CPA-client privilege vs. the confidentiality ethics requirement.

Clients who consult their CPA for tax planning advice believe any communications with their CPA are privileged, i.e., what they tell the CPA cannot be disclosed by the CPA in court. But are these communications "privileged"? On rare occasions, a CPA's client will receive a letter from an attorney claiming that a law firm's preparation services are superior to nonlawyers' services because tax preparation by the attorney is privileged. Does a "privilege" apply here? The answers to these questions may surprise practitioners and their clients alike.

This column will define what exactly a professional privilege is; how it relates to the ethical requirement of confidentiality; how clients, CPAs and attorneys seem to confuse these concepts; and outline discussions currently taking place within the AICPA Tax Division as to whether the Institute should seek a tax matters privilege for clients of CPAs similar to the attorney-client privilege in tax matters.

Confidentiality

requirement vs. privilege

Professional privilege is frequently confused with the ethical requirement of confidentiality. Under certain circumstances, litigants are granted a "privilege" to object to the introduction in court of evidence relating to confidential communications with certain professionals. Privilege, then, is a shield used during litigation by the client, or by a professional on the client's behalf, to restrict access by opposing litigants to the client's confidential communications.

The confidentiality requirement, on the other hand, is a sword that can be used against a professional who makes an improper disclosure of client information. Confidentiality is an ethics requirement certain professions assume to support the character of each professional's relationship with his client.

All CPAs and attorneys are ethically bound by the requirement not to disclose confidential client information without client permission. This requirement for CPAs is spelled out in Rule 301 of the AICPA Code of Professional Conduct. That rule carves out exceptions if disclosure is necessary to

--fulfill one's obligations under Rules 202 and 203 to comply with mandatory technical standards and accounting principles;

--comply with a validly issued enforceable subpoena or summons;

--meet the requirement to have one's practice reviewed; and

--initiate an ethics complaint or respond to a recognized investigative or disciplinary body.

The second exception pinpoints the most obvious difference between the confidentiality requirement and a client privilege. The obligation not to disclose client information does not apply in the face of an enforceable summons or subpoena. A client privilege is first activated at that point.

Therefore, when the client consults a CPA for tax planning advice, the client has the right to expect that the CPA will maintain the confidentiality of any communications as to that advice unless one of the four circumstances described comes into play. Failure to maintain that confidentiality can cost the CPA his AICPA and state society memberships and even his certificate and license to practice.

Note: Some states vary with regard to exceptions carved out from the confidentiality requirement. A practitioner faced with the issue of whether client confidentiality may be breached in one of the four situations outlined in Rule 301 is well-advised to consult statutes and the rules and regulations promulgated by his state board of accountancy.

In addition, the Internal Revenue Code imposes penalties on a tax return preparer who improperly discloses a taxpayer's tax return information: a civil penalty of $250 per disclosure (Sec. 6713) and criminal penalties of up to a $1,000 fine or up to one year in prison or both for such a disclosure (Sec. 7216).

The attorney-client privilege was a "common law privilege" created by the courts to advance the goals of the adversarial legal system. Some states have created an accountant-client privilege by statute, but none of these state accountant-client privileges are recognized at the federal level. So in litigating federal tax matters, there is no privilege for clients of CPAs.

A little-known fact about attorney-client privilege is how narrow it is. In order for litigants to be successful in using privilege to keep their communications out of court, they must show that the communication was:

* Confidential: Not everything a client tells a lawyer is privileged. If the communication took place in a setting where confidentiality would not normally be expected--such as a social gathering where other people would likely overhear the conversation--the communication would not be privileged.

* Related to receiving legal advice: Not all services rendered by lawyers constitute legal advice. Several courts have denied privileged treatment for communications relating to tax preparation by lawyers on the grounds that the services rendered were not "legal services." Instead, the lawyer was acting as a "mere scrivener."

