The need for CPA-client privilege in federal tax matters.

EXECUTIVE SUMMARY

The attorney-client privilege has long been a part of the Federal law, while clients of CPAs enjoy no such confidentiality in their communications. The IRS has recognized that attorneys and CPAS assist taxpayers equally in representing them before it, and has accordingly granted those groups (along with enrolled agents) parity in their dealings with the Service. This article addresses the concept of attorney-client privilege, explores its parameters, and explains why the time is ripe to adopt a CPA-client privilege for Federal tax purposes.

Taxpayers have long enjoyed the special status of privileged communications in tax matters. However, this common-law-based attorney-client privilege is rather formalistic--that is, non-attorney tax advisers must filter their advice through an attorney to protect the taxpayer's privilege. Because legal advice in tax matters most often involves technical and procedural tax issues apart from litigation, it seems too formalistic to require the insertion of a lawyer merely to "protect the privilege."

Congress has granted parity to CPAs, lawyers and enrolled agents practicing before the IRS.(1) Circular 230(2) was promulgated to embody rules for the administration of practice before the Service. Because it is legally and commonly recognized that CPAs and enrolled agents represent taxpayers before the IRS in the same manner as do lawyers, taxpayers should enjoy the same special status of privileged communications when dealing with their non-legal tax advisers.

What Is a Privileged Communication?

Written or oral communications, made in confidence, in the context of soliciting legal advice, may constitute privileged communications, if the privilege has not been waived.(3) The attorney-client privilege is long founded in the common law and has been incorporated into the Federal Rules of Evidence.(4) The purpose of the attorney-client privilege "is to encourage full and frank communication between attorneys and their clients and thereby promote broader public interests in the observance of law and administration of justice."(5) The privilege applies to corporations as well as to individuals as a defense to compelled disclosure of an asserted confidential communication in a tax controversy.(6)

Whether or not an attorney is involved, the privilege does not apply to matters such as the communication of business advice, tax return preparation, advice in committing criminal or fraudulent activity, or to facts or preexisting documents.(7) But legal bills and time records that describe the legal services provided may be privileged to the extent of the descriptions.(8) However, there is no privilege if it has been waived by a publication or sharing of the communication with someone outside the chain of the legal advice (i.e., with one who does not have a need to know).

Types of Advice or Information to Be Protected

Taxpayers (corporate or individual) must carefully and prudently consider a plethora of facts and applicable law to reach reportable positions on their tax returns, because the U.S.'s self-assessment system of reporting income is reinforced with significant additions to tax, penalties and interest codified in Federal tax law.(9) Taxpayers with complex tax situations often seek help from in-house and outside tax advisers. It is well established that taxpayers may, in good faith, reasonably rely on the advice of outside advisers in reporting tax positions to avoid penalties.(10) Compelled disclosure of tax advice sought (and/or rejected) would make taxpayers less likely to seek outside advice in the first place.

Generally, taxpayers seek to protect the thought processes, notes, opinions and analyses of their advisers; this may include tax opinions, tax planning memoranda, analyses of what constitutes substantial authority, discussions of contrary authority and analyses of alternatives rejected in tax planning. Taxpayers may also seek to protect transfer pricing reports and valuation reports. It may be difficult to define just what is privileged from disclosure compelled by the IRS in the course of an examination or tax controversy.

Protecting Client Confidences

The attorney-client privilege extends to communications by an attorney's client to an accountant hired by the attorney to assist him in understanding the client's financial information.(11) Advice of an accountant hired by a lawyer, including in-house (general) counsel, to assist in giving tax advice to a client, is privileged.(12) Alternatively, the client may choose to engage the CPA to work with legal counsel.

