IRS aggressively challenges privilege.

IRS Chief Counsel B. John Williams has stated publicly that the IRS intends to aggressively challenge the assertion of privilege in response to a request for tax shelter information. True to his word, the government filed summons enforcement actions on July 9, 2002, against two national accounting firms, requesting, among other things, that the courts find the firms' assertion of privilege as to information or documents improper. Who will prevail in these disputes is less than clear; however, the answers will be based on judicial judgment calls as to the application of highly specific facts to deceptively complicated rules of law.

Basically, the attorney-client privilege protects from disclosure communications that a client makes to an attorney for the purpose of obtaining legal advice. In 1998, Congress extended the privilege to communications made to a Federally authorized tax practitioner (which generally includes CPAs) to the extent the communication would be considered privileged if it were between a taxpayer and an attorney; see Sec. 7525. The privilege does not apply to written communications with a corporation about a corporate tax shelter. (For a discussion, see Mendelson, Herskovitz and Einhorn, "The New CPA-Client Confidentiality Privilege" TTA, Oct. 1998, p. 676.)

In the context of IRS summonses for tax-shelter-related information, the question is whether client identity, opinion letters and related documentation are privileged, and, if so, whether the privilege was waived. Generally, courts have held that the attorney-client privilege does not extend to client identity, because identity generally is not communicated for the purpose of obtaining legal assistance, and disclosure of the identity does not normally reveal a communication's content. Client identity, however, might be deemed privileged if the substance of the client's activities or communications with the attorney was already known and its disclosure would effectively expose client confidences.

In its purest form, the attorney-client privilege appears to extend only to communications that a client makes to an attorney. The extent of protection afforded to attorney-to-client communications has been much litigated, with differing results. Despite the language in some cases, it is fairly well settled that the privilege applies to communications from an attorney to a client, especially if disclosure of the attorney's communications might reveal the client's confidential communications.

Several courts have held unqualifiedly that the privilege protects communications of legal advice and opinions, regardless of whether they reveal client confidences or respond to a client's specific request for advice. The privilege would not protect communications from third parties, even if made specifically for a client's benefit. Further, it does not protect all of an attorney's activities on a client's behalf; an attorney's communications with persons other than the client, even if made on the client's behalf, generally would not be privileged.

It is well established that documents that are not confidential attorney-client communications would not become privileged if transmitted to an attorney. Conversely, if a document is privileged in the client's hands prior to a transmittal, the transmittal would not destroy the privilege if the document was transmitted to obtain additional legal advice.

The difficult question is the extent to which facts and information gathered from third-party sources by a tax practitioner are privileged when incorporated into legal advice rendered to a client. The courts generally sort this out by weighing the competing policy considerations of protecting attorney-client communications against the law's general bias against preventing disclosure of relevant information.

Even if information and documents sought by the IRS are privileged, the privilege can be waived easily. Most courts have held that material communicated to an attorney for incorporation into a return is either not privileged because it was never intended to be kept confidential, or the privilege was already waived via disclosure to a third party--the IRS. However, even this issue has been less than clear, as some courts have held that the privilege has to be waived as to information actually incorporated into a return and filed with the IRS, including underlying details. Thus, a taxpayer may have to provide detailed components of reported figures and calculations, but may not have to disclose other privileged information not forwarded to the IRS.

Conclusion

The relatively simple question of privilege often leads to complex answers. Certainly, the answers are not as clear as some in the IRS would have practitioners believe.

FROM M. TODD WELTY, J.D., CPA, MEADOWS, OWENS, COLLIER, REED, COUSINS & BLAU, L.L.P., DALLAS, TX