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Privileged tax advice may not be 'privileged' much longer.

Many finance professionals have noted with some concern that federal agencies and public accounting firms are generating wave after wave of new disclosure policies. The Securities and Exchange Commission (SEC), the Department of Justice (DOJ), the Public Company Accounting Oversight Board (PCAOB), the Environmental Protection Agency (EPA) and the public accounting firms have expanded or recently begun to require disclosures of otherwise protected information.

The Sarbanes-Oxley Act's mandate to improve the quality of corporate disclosures and to strengthen auditors' independence has caused financial auditors to require companies to disclose privileged information, particularly as it relates to tax positions. Independent auditors are now routinely demanding that public companies disclose the privileged and confidential tax advice that helped to inform the companies' judgment about the adequacy of reserves for contingent tax liabilities. The audit firms are making it clear that the penalty for not disclosing this confidential tax advice will be a qualified financial statement.

The dilemma, of course, is that companies that disclose tax advice to auditors will waive the right to protect that tax advice against compelled disclosure to the Internal Revenue Service (IRS). Quite simply, disclosing privileged information to one person causes the privilege to be waived to all, except when such disclosures are judicially compelled. Since disclosures to outside auditors will not be regarded as "judicially compelled," the courts will likely hold that such disclosures are voluntary, and any protecting "privileges" are waived.

Actually, the consequences may be worse still. Taxpayers may be required to waive the privileges for the tax advice that is disclosed to the auditors, and also for all other tax advice on the same subject. The new reality is that companies must choose between certified financial statements and confidential and privileged tax advice. This choice is not really a choice; companies cannot allow qualified financial statements, and must therefore disclose privileged tax advice to their auditors. As a result, the IRS is likely entitled to access that tax advice.

Similarly, companies that cooperate with SEC inquiries and investigations by voluntarily disclosing confidential tax advice to the SEC likewise waive the ability to protect that advice against compelled disclosure to the IRS. The SEC has expressed its willingness to help companies protect the confidentiality of information disclosed to the commission, but under current law, it is doubtful that the SEC can help much.

Companies Would Curb Access

The IRS, understandably, would be interested in pursuing the very tax advice for which protection will have been waived. If that happens, companies will act to ensure that it would not be made available to their auditors--either by not soliciting "written" advice in the first place, or by seeing that steps are taken within the taxpayer's organization to isolate such advice from the taxpayer's financial group. Financial reporting is likely to suffer as a result.

Although high-ranking SEC officials acknowledge the companies' dilemma--that is, to choose between a qualified financial statement and waiving protection for confidential tax advice--the SEC believes this tax information is vital. Companies should not look to the SEC for relief, given the mandate that it believes was sent by Sarbanes-Oxley.

In an effort to change the law, a coalition of multinational companies has formed to help secure the means to protect the confidentiality of tax advice disclosed to outside auditors or the SEC. The coalition believes this will require new legislation to ensure that such disclosures will not waive the attorney-client privilege, the tax-advisor privilege and the work product doctrine. In the interim, the coalition has requested that the Treasury Department and the IRS consider a self-imposed moratorium that would restrict access to taxpayers' privileged tax advice rendered unprivileged solely by the waiver created by turning over such information to outside auditors, as described above.

The coalition's strategy is to educate lawmakers about the harm to public companies and to press for remedial legislation. To that end, the coalition seeks to amend the Internal Revenue Code to protect confidential tax advice disclosed to outside auditors or the SEC against compelled disclosure to the IRS. The coalition believes that to be successful, it should include a broad cross-section of interests, and is still accepting new participants.

The law must be changed: The privilege for tax advice is too important. An essential condition of quality legal advice is full and open communication between the client and the tax counselor. Existing privilege fosters such communication.

If you want to participate in the coalition or share your concerns, please contact Larry Langdon at 650.331.2075 or Charlie Triplett at 202.263.3262, or Mark Prysock at FEI at 202.626.7804.

Mark Prysock ( is Director of Public Affairs and General Counsel for FEI and works in its Washington, D.C., office.
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Title Annotation:Washington Insights
Author:Prysock, Mark
Publication:Financial Executive
Geographic Code:1USA
Date:May 1, 2005
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