The Impact of the “More Likely Than Not” Standard on Federal Tax Returns

In May 2007, Congress passed the Small Business and Work Opportunity Tax Act of 2007 (“the Act”), portions of which relate to the preparation of federal tax returns. Changes made by the Act require tax professionals to advise their clients whether all positions to be reflected on the client’s federal tax returns meet a confidence level of “more likely than not.”

A tax position with a confidence level of more likely than not means that there is a reasonable belief that it is more likely than not to be the correct position (i.e., greater than a 50 percent likelihood) upon examination by taxing authorities. The definition of federal tax returns includes the preparation of federal income, gift, estate, trust, employment, excise, and exempt organization tax returns.

Positions taken on federal tax returns that do not have a more likely than not level of confidence must at least have a “reasonable basis” level of confidence and must be disclosed on the taxpayer’s tax return. A reasonable basis level of confidence generally means that the tax position has at least a 20 to 25 percent likelihood of being sustained upon examination by taxing authorities.

The determination of whether a position meets the “more likely than not” standard or has a reasonable basis will be based upon the client’s facts as well as all relevant tax authorities, including the Internal Revenue Code, Treasury Department Regulations, Internal Revenue Service (“IRS”) pronouncements and relevant court cases. If a taxpayer knowingly misrepresents facts or provides false information related to a position taken on a tax return, then the tax preparer may not be deemed to know about such position. Thus, the tax preparer would not be liable for related penalties under this provision.

In addition to the changes mandated by the Act, the Department of the Treasury has also proposed changes to Circular 230. Circular 230 governs the practice of “tax” before the IRS. A tax professional may not advise a client to take a position on a tax return unless it meets the more likely than not standard or the position meets the reasonable basis standard and is properly disclosed on the client’s tax return.

The legal and regulatory changes referred to herein impose a greater standard on all tax professionals. The changes apply to all tax returns filed and advice provided after December 31, 2007. As a result, we will be required to evaluate the positions taken on any federal tax returns filed after December 31, 2007, and conclude whether such positions meet the more likely than not standard.

For any client positions that do not meet that standard but do meet the reasonable basis standard, we will advise the client to disclose such positions to the IRS by making an appropriate disclosure on the client’s tax return. If the client refuses to disclose a reasonable basis position on their tax return, then we are precluded from signing the return and may be required to withdraw from the engagement.

In most cases, the positions taken on a client’s return will reflect transactions consummated during the year covered by the return. However, there may be cases where the positions reflected in the return result from a transaction entered into in a prior year. In either case, we are required to evaluate all such positions reflected in tax returns to be filed after December 31, 2007, and advise of any positions that are required to be disclosed to the IRS.

Assessing the confidence level of all positions reflected on a client’s federal tax returns due after December 31, 2007 may require additional analysis. It is not possible to estimate the additional amount of work and corresponding fees associated with this effort until we have an opportunity to understand the facts and discuss the position(s) with each client. We will, however, advise of any positions that require further analysis once the issues have been identified, and we will discuss any requisite fee increase associated with that analysis prior to undertaking the work.

The business terms section of each client’s tax engagement letter or Memorandum of Understanding has been modified to reflect the above described changes in our standards and policies.

We will continue to provide all clients with the highest quality tax services going forward. Please do not hesitate to contact us with any questions concerning this matter.

FOR MORE INFORMATION, PLEASE CONTACT:

Brooks Nelson
Director of Tax
Cherry, Bekaert & Holland, L.L.P.
800.849.8281
bnelson@cbh.com

About Cherry, Bekaert & Holland, L.L.P. (CB&H)

As the Southeast’s accounting and consulting Firm of Choice, Cherry, Bekaert & Holland, L.L.P. (CB&H) is uniquely positioned to provide quality, cost-effective and value-added services to a diverse and successful client base. The Firm sets itself apart by delivering the extensive industry specialization and service opportunities of a national firm, but with the accessibility, service continuity and level of personal relationship expected from a local business. Ranked nationally among CPA firms, CB&H’s resource network stretches regionally across six states, including the large metro markets of Atlanta, Charlotte, Hampton Roads, Raleigh, Richmond, Tampa and Washington D.C., and nationally and internationally through an alliance with Baker Tilly International, a worldwide network of independent accounting firms.