banister, No. 2003-02 (Treas. disciplinary app. 6/25/04), involving disbarment of a CPA for numerous Circular 230 violations, including failure to exercise due diligence in preparing tax returns and providing false opinions). Cheek involved alleged violations of criminal provisions of the Code (Secs. 7201 and 7203) by an individual taxpayer for willfully attempting to evade federal income tax and willfully failing to timely file his federal income tax return. In Banister, the appellate authority at that time generally concluded that the Cheek approach to willfulness was appropriate given the overlap between some of the types of criminal conduct in the Code and Circular 230. (Compare, e.g., Secs. 7201, 7203, and 7206 with Sections 10.51(a)(6)–(8) of Circular 230.)
Cheek defines willfulness as a “voluntary, intentional violation of a known legal duty” without regard to any “bad motive” or “evil intent” of the taxpayer. Thus, under this standard, to prove willfulness the government must show that the law imposed a duty, the practitioner knew of the duty, and the practitioner voluntarily and intentionally violated the duty. Cheek also provides that a good-faith mistake, even if not “objectively reasonable,” negates a finding of willfulness in the case of a violation of a Code provision, in view of the Code’s complexity. On the other hand, under Cheek an objection to a Code requirement on constitutional grounds generally would not negate willfulness because constitutional objections are viewed as less likely to be consistent with an honest mistake.
In two recent decisions, the current appellate authority has questioned whether the willfulness standard in Cheek is appropriate for disciplinary proceedings under Circular 230, notwithstanding the fact that the practitioner in each case was found to have willfully violated Circular 230 under the Cheek standard. (See Director, Office of Prof. Resp. v. Kilduff, No. 2008-12 (Treas. disciplinary app. 1/20/10), involving a 48-month suspension for an attorney’s failure to file his own federal income tax return for one year and his late filing of his personal returns for five years, and Director, Office of Prof. Resp. v. Gonzales, No. 2007-28 (Treas. disciplinary app. 12/9/09), involving a 36-month suspension for an enrolled agent’s failure to timely file her personal federal income tax returns for five years.) In Gonzales, the appellate authority further suggested that the definition of “willful” under the State Bar of California’s Rules of Professional Conduct might be preferable:
For example, the California Supreme Court has determine[d] that the term “willful” under the Rules of Professional Conduct of the State Bar of California means “simply a purpose or willingness to commit the act, or make the omission referred to. It does not require any intent to violate law, or to injure another, or to acquire any advantage.” [Citing Phillips v. State Bar of Cal., 782 P.2d 587, 591 (Cal. 1989), and quoting Durbin v. State Bar, 590 P.2d 876 (Cal. 1979)]
The above quotation could be read as supporting a willfulness standard that does not require a practitioner to know of the duty he or she is accused of having violated. The quotation could also be suggesting, at least in the case of an attorney or a CPA, that the definition of willfulness should vary depending upon the rules of the jurisdiction in which a practitioner is licensed to practice law or accountancy (although the practitioner in Gonzales was an enrolled agent). Regardless, it is clear that the appellate authority was signaling a potential lowering of the Cheek willfulness standard for purposes of Circular 230.
How to Define “Willfulness”?
The basic Cheek test for defining “willfulness”—“a voluntary, intentional violation of a known legal duty”—seems sound in the Circular 230 context. Thus, a practitioner should not be considered to have willfully violated Circular 230 unless the government demonstrates that the law imposed a duty on the practitioner, the practitioner knew of the duty (even if he or she did not know the duty was in Circular 230), and the practitioner voluntarily and intentionally violated that duty. To promote consistent outcomes in Circular 230 cases, the willfulness standard should not vary depending upon the rules of a practitioner’s licensing jurisdiction.
This high standard of willfulness is appropriate given the quasi-penal nature of Circular 230, the vagueness of key requirements (such as the due diligence requirement), and the overall complexity of the regulation. Circular 230 not only reflects complex Code concepts; it also incorporates substantial nontax requirements that may not be familiar to many practitioners. For example, a practitioner, even if not an attorney, must adhere to the complicated conflict-of-interest provisions of Section 10.29, which reflect those in Rule 1.7 of the ABA’s Model Rules of Professional Conduct. As another example, Section 10.30 imposes detailed advertising and solicitation rules, including specific document retention requirements, which may not conform to the rules of a state in which a practitioner is licensed to practice.
Further, although the Cheek willfulness test was adopted in a criminal setting, Circular 230’s standard of proof is lower than the “beyond a reasonable doubt” standard in criminal cases (see §10.76(b), imposing a preponderance of the evidence standard under Circular 230 if the sanction is censure or suspension of less than six months and a clear and convincing standard if the sanction is a monetary penalty, suspension of six months or more, or disbarment). Moreover, Congress did not voice any objections to the longstanding Cheek approach in 2004 when it authorized the additional sanctions of censure and monetary penalties, which could be triggered for willful violations (see the American Jobs Creation Act, P.L. 108-357, §822(b)).
Any definition of willfulness should also have an escape valve for good-faith mistakes or other sympathetic circumstances not contemplated by the drafters of the underlying provisions. Such an exception is essential from the standpoint of fundamental fairness and helps to encourage voluntary compliance with the tax laws by both practitioners and their clients. Moreover, Treasury has previously indicated that willful (as well as reckless and grossly incompetent) violations are inconsistent with reasonable cause and good faith (see T.D. 8545, explaining why an express reasonable cause exception was not added to Circular 230’s return preparation provisions).
It is less clear whether it is appropriate to maintain, as in Cheek, that a good-faith defense to a willful violation of a Code provision generally does not have to be objectively reasonable. It would seem that at least where there are repeated violations of a fundamental and straightforward obligation (such as repeated failures to timely file one’s own Form 1040), it would be fair and appropriate to require that any excuse for the violations be objectively reasonable. This approach is close, in any event, to that taken in the Banister decision by the prior appellate authority. In Banister, the appellate authority stated that the differing responsibilities of taxpayers and practitioners in the tax system require a “greater skepticism in disciplinary proceedings under Treasury Circular 230 when such practitioners seek to establish good-faith mistake defenses with respect to positions that are not objectively reasonable.”
The Cheek definition of willfulness also fits well in the Circular 230 context because that definition is more stringent than the relatively strict definitions of “reckless” or “grossly incompetent” violations. Reckless conduct includes a “highly unreasonable omission or misrepresentation involving an extreme departure from the standards of ordinary care,” and gross incompetence includes conduct “that reflects gross indifference” and “preparation which is grossly inadequate” (see §10.51(a)(13)).
Need for an Inclusive and Transparent Process
Any change in the willfulness standard for purposes of Circular 230 should be undertaken as part of the traditional notice and comment rulemaking process, not unilaterally by the appellate authority. In that process, Treasury may determine that it is preferable to address specific abuses by supplementing or modifying the types of disreputable conduct under Section 10.51 rather than by lowering the general willfulness standard in Section 10.52. Regardless, practitioners, professional organizations, and other stakeholders should have an opportunity to provide input on potential revisions before they take effect. An inclusive and transparent approach is also important in view of the perceived lack of independence in the administrative appeals function in Circular 230 cases.
Editor: Mary Van Leuven, J.D., LL.M.
Mary Van Leuven is Senior Manager, Washington National Tax, at KPMG LLP in Washington, DC.
For additional information about these items, contact Ms. Van Leuven at (202) 533-4750 or firstname.lastname@example.org.
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This article represents the views of the author or authors only and does not necessarily represent the views or professional advice of KPMG LLP. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.