Attorney-Client Privilege Tax Return Preparation
Attorney-Client Privilege Tax Return Preparation: The privilege between a client and attorney on legal issues is nearly airtight. This is not true of the confidentiality between a 3rd party CPA or outside tax professional, and the client.
In general, representing clients in IRS tax matters can be very complicated, due to the overlapping of tax and legal issues. The courts have not definitively ruled on what tax information is protected and is not protected under the attorney-client privilege. The application of the attorney-client privilege is especially complicated in offshore tax matters, due to the fact that many tax issues require a thorough legal analysis before coming to a resolution — such as PFICs.
When an attorney represents a client in a hybrid tax or legal matter and refers the tax preparation to an outside CPA or accountant, they oftentimes put the attorney-client privilege unnecessarily at risk by falsely relying on the Kovel Letter.
Under the false pretense of Kovel, the attorney tells the client that the attorney-client privilege extends to the tax return preparation. In these types of situations, the client may risk the privilege by divulging confidential legal information to the CPA that is actually not protected.
Conversely, that same information would have been protected if it was made to an attorney or in-house to one to the attorney’s staff members.
Let’s review the basics of the attorney-client privilege and how it may impact tax return preparation.
Unreported Offshore Account Example
Michelle is a foreign national who resides in the United States and is a US Legal Permanent Resident (aka Green Card holder). She had previously retained a CPA but did not divulge the information about her foreign accounts to the CPA.
There may have been a mix of misunderstanding and miscommunication, along with a partially completed tax binder by Michelle — noting that English is not her first language.
Michelle learns later that she should have disclosed all of her accounts to the IRS. She speaks to an attorney and the attorney offers to take her case. Instead of handling the tax preparation matter in-house, the attorney refers the case out to a local CPA for the tax preparation. Since Michelle has several foreign investment accounts that would qualify as PFIC along with an interest in two Sociedad Anonimas, the legal and tax aspect of Michelle’s case are hopelessly intertwined.
Michelle worries about divulging information to the outside CPA, but the attorney tells her that it is covered under Kovel and everything she tells the CPA is covered under the attorney-client privilege.
Michelle works together with the CPA and divulges more information then she should have. She asks his opinion on willful vs. non-willful and other confidential legal facts which are not necessary for the CPA to prepare the tax returns.
She has an unsettling feeling about the extent of the information she told the CPA, since the attorney was not present during these communications. A few years later, Michelle is audited by the IRS. How will the attorney client privilege protection play out?
What is a Kovel Accountant?
Kovel is one of the most overused (and misunderstood) mechanisms in tax law. It is not statutory law and does not per se extend the attorney-client privilege for communications made to an outside CPA. Kovel does not extend to tax return preparation.
Rather, it is the result of an appellate court case (U.S. vs. Kovel (296 F.2d 918 (2d Cir. 1961))). Kovel is used in very specific situations in which an attorney may require the advice of an accountant in order to prepare the legal aspect of the case.
In such a case, it allows the attorney to make some communications with the non-attorney and extends the privilege for information the attorney needs to build their case. Two very important fax about this scenario:
- The tax return preparation itself is not covered; and
- The purpose is for the CPA to assist the attorney with technical advice. If the client provides other information to the CPA that is not required for the CPA to provide the attorney with technical advice, the communications are not protected.
Result: When the IRS interviews the new (or old) CPA, Kovel is not going to protect attorney-client privileged information that should have never been disclosed to the CPA in the first place.
Since clients oftentimes are not aware of these nuances, it may lead to a breach of the attorney-client privilege on important confidential issues.
U.S. vs Abrahams May Extend the Attorney-Client Privilege
The case of Abrahams is a good example of how the Attorney-Client Privilege and Confidential Protection works and may extend the benefit to ancillary matters surrounding tax return preparation. In Abrahams, the attorney also handled tax preparation for his clients.
“Abrahams is an attorney who prepares income tax returns for his clients, and also represents many of them in disputes with the Internal Revenue Service before the Tax and Claims Courts.”
The IRS wanted the Attorney’s Documents
“The summons demanded that Abrahams produce “[a]ll documents relating to the preparation of income tax returns for others for others…and included a nonexclusive list of six categories of materials. Abrahams’ protestations at a hearing before the district court exposed two ambiguities in the language of the summons. First, if “relating to” is read very liberally, the summons covers all the material for Abrahams’ Tax and Claims Court litigation, since these cases “relate to” what was claimed on clients’ tax returns…”
The Attorney Claimed Privilege and the IRS disagreed
“Abrahams asserted below that all the information demanded by the IRS was protected against disclosure by the attorney-client privilege. The government claimed that none of it was.”
Court Held Legal Communications re: Tax Return Preparation Could be Protected
“For its part, the IRS argues that the questionnaires information is automatically unprotected because the clients completed the questionnaires in order to allow Abrahams to prepare their returns. We cannot fully accept that contention. Although communications made solely for tax return preparation are not privileged, communications made to acquire legal advice about what to claim on tax returns may be privileged” (emphasis added).
Attorney-Client Privilege in International Tax Matters
When it comes to international tax, oftentimes the tax and legal issues are entwined at every step of the way. Due to the complexities of international reporting and offshore compliance, protecting the attorney-client privilege is very important.
When a taxpayer speaks directly with his CPA about complicated international tax matters that require a legal analysis as well, it may put the attorney-client privilege in jeopardy which is why practitioners should be extra careful in matters involving offshore disclosure.
International Tax Audits and the Statute of Limitations
International tax audits and examinations come in many different flavors. For example, when a person completes a streamlined disclosure, they may not be directly audited for the actual 14654 or 14653 — but the IRS has other ways to get at the taxpayer.
If the taxpayer has significant amounts of foreign tax credit (+$50,000), then those cases almost automatically go to the exam unit and are audited due to the amount of foreign tax credits — which can lead to the audit on ancillary issues as well.
In addition, there is an exception to the 3-year standard statute of limitations for audits that is automatically extended for six years in accordance with IRC 6501. In conclusion, not all tax representation may encroach on the attorney-client privilege but with the increase in enforcement of fraud and international-related matters (both of which can carry very high penalties), it is an important consideration for representation.
Golding & Golding: About Our International Tax Law Firm
Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure.
Contact our firm today for assistance with getting compliant.