Work-product privilege.

In the course of examining a taxpayer's return, the IRS may attempt under Sec. 7602 to summons "any books, papers, or other data which may be relevant. " The common test of whether materials are relevant (and therefore subject to Sec. 7602 summons authority) is whether the documents "may throw ligt upon correctness of the return" at issue (Wyatt, 637 F2d 293 (5th Cir. 1981)). The taxpayer may then still claim that some "privilege" protects him from the requirement to deliver certain documents.

Accountant-client privilege: The Supreme Court in Couch, 409 US 322 (1973), held that "no confidential accountant-client privilege exists under federal law, and no state-created privilege has been recognized in federal cases."

Attorney-client privilege: The attorney-client privilege generally applies. to communications made in confidence by a client to an attorney for purposes of obtaining legal advice, and to communications made by an attorney to the client if such communications contain legal advice or reveal any confidential information on which the client seeks advice. Typically, the determinative factor in ascertaining the applicability of the attorney-client privilege is that the communication be made in confidence for the purpose of obtaining legal advice from the lawyer. The attorney-client privilege may extend to communications made by third parties, such as CPAs, who assist attorneys in providing legal services, if such communications to a client's attorney are made at the request of the client. The test of whether a CPA assists an attorney appears to be whether the CPA or the attorney is the client's primary representative. An attorney is the primary representative if the attorney is hired directly by the client and the attorney retains a CPA in the course of rendering legal services. in this case, the attorney-client privilege may attach to communications with the CPA and his workpapers. A CPA is the primary representative if the CPA is hired directly by the client and communications with an attorney are incidental to rendering accounting services. In this case, the attorney-client privilege attaches to neither the CPA nor the attorney communications. Furthermore, voluntary disclosure of otherwise privileged information waives the privilege.

Work-product privilege: The work-product privilege, as developed by the Supreme Court in Hickman v. Taylor, 329 US 495 (1947), protects documents, interviews, statements, memoranda, correspondence, briefs, mental impressions and other tangible items prepared by an attorney in anticipation of litigation. The scope of the protection provided by the work-product Privilege is broader than the protection provided by the attorney-client privilege. The work-product privilege has been extended under Fed.R.Civ.P. 26(b)(3) to protect documents and other materials prepared by third parties in anticipation of litigation, regardless of whether the party was retained by the client or by his attorney. Whether litigation may be anticipated is based on a reasonableness test, taking into account all the facts and circumstances surrounding the pending issue. Litigation may be reasonably anticipated before a lawsuit is commenced. To show that a document was prepared in anticipation of litigation, a litigant must demonstrate that the document was created with a specific claim, supported by concrete facts, which likely lead to the specific litigation in mind, not merely assembled in the ordinary course of business or for other nonlitigation purposes. The work-product privilege may also protect documents prepared in anticipation of another trial or other litigation, regardless of whether the documents are directly related to the case at bar. Although the attorney-client privilege is inviolate, the work-product privilege can be pierced if the party seeking discovery can demonstrate substantial need.

A unanimous Supreme Court decision has held that CPAs' tax-accrual workpapers were not protected under work-product privilege because a CPA's "obligation to serve the public interest assures that integrity of the securities markets will be preserved, without the need for a work-product immunity for accountants' tax accrual workpapers" (Arthur Young & Co., 465 US 805 (1984)).

Bernardo

The Tax Court has recently discussed the applicability of the attorney-client privilege and work-product privilege as applied to a CPA engaged in an IRS audit (Bernardo, 104 TC No. 33 (1995)).

Bradford and Marybeth Bernardo claimed a $593,000 charitable contribution deduction on their 1986 return for the donation of a sculpture to the Massachusetts Bay Transportation Authority (Authority). The taxpayers' contribution base under Sec. 170 was zero for 1986. They claimed carry-over deductions in the total amount of $490,818 on their 1987, 1988 and 1989 returns. The taxpayers' attorney provided legal advice on the structure of the donation and its tax treatment. In providing legal advice, he relied, in part, on a CPA who oversaw the preparation of the taxpayers' returns for the years in question. The taxpayers had divorced after the filing, but prior to the examination of their joint income tax returns. The CPA provided information about the taxpayers' tax returns to the attorneys representing Bradford Bernardo in his divorce from Marybeth Bernardo. The CPA was hired and paid by the taxpayers. He was not engaged by, and therefore never received a letter of engagement from, the taxpayers' attorney.

During April 1991, the IRS notified the CPA that its Art Advisory Panel had determined that the sculpture's fair market value (FMV) was substantially less than the deduction claimed on the taxpayers' 1986 return. Thereupon, the CPA informed the taxpayers that he believed they would have to legally challenge the Service's position. The IRS issued a deficiency notice on the grounds that the taxpayers failed to establish that they were entitled to a deduction. The notice alternatively stated that if the taxpayers established their entitlement to a deduction, the amount should be limited to $100,000. The taxpayers petitioned the Tax Court for a redetermination of the deficiency. During the discovery phase of the Tax Court proceedings, IRS District Counsel sought several documents and filed a motion to compel their production. The documents sought included some prepared by the CPA during the Service's audit of the taxpayers. The taxpayers claimed the attorney-client and work-product privileges.

The Tax Court held that the CPA was hired by the taxpayers and was their primary representative before the IRS. The CPA's communications with the attorney were incidental to his representation of the taxpayers because he was not retained by the attorney. Therefore, the attorney-client privilege did not attach to communications by or with the CPA.

The Tax Court further held that the point at which litigation was reasonably anticipated by the taxpayers was when they received a ruling from the Art Advisory Panel determining that the value of the sculpture was substantially less than that claimed on their returns, not the date of the statutory notice of deficiency. Thus, the work-product privilege attached to all materials created after receipt of the Panel's ruling that were related to the charitable deduction. Furthermore, documents prepared by the CPA in anticipation of potential divorce litigation retained their work-product privilege despite relating to a separate matter.

Planning considerations

A tax engagement letter may be used to help establish who is the taxpayer's primary representative. Tax engagement letters also may be used to establish that the services are to be provided in anticipation of litigation. A tax engagement letter may help to fix a point in time when any additional work product may be excluded from discovery by the Service and to help document why litigation is anticipated.

It may also be advantageous to retain an attorney at the early stages of the audit or the appellate conference, in order to have the privilege protect early work product.

From Charles I. Burt, II, M.T., PA, Cleveland, Ohio, and Hans Sprohge, CPA, Ph.D., Wright State University, Dayton, Ohio