The US Senate is expected to pass a bipartisan bill — with support from the Bush administration — this summer that would require corporations to have at least a “more-likely-than-not” opinion that a tax position is justified in order to avoid steep penalties if the company is caught on audit. Under current law, such penalties can usually be avoided by showing there was “substantial authority” for a position. Substantial authority is a weaker standard than “more likely than not.”

In addition, a company would not be able to rely in the future on an opinion where the tax adviser receives fees from a broker or investment bank, or the fees he is paid are contingent on a successful closing or the amount of the tax savings the adviser can generate.

The Senate bill distinguishes among three types of aggressive tax planning.

Corporations would have to flag for the IRS all “listed transactions” (transactions that the IRS has put the public on notice will be challenged). If the IRS then disallows the tax benefits, the company would face an automatic 20% penalty. There is no way to avoid the penalty by showing that the company thought it had good grounds to claim the tax benefits. The penalty would jump to 30% if the company failed to disclose the transaction to the IRS, and it would have to report the penalty to its shareholders in a filing with the US Securities and Exchange Commission.

The next level down of aggressive tax planning is “reportable transactions” that have tax avoidance as “a significant purpose.” The Bush administration is still fine tuning a list of warning signs that make a transaction “reportable.” The warning signs include the fact that the company is indemnified against loss of the tax benefits or the transaction was marketed under conditions of confidentiality. If such a transaction is not reported and the tax benefits are later disallowed, then the company would face an automatic 25% penalty and have to report the penalty to the SEC. The company could avoid the penalty only by flagging the transaction for the IRS and by having a credible “more-likely-than-not” opinion from an outside tax adviser.

Another level down is “reportable transactions” that do not have tax avoidance as “a significant purpose.”

The company would avoid an extra taxshelter penalty simply by flagging the transaction for the IRS. However, if it failed to report, it would need a credible “more-likely-than-not” opinion to avoid the extra penalty.

The bill not only requires companies to get stronger opinions in the future but, for the first time, it also will put directly into the US tax code standards for tax opinions. For example, the law or accounting firm giving the opinion will not be able simply to rely on representations from the company about material facts that turn out in retrospect to have been unreasonable. In a joint statement released by the Senate tax-writing committee, the committee chairman, Max Baucus (D.-Montana), and the senior Republican, Charles Grassley (R.-Iowa), said they “think a taxpayer should not claim a position on a tax return that the taxpayer does not believe is correct unless this fact is disclosed to the IRS.”

Under the bill, each “material” adviser — meaning law firm, investment bank, broker — involved in structuring, selling or implementing any tax shelter would have to report details about the transaction, including the advice given, to the IRS. Advisers would have to forfeit as much as 75% of their fees or $200,000, whichever is greater, for failure to report a “listed transaction.” The penalty for failing to report other transactions is $50,000.