Further, the work product doctrine protects documents, "interviews, statements, memoranda, correspondence, briefs, mental impressions," and tangible things prepared by an attorney in anticipation of litigation or trial.(13) This doctrine is broader than the attorney-client privilege and applies to materials prepared by a taxpayer's representative, regardless of whether the representative was retained by the taxpayer or his lawyer.(14) A recent Second Circuit case suggests that the work-product doctrine may apply when a CPA plans a transaction for a client and that, based on the complexity, materiality and lack of substantial authority for the reporting position on the transaction, such work may be deemed to be in anticipation of litigation.(15)

There is no accountant-client privilege under Federal law,(16) although at least 16 states have recognized some form of such privilege.(17) Tax return preparation is not "legal advice,"(18) nor is a CPA's tax planning advice, even though the same advice from a lawyer may be protected. A CPA's tax accrual workpapers are not privileged, due to the public role of the CPA, but Internal Revenue Manual (IRM) 4024.4 provides that the IRS will not seek them, except in unusual circumstances.(19) The IRS voluntarily limited its scope of inquiry into accountants' workpapers in IRM 4024.4.

Practice Before the IRS

Congress and Treasury recognized that there was a special need to regulate and monitor Federal tax practice to encourage ethical and effective representation of taxpayers before the IRS(20); in addition, taxpayers were granted the legal right to be represented before the IRS.(21) Lawyers, CPAs and enrolled agents, among others, were recognized as having specialized practices that assist taxpayers in appearances before the IRS. Circular 230 treats lawyers, CPAs and enrolled agents equally in all aspects of practice before the IRS by giving them parity.(22)

The Disparity in Privileged Communications

Taxpayers have recurring relationships with tax advisers, just as they do with other service providers. Should they be forced to seek outside counsel in tax matters that may be subject to controversy with the IRS for fear of being compelled to disclose advice received from their accountants? Small taxpayers and small businesses (as well as larger taxpayers) may find it duplicative, expensive and time consuming to engage lawyers solely to protect communications subject to the privilege. Taxpayers should be able to freely choose their advisers based on the quality of their advice and familiarity with the facts, rather than their legal status.

Extending the Privilege to CPAs

The privilege can be extended to cover CPA-client communications either by administrative grace or by legislation. The IRS chose to exercise restraint in seeking accountants' workpapers only in rare or unusual circumstances under IRM 4024.4; similarly, the IRS could provide that, in the ordinary course, it will not seek a CPA's advice to a client to the extent that it could not reasonably obtain such advice from a lawyer under the common-law privilege.

Other agencies and departments of the Federal government may choose to recognize such administrative grace by the IRS, but they may not be bound to do so in litigation. Consequently, it may be in the interest of all taxpayers to seek a statutory right to protect their privacy in tax matters when dealing with any of their tax advisers--whether they be lawyers, CPAs or enrolled agents.

RELATED ARTICLE: IN MEMORIAM

The accounting profession and the AICPA lost one of the giants in the tax field on December 18, 1995, with the death of Saul Braverman at the age of 78. Saul was the recipient of the 1993 Arthur J. Dixon Memorial Award, the highest honor the AICPA can bestow in the field of taxation, and the decision of the Tax Executive Committee to honor Saul with that award reflected its view that Saul's career was one embodying professionalism at the very highest levels.

For the profession, Saul served the AICPA Tax Division with distinction for over 30 years. In addition to two separate terms of service on the Tax Executive Committee, he chaired the Responsibilities in Tax Practice Committee, the Tax Forms Committee and the Client/CPA Tax Matters Privilege Task Force. At varying times, he also served as a member of the Tax Administration and Procedures Committee, the Tax Policy and Planning Committee, the Tax Practice Management Committee and the Liaison with Other Professional Organizations Committee.

Saul contributed to our profession outside of the Tax Division, as well. He was a member of the Advisory Group to the Commissioner of the Internal Revenue in the early, 1980s, was one of the first official liaisons from the AICPA to the American Bar Association Tax Section, and also served on the Auditing Standards Board Task Force on Financial Forecasts and Projections. Because of his dual role with the ASB and the Responsibilities Committee of the Tax Division, Saul played a significant part in the efforts of the Treasury Department to draft provisions in Circular 230 concerning accountants' responsibilities for tax shelter opinions.

All of these activities occurred as additional contributions from a most active practitioner. Saul started his firm in Beverly Hills, California, in 1947 (now Braverman, Codron & Co.), was its managing partner as it grew, and retired in 1993 having seen the firm expand to 55 people (including eight partners). An active writer and speaker, Saul was published in (among other publications) The Journal of Taxation, and served for 17 years on the Editorial Advisory Board of The Tax Adviser

Saul leaves a void in our profession that will be difficult to fill. He was articulate, delightfully controversial, never without a fresh idea (or willingness to espouse it), and a professional colleague who operated only under the highest of principles. He is already missed by his many friends across the country, and we at the Tax Division wish to extend our deepest condolences to his wife, Ruth, his four sons and six grandchildren.

