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"Mining" client data: taxpayer privacy issues.

Many new technologies are emerging that will help tax practitioners work faster and smarter. Over the next few years, there will be various new "smart" software programs designed to automate analysis of historical data. In addition, it will not be long before practitioners see a single data stream flowing seamlessly from general ledger to financial statements to tax returns to Websites and annual reports.

These new products could have a significant impact on the practices of tax advisers. In addition to calculating tax and printing forms, smart software will enable tax practitioners to more readily add value to routine client services. It will automate the analysis of clients' unique situations, providing tax-savings tips and strategies, as well as general business consultation geared toward the client's specific needs. With these benefits, however, come responsibilities. Even though these new technologies enable CPAs to mine historical client data in countless ways, CPA practitioners are still required by both professional ethics and statutory requirements to treat client data in a confidential manner.

Privacy Laws

Under Sec. 7216, return preparers are legally responsible, and risk criminal sanctions, for unauthorized disclosure of return information. Knowingly or recklessly disclosing or using this information is a misdemeanor, punishable by a year in jail or a $1,000 fine, or both, plus costs of prosecution.

CPAs and attorneys who prepare returns may disclose and use tax information in the ordinary course of rendering accounting or legal services to that client. In many cases, however, it is not clear which services fall under the umbrella of "accounting services." Some activities performed by CPAs, such as selling life insurance and mutual funds, clearly go beyond rendering traditional accounting services. In such cases, CPAs can use the data to solicit additional business if they first obtain the client's written permission. If doubt exists as to whether other services fall within the definition of accounting services, CPAs would be well served to get the client's written permission. The requirements for a valid consent are enumerated in Regs. Sec. 301.72163. It appears that CPAs may obtain a client's consent through an engagement letter. (Disclosure in response to a subpoena or court order does not violate the law.)

Data Confidentiality and the IRS

The IRS is under a directive from Congress to have 80% of all individual tax returns fried electronically by 2007. Despite the steady growth in e-filing, many observers feel there is no way the Service can reach this goal unless e-filing is provided free of charge. Along these lines, the Clinton Administration's 2001 Budget proposal included a provision that would have required the IRS to offer one or more options to the public for free preparation and filling of tax returns by 2002. (Undoubtedly, the Administration took note of the free return preparation offered online by T. Rowe Price, Fidelity, Vanguard, H.D. Vest, and other financial service providers.)

Last August, the IRS issued a "request for information" to determine the public and private sectors' reactions to the "opportunity" to offer free tax preparation and filing via the Internet. Many observers were taken aback when the Service wanted to know what providers of the free service might expect in return. The IRS said that it planned to issue a request for proposal to organizations that would be able to provide free online tax preparation and e-filing, "in exchange for some combination of monetary and nonmonetary consideration." The nature of the "nonmonetary consideration" was unclear, with the implication being that it might include access to, as well as use of, taxpayer data. According to then IRS Assistant Commissioner for Electronic Tax Administration, Robert Barr, there is in fact a link between the incentives the Service might offer to vendors willing to offer free tax preparation and the privacy rules governing the use of client data.

The link between free tax preparation and taxpayer privacy could be the taxpayer data, which could be used by commercial enterprises to market products and services to the taxpayer. Given the high cost of landing new customers, providing free tax preparation could be an attractive marketing channel for these businesses. For example, an individual who claimed dependents could be a candidate for life insurance or a college savings program, just as an individual who deducted mortgage interest might be of interest to an insurance or mortgage company. Targeted banner ads on Websites could be triggered when a taxpayer makes an entry on a specific line of a return. In this scenario, taxpayers would have to consent to being marketed to in exchange for using free online software. (Presumably, a click-through approach on a Website could be construed as taxpayer consent to the marketing.)

Mr. Barr's replacement, Terry Lutes, indicated that Sec. 7216 is the controlling statute. He pointed out that a recent Forrester Research study showed that 75% of all returns (presumably, Form 1040s) soon would be filed via the Internet on the financial institution channel. He also pointed out that Congress enacted Sec. 7216 long before the advent of electronic filling and online banking.

Enter the FTC

The IRS is not the only Federal agency dealing with privacy issues. Pursuant to the 1999 Gramm-Leach-Bliley Act, the Federal Trade Commission recently issued regulations requiring financial institutions to notify customers about their information collecting and information-sharing practices by July 1, 2001.The irony is that, for purposes of this law, providing tax planning and tax return preparation services causes the provider to be a "financial institution" subject to these regulations.

In reality, these regulations should not impose much of a burden on practicing CPAs. As long as they notify clients of the types of data retained and that they do not disclose personal information, CPAs are in compliance. CPAs might want to use this opportunity to engage in a little self-promotion, touting their independence and objectivity, and distinguishing themselves from the banks, brokers, insurance companies and mutual funds that are all clamoring to be the one-stop financial services shop, once again reinforcing the concept of the CPA as the one "most trusted adviser"

FTC Privacy Disclosure Requirements

An AICPA task force has developed a practice guide to help members comply with the new Federal Trade Commission and Securities and Exchange Commission disclosure requirements provided by the Graham-Leach-Bliley Act of 1999, due to go into effect on July 1, 2001. This guide is available at

Editor's note: Mr. Holub is a member of the AICPA Tax Division's Tax Practice Responsibilities Committee. Mr. Reeves is a member of the Member Tax Practice Improvement Committee.

If you would like additional information about this article, contact Mr. Holub at (813) 222-8555 or, or Mr. Reeves at (817) 252-4212 or

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Article Details
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Author:Holub, Steven F.
Publication:The Tax Adviser
Geographic Code:1USA
Date:Jun 1, 2001
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