* Not disclosed to third parties by the client: A privilege can be "waived" by the client. This occurs if the client ceases to act as if the communication is confidential. For instance, if a client has a confidential communication with his lawyer, and then discusses the matter with others, he has waived the privilege. Some courts have denied the protection of the attorney-client privilege in tax preparation matters because the client has subsequently dislosed the communication to a third party, the IRS. In these situations, the client has been deemed to have waived the privilege.

In tax preparation matters, there is no attorney-client privilege. This is because either the services rendered are not considered legal services by the courts or the client has waived the privilege by filing the tax return with the Government. The U.S. Court of Appeals decisions on this issue all refuse to apply the attorney-client privilege to tax preparation communications on one of these two grounds. The law firm solicitation letter mentioned in the first paragraph, then, is incorrect.

Although no attorney-client privilege extends to tax preparation, such a privilege does include confidential communications involving either tax planning or representation in judicial and administrative proceedings, or both. In these two areas clients' confidential communications to their attorneys are afforded some protection not available for confidential communications to their CPAs. This is why many tax practitioners refer clients who need the protection of a privilege to attorneys, who in turn might hire the tax practitioner to provide the tax expertise.

AICPA Tax Division

discussions on whether

to seek a privilege

The AICPA Tax Division is currently studying the issue of whether the AICPA should seek a federally created tax matters privilege, or some other privilege-like protection for clients of CPAs, similar to that currently in effect for attorneys. The issues are complex.

Those division members opposing AICPA action on this issue point out that very few clients of CPAs have experienced problems due to the lack of a privilege to protect communications. This alone weighs against spending much time, effort and money seeking such a privilege.

In addition, the law relating to client privilege is very complex. Some CPAs anticipate a need to consult their attorneys whenever a potential issue of privilege arises. Other CPAs counter that attorneys avoid such a potential liability by simply claiming that all client communications are privileged. This approach requires the courts ultimately to sort out the accuracy of the claimed privilege.

Finally, those in opposition are concerned that a mistaken disclosure by a CPA of a privileged piece of information could result in heightened exposure to malpractice litigation. This argument is based on (1) an understanding of how complicated the law of privilege is and (2) the fear that CPAs will misunderstand privilege and not use it correctly on behalf of their clients. Of course a disclosure of privileged information would probably also violate the ethics confidentiality requirement and would cause malpractice problems on those grounds.

Those Tax Division members favoring the idea that the AICPA should seek a federally created tax matters privilege point out that the current situation puts the accounting profession at a competitive disadvantage to the legal profession in rendering services substantially identical to those performed by lawyers.

Others emphasize that the number of clients who suffer because they lack a privilege to protect the confidentiality of communications with their CPAs is irrelevant. If even one client suffers the indignation of having his CPA serve as a witness against him, that is one client too many. These proponents argue that the confidences of all clients of CPAs should be protected to the same degree they would be if they had been served by lawyers.

Arguments have been aired on both sides of the issue, but no decision has been made by the Tax Division on whether to actually seek a privilege. Quite possibly no decision will ever be made, since the arguments favoring and opposing such a privilege are all sound.

Confidentiality checklist

Although CPAs want their offices to appear to be friendly places to do business, this friendliness can result in slack office procedures when it comes to confidentiality. The following questions may help practitioners gauge their office routine and improve confidentiality practices.

* If the firm employs a receptionist to answer incoming calls, is the receptionist cautioned not to speak of clients' names and messages while others are present in the lobby area?

* Is the staff specifically instructed not to mention client names and matters to family and friends?

* Is the staff encouraged to clear their desks every night before heading home?

* Is the staff work area, where tax returns are prepared and checked, away from passers-by, such as deliverymen or clients being escorted to partners' offices?

* Are passwords used on computers containing confidential client tax information?

* Do these computers contain computer locks and, if so, are they used?

* While "on the job" at a client's location, is an attitude fostering confidentiality maintained as much as possible?