Posted in Parts I, II and III.
Tax advisers may rely on the practitioner-client privilege of Sec. 7525 and the work product doctrine to protect certain communications and materials from IRS summons and discovery.
Despite careful measures to protect privileged communication, exceptions may override the practitioner privilege. Two exceptions that have long applied to the attorney-client privilege, the crime-fraud exception and the return preparation exception, also apply to the practitioner privilege. Two additional exceptions, the tax shelter exception and the criminal-proceeding exception, are unique to the practitioner privilege.
Neither the attorney-client privilege nor the practitioner privilege applies to communications between a client and adviser in furtherance of a crime or to perpetuate a fraud. 18 The Seventh Circuit has pointed out that advice relating to future wrongdoing rather than past wrongdoing does not come under the privilege. 19 This is true even if the tax practitioner is unaware of the client’s criminal or fraudulent intent.
Return Preparation Exception
Courts have generally not considered communications made for preparing a tax return to be privileged. In establishing the practitioner privilege, Congress made it clear that “information that is communicated to an attorney for inclusion in a tax return is not privileged because it is communicated for the purpose of disclosure.” 20 Some courts have parsed the information to allow a privilege for communications that took place during return preparation but were not divulged on the return. 21 In addition, the type of communication that is covered under the privilege is legal or tax advice. Merely placing information on tax forms does not meet the definition of giving advice. In Davis, 22 the Fifth Circuit acknowledged that some knowledge of the law is used in preparing a tax return but said tax return preparation is primarily an accounting service. However, interpreting statutes or case law during an audit of a tax return has been determined to be providing legal advice to which privilege may attach. 23
Tax Shelter Exception
Sec. 7525(b) creates an exception to the practitioner privilege for any written communication between a federally authorized tax practitioner and any person “in connection with the promotion of the direct or indirect participation of the person in any tax shelter (as defined in section 6662(d)(2)(C)(ii)).” 24 This exception also applies to communication with the person’s director, officer, employee, agent, or representative, or any party holding a capital or profits interest in the person. In general, the burden of proof in asserting a privilege is on the party claiming the privilege; in this case, the taxpayer. When an exception is claimed, however, the opposing party must exhibit some evidence that the exception applies. When the IRS claims the application of the tax shelter exception, it must introduce evidence that the documents it seeks are related to a tax shelter and were created in connection with promoting participation in that shelter either directly or indirectly. The fact that a communication relates to a tax shelter is not sufficient to overcome the privilege; it must be in promotion of participation.
Case law on this exception is limited. However, two elements have emerged as the subject of significant analysis by the courts: that the communication must be written, and that it must be in connection with the promotion of a tax shelter.
Although this might appear to be the least ambiguous of the requirements for the exception, in Countryside Limited Partnership, 25 the Tax Court took an interesting viewpoint. It determined that handwritten notes taken by a partner during a series of tax planning meetings with the partnership’s tax accountant merely reflected oral communications that did not meet the requirement of a written communication because they were not communicated to anyone. It was decisive that the notes were not shared with anyone, and this meant there was no transmission of the written material. In BDO Seidman, LLP, 26 the Seventh Circuit, in considering the tax shelter exception, noted that oral communications between a practitioner and client remain within the general rule of the privilege.
Several courts have applied their own definition of “promotion,” with varying results. Congress did put a boundary on the definition when it excluded routine communications from the exception. Committee reports indicate “[t]he conferees do not understand the promotion of tax shelters to be part of the routine relationship between a tax practitioner and a client.” 27 In Countryside 28 the Tax Court refused to treat the accountant’s input as promotion because it appeared to be part of the routine advice offered over a long-term relationship and was not subject to any unusual billing or special arrangement. The court noted that the tax advice provided was distinct from promotion of a tax shelter. The advice was offered in response to a client request, and the accountant had no stake in the outcome. In Valero, 29 the Seventh Circuit emphasized that promotion would be a preliminary activity and relied on that interpretation to conclude that tax advice on how to structure a substantial foreign currency loss constituted promotion. It refused to confine the exception to “actively marketed tax shelters or prepackaged products” 30 and held the exception included advice given on a single transaction that appeared to meet the definition of a tax shelter.
To be continued… in Part III
By: Linda Burilovich, Ph.D., CPA The Tax Adviser Practice & Procedures, 04/01/13
Edited and posted by Harold Goedde CPA, CMA, Ph.D.
Footnotes18 Clark, 289 U.S. 1 (1933). 19 BDO Seidman, LLP, 492 F.3d 806 (7th Cir. 2007). 20 H.R. Conf. Rep’t No. 105-599, 105th Cong., 2d Sess. 267 (1998). 21 Colton, 306 F.2d 633 (2d Cir. 1962). 22 Davis, 636 F.2d 1028 (5th Cir. 1981). 23 Frederick, 182 F.3d 496 (7th Cir. 1999). 24 Sec. 7525(b) was amended by the American Jobs Creation Act of 2004, P.L. 108-357, to apply to participation of any person (previously, it was participation of a corporation). 25 Countryside Limited Partnership, 132 T.C. 347 (2009). 26 BDO Seidman, LLP, 492 F.3d 806 (7th Cir. 2007). 27 H.R. Conf. Rep’t No. 105-599, 105th Cong., 2d Sess., 269 (1998). 28 Countryside Limited Partnership, 132 T.C. at 354–5. 29 Valero Energy Corp., 569 F.3d 626 (7th Cir. 2009). 30 Id., slip op. at 16.