Privilege and confidentiality: confusing principles.

Privileged communications and confidentiality are important principles in the accounting profession, in general, and in tax practice, in particular. This subject and the efforts and considerations of the AICPA Tax Division in recommending a privilege for CPAs were discussed in the Tax Currents column in the February issue of The Tax Adviser, at 123-125.

Clients believe that anything they tell their CPA is privileged. They believe CPAs have the same privilege as attorneys. As far as confidentiality goes, clients feel their financial and tax affairs are very personal and should not be shared with anyone else without their permission. That much is true. The accounting profession mandates that practitioners respect and keep private their clients' financial affairs and tax affairs. But there is a big difference between privileged communications and confidentiality.

Confidentiality has ethical, professional and moral responsibilities associated with it. A CPA's most essential element is his integrity. If clients knew or felt that the CPA was not keeping their financial and tax information confidential, they would lose faith and credibility in him, which means lost clients, lost business and lost reputation. So, from a professional standpoint, guarding the confidentiality of client information is as sacred as the privilege between doctor and patient, or between clergyman and parishioner.

A privilege is a special treatment that protects certain confidential communications from being disclosed in a legal proceeding. The privilege under current law applies only to attorneys. All privileged communications are confidential, but not all confidential, but not all confidential communications are privileged. The CPA should fully understand the necessity of maintaining the confidential nature of a client's information.

In a criminal setting, in which a practitioner is advising his client to get a criminal tax fraud lawyer, comments such as "Don't tell me anymore", "What I don't know about you can't hurt me", "If I know that information I will have to professionally respond differently than if I didn't know that information" may be appropriate, until such time as the attorney/client privilege has been established.

In civil tax matters the rules are different. It is much better to know what clients are doing and thereby be able to advise them correctly. Practitioners want to have the choice of deciding whether to go forward and represent the client or not - if they believe there is a conflict of interest or a violation of ethical rules. They also would like the opportunity to advise clients that with proper disclosure the may advance difficult positions, and avoid harsh or unwanted penalties (while at the same time increasing their chance of having that particular issue or item or series of items scrutinized by the IRS).

Privileged communications

Areas of practice for CPAs and attorneys:

1. Tax preparation: Preparation of any type of federal or state tax return or other reporting document to governmental bodies. 2. Consultation: Advising a client on a particular aspect or series of aspect of a transaction or series of transactions that will ultimately be incorporated into a tax return. Consultations may be of a relatively small or relatively large portion of a principle or reporting that gets included in a tax return. 3. Representation: Representing a client before a governmental body in connection with a tax controversy or advancing a principle or request before a governmental body.

Privilege does not apply to tax preparation by attorneys or CPAs. However, it may be difficult at times to determine when there is an overlap between the tax preparation function and the consulting and/or representing areas of practice.

Attorney/clients privileges:

1. First is the concept of "common-law" privilege. Parties to litigation are granted the privilege to object to the introduction in evidence of confidential communications with their attorneys under certain circumstances. Generally, four conditions are necessary to establish a "common-law" privilege

The communication must originate in a confidence that they will not be disclosed.

This element of confidentiality must be essential to the full and satisfactory maintenance of the relationship between the parties.

The relationship must be one which, in the opinion of the community, ought to be sedulously fostered.

The injury that would inure to the relationship by the disclosure of the communications must be greater than the benefit thereby gained for the correct disposal of litigation.

The client is the holder of the privilege; he asserts the privilege, and it belongs to him. Thus, the privilege protects the clients, not the professional. 2. The second kind of attorney/client privilege is one that is recognized to encourage full disclosure by the client for the furtherance of the administration of justice. In order for the attorney/client privilege to apply:

There must be an attorney/client relationship. The client must believe he is confiding in an attorney with the information to be kept privileged.

The privilege protects oral and written communications between lawyer and client. Documents or information conveyed outside the privilege cannot subsequently be made privileged by a client's request; the information must be intended to be privileged when communicated and subsequently not waived.

The communication must be confidential. The client must expressly state (or reasonably expect) that the communication will be confidential, if information is conveyed in an overtly noncofidential setting, such as in public, it would not be deemed to be privileged.

The privileged must be intact. The client does not waive the privilege or permit partial disclosure of the information out of the privileged setting.

