Calculator and Folders and Documents


Gregory S. DuPont May 3, 2019

Although the federal Tax Code (the Code) and its accompanying regulations cover myriad topics, they do not address every possible financial transaction. In addition, some parts of the Code, its regulations, or other Internal Revenue Service (IRS) guidance may be ambiguous or subject to interpretation. In some cases, these ambiguities result in challenges by taxpayers in the Tax Court to particular rulings by the IRS. When the tax consequences of financial transactions do not appear to be adequately or clearly addressed by existing IRS guidance, taxpayers may want to request a private letter ruling from the IRS before proceeding with the transaction.

A private letter ruling is a written opinion, in advance, from the IRS as to the tax implications of a proposed transaction outlined by the requesting taxpayer. A favorable ruling usually ensures the transaction will not be challenged on the taxpayer’s tax return—provided the taxpayer completes the transaction as described in the ruling request and has not omitted pertinent information.

Because of the cost involved, most ruling requests tend to come from businesses and wealthy taxpayers whose financial transactions are complex and involve large sums of money. For example, a business might request a ruling involving the restructuring or selling of the business, a change in accounting methods, or a nonqualified deferred compensation plan for key employees. Wealthy taxpayers may seek advance guidance regarding the structuring of a trust, transfers of family wealth that might have gift or estate tax implications, or charitable giving strategies.

Pros and Cons

While it may not be obvious at first glance, there is both an upside and a downside to a private letter ruling request. Among the advantages are:

o A ruling can serve as a form of “tax liability insurance” against any uncertainty surrounding the tax implications of a proposed transaction. Consequently, it may ward off potential controversy arising in a subsequent audit.

o If the proposed transaction involves other parties, a ruling request may put other participants at ease and facilitate the transaction.

o Occasionally, the IRS will offer suggestions during its initial review for modifying the proposed transaction so that a favorable ruling may be achieved.

Among the disadvantages are:

o Rulings can be expensive, involving professional advisory and IRS filing fees. To justify the cost, a private letter ruling request generally should involve substantial amounts of money.

o Rulings can take time, potentially thwarting a time-sensitive transaction.

o In providing the necessary information, a taxpayer may inadvertently expose issues that the IRS may later decide to pursue in an audit. An adverse ruling could also raise an audit “flag.”

Bear in Mind

Since the IRS does not rule on every letter ruling request, it generally provides the requesting taxpayer with a verbal response as to whether it will consider the request. Letter rulings may be later modified or rescinded by the IRS.

Although important letter rulings are published (generally without names to protect the taxpayer), they apply only to the requesting taxpayer. While other taxpayers with a similar set of facts can look to prior rulings for guidance on how the IRS might view a particular transaction, prior rulings are no guarantee the IRS will rule similarly on a different set of circumstances. With this in mind, it is important to remember that private letter rulings cannot be read as precedent-setting rulings.