Editor's note: Mr. Mendelson is a member of the AICPA Tax Division Responsibilities in Tax Practice Committee. He chairs the AICPA Executive Committee Working Group on Parity in Tax Practice Before the IRS and also serves on the Financial Status Audit Task Force. (1) See 5 U.S.C. [sections]500 and Treasury Department Circular 230, Regulations Governing the Practice of Attorneys, Certified Public Accountants, Enrolled Agents, Enrolled Actuaries and Appraisers Before the Internal Revenue Service (hereinafter, "Circular 230"). (2) See Gardner and Willey, "The Tax Practitioner's Guide to Circular 230 (Parts I and II)," 26 The Tax Adviser 647 and 711 (Nov. and Dec. 1995). (3) See Wolfman, Holden and Harris, Standards of Tax Practice (Little, Brown & Co., 3d ed., 1995), [sections]403.1.2; 8 Wigmore, Evidence (McNaughton rev. 1961), [sections]2292. (4) Federal Rule of Evidence 501. (5) Upjohn Co., 449 US 383 (1981)(81-1 ([paragraph] USTC 19138), at 81-1 USTC 86,142 (holding that answers on a corporate questionnaire prepared by general counsel and completed by officers and employees were privileged communications). (6) See Louisville & Nashville R Co., 236 US 318, 336 (1915). (7) Upjohn, note 5, at 81-1 USTC 86,145. (8) In re Grand Jury Witness (Richard J. Salas), 695 F2d 359, 362 (9th Cir. 1982). (9) See Secs. 6651-6724 (IRC Chapter 68) and 7201-7344 (IRC Chapter 75). (10) See Regs. Sec. 1.6664-4(c). (11) Louis Kovel, 296 F2d 918, 922 (2d Cir. 1961)(9 AFTR2d 366, 62-1 USTC ([paragraph]) 9111). (12) See Upjohn, note 5, at 81-1 USTC 86,143; Kovel, id. (13) See Hickman v. Taylor 329 US 495, 511 (1946) (holding that oral and written statements of witnesses secured by adverse party's counsel in the course of possible litigation were privileged). (14) See Federal Rule of Civil Procedure 26(b) (3). (15) Monroe Adlman, 2d Cir., 1995 (76 AFTR2d 95-7188, 95-2 USTC ([paragraph]) 150,579) (holding that accounting firm memo prepared for corporate client's tax attorney-vice president relating to the corporation's restructuring was not privileged because it was not prepared in confidence for purposes of obtaining legal advice from that attorney). (16) See Arthur Young & Co., 465 US 805, 817 (1983) (53 AFTR2d 84-866, 84-1 USTC ([paragraph])9305). (17) Causey and Causey, Duties and Liabilities of Public Accountants Accountant's Press, 5th ed., 1995), p. 116, Exhibit 4-2, identifies 16 states that have accountant-client testimonial privilege statutes. The authors have identified 36 states (and the District of Columbia) that provide some form of privilege to accountant-client tax advice (Alabama, Alaska, Colorado, Connecticut, Florida, Georgia, Hawaii, Idaho, Illinois, Indiana, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Michigan, Minnesota, Mississippi, Missouri, Montana, Nebraska, Nevada, New Hampshire, New Jersey, New Mexico, North Carolina, North Dakota, Ohio, Oklahoma, Oregon, Pennsylvania, South Carolina, Tennessee, Texas, Wisconsin and Wyoming). (18) Martin J. Lawless, 709 F2d 485, 487 (7th Cir. 1983) (52 AFTR2d 83-5818, 83-1 USTC 19414) (holding that information transmitted to an attorney to prepare estate tax return was not privileged). (19) See note 16; IRM 4024.4, Guidelines for Requesting Audit or Tax Accrual Workpapers (5/14/81). (20) See e.g., Circular 230, note 1. (21) See Sec. 7521 (b) (2). (22) Circular 230, note 1, at [sections]10.3.