Neither an attorney nor a CPA has privilege for the tax preparation function. A CPA has no privilege under any circumstances, but an attorney may have a privilege in connection with consultation and representation, if the information conveyed to him is conveyed in the setting described above and is not waived by the client. When an attorney is questioned as to whether information was conveyed in a consultation and/or a representation status (as opposed to a tax preparation status), the attorney should consider all information conveyed in a privileged setting and let the courts determine what is unprivileged.

Keeping this in mind, the CPA should consider that in a potentially criminal or fraudulent setting, clients should always be advised that the CPA does not have a privilege and that if the client feels that any of his acts or omissions could be deemed to be fraudulent, be should consult a qualified tax attorney in a privileged setting to discuss those sensitive issues. Tax attorneys, as a general rule, will retain an accountant unfamiliar with the client to convey privileged communications to the CPA to protect the work product of the CPA.

In a civil proceeding, the CPA has no privilege. The CPA must understand and recognize this and inform his client.

In civil tax matters, consultations and representations, it is rare (if ever) that the IRS will subpoena or demand all of a taxpayer's files or correspondence that has gone back and forth between the CPA and the taxpayer. The Service does have the right to subpoena this information, but generally does not do so. The burden of proof in establishing a tax position is on the taxpayer. That means that, if a position or a tax return is challenged, the taxpayer, and not the IRS (which is subpoenaing private files or private information), must put forth evidence to prove that matter. With this in mind, a CPA should consider only those circumstances that he feels may become fraudulent or may subject the client to criminal scrutiny, before advising or recommending that the client seek attorney/client privilege in connection with advancing the professional relationship with the client. Insurance/general protection: Controversies can arise when the CPA prepares a tax return or advances a position for the taxpayer without having full knowledge of the taxpayer's facts and circumstances. A client may be upset with the CPA if an adjustment or proposed adjustment is made because the CPA did not want to "ask" sensitive question or "did not want to know." If a practitioner chooses not to advise his client in writing on a particular position (knowing that the client will reject the advise as contrary to his course of action), for his own protection the practitioner should document and place in his file a memorandum of oral discussions held with the client on the positions taken and the facts as he understands them.

The concern about having information in files that could be subpoenaed is less than having a client upset on audit when a change is proposed and the facts surrounding the tax return or transaction do not support the method in which it was reported. The CPA must look out for himself, as well as his clients. He should never knowingly or willingly disclose or give up to the governmental voluntarily sensitive, confidential or potentially harmful documents or information. If forced to do so, the CPA should consult qualified legal counsel. With this in mind, the CPA should consider when it would be appropriate to consult with qualified tax attorney regarding further communications with the tax-payer

Confidentiality

A confidential communication is made with the intention that it not be disclosed. CPAs impose on themselves an ethical requirement to maintain the confidentiality of client information. Rule 301 of the AICPA Code if Professional Conduct states that" a member in public practice shall not disclose any confidential client information without the specific consent of the client."

State and federal agencies regulating professional conduct impose a legal requirement of confidentiality on CPAs. Many states gave their own set of rules regarding confidentiality.

All confidentiality requirements have exceptions for disclosures. For instance, CPAs must respond to a validly issued subpoena or summons, this overrudes the requirement to maintain condentiality. This means that a CPA is required to keep information confidential that he obtains, receives or becomes aware of from his client. But in the event a valid subpoena is issued, the CPA would be required to produce or disclose the information that has come into his sphere of knowledge. The things a CPA learns by wandering the halls of his clients' offices and hearing employees talk, or seeing or reviewing documents in the financial statement preparation process, or by analyzing (for other reasons) financial transactions for the tax accrual or financial statement preparation, all are within the confidentiality rules of the CPA's professional and ethical and moral obligations. They are not privileged communications, however.

Conclusion

In a professional relationship based on trust, the importance of maintaining confidentiality must be stressed to shareholders, partners, upper level staff and clerical and support staff. If does not make a difference to a client who releases confidential information; all the client knows is that the confidential nature of his affairs has been violated.

As to privilege, the CPA should make sure that this clients and members of the organization understand that the CPA does not have privilege. The CPA should be cognizant of those very sensitive matters that may involve criminal or fraudulent overstones, and judiciously advise his client to seek adequate legal counsel in those instances. In all other instances of a civil nature the CPA should obtain (to the best of his abilities) s much of the facts and information surrounding the client and specific transactions, and document those that are sensitive for his own benefit. The chances, in a civil matter, of having to give up internal memoranda, or opinions of the CPA that are internal only or for "client eyes only" are remote in today's climate. A better job can be done for the client with full knowledge and cooperation.