Posted in Parts I, II and III.

Executive Summary

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.

The Sec. 7525 privilege is similar to the attorney-client privilege but is limited to confidential communications on federal tax law matters not involving allegations of a crime or fraud. The privilege does not apply to written communications in connection with the promotion of, or participation in, a tax shelter. It is also limited to communications of tax advice, as opposed to tax return preparation.

Especially when a tax controversy is or may become a criminal proceeding, an attorney generally can better represent a client, although CPAs may still play a role through a Kovel arrangement.

The work product doctrine protects confidential materials that are collected or prepared in anticipation of litigation, unless an opposing party demonstrates the materials are essential to its case and can be obtained in no other way.

When performing services as a tax adviser, an accountant should understand when communications and work product are privileged and when they are not. The IRS is granted significant power to pursue information in examining a tax return or collecting a tax liability, and the courts have interpreted this summons power as broad authority to obtain confidential information in work product produced for, and communications with, a taxpayer. Some communications and work product, however, are considered privileged and not subject to summons enforcement under specific criteria. An accountant may assist in protecting a client’s confidential information by proactively taking steps to ensure these criteria are met.

Two privileges may apply to an accountant’s tax advice to a client: the practitioner-client privilege granted by Sec. 7525 and the work product privilege established by the Supreme Court in Hickman 1 and codified in the Federal Rules of Civil Procedure. 2 The application of each privilege is based on specific standards that are carefully weighed by the court when the privilege is claimed. If the practitioner and the client have maintained a defensive posture throughout the communication and documentation process, it is more likely that the privilege will be upheld and IRS access will be denied. This can be a vital protection for a client when tax advice contains opinions about gray areas in the tax law and speculation regarding potential litigation in those areas. This article examines the rules and definitions that form the basis for these privileges and identifies certain measures that can increase the protection of sensitive client information.

The Practitioner-Client Privilege

Sec. 7525 extends the common law protections of attorney-client privilege to a client who is communicating with a federally authorized tax practitioner regarding tax advice. The practitioner must be authorized under federal law to practice before the IRS, and such practice must be subject to federal regulation under 31 U.S.C. Section 330. Authorized tax practitioners include licensed attorneys, CPAs, enrolled agents, and enrolled actuaries.3  The practitioner must be rendering tax advice with respect to a matter that is within the scope of the individual’s authority to practice before the IRS. 4 Thus the privilege extends only to federal tax matters related to U.S. tax law. 5 It does not cover foreign tax advice or matters relating to state or local income tax. It also does not cover tax return preparation services.

The practitioner privilege applies to the extent the communication would be considered a privileged communication if it were between a taxpayer and an attorney. However, it is more limited in scope than the attorney-client privilege, in that it applies only in noncriminal proceedings before the IRS and federal courts. 6 It does not apply to written communications in connection with the promotion of, or participation in, a tax shelter, nor does it protect against disclosure of communications to any regulatory body other than the IRS. 7

Basic Elements of Privileged Communication

To properly understand the practitioner-client privilege, one must analyze the rules and limitations of the attorney-client privilege. The attorney-client privilege is the most familiar protection of confidential communication in a legal setting and can be invoked in an IRS summons challenge. Certain elements of privileged communication must be present to preserve its protection: The communication must be for the purpose of legal advice, and it must be confidential. These requirements are also elements of the practitioner-client privilege.

The first element needed to successfully invoke attorney-client privilege is that the attorney must be acting in his or her capacity as a lawyer. Communication in which a client seeks or an attorney provides legal advice is protected. Legal advice is protected whether it comes from outside counsel or in-house counsel. 8  However, if an attorney is providing accounting services (including tax preparation), giving business advice, facilitating transactions, or receiving or disbursing money, he or she is not doing “lawyer’s work,” and these communications are not privileged. The distinction between legal advice and business advice is not always clear. The same concern exists for the tax practitioner in distinguishing tax advice from other client services, including tax return preparation (see below). Both the source and the content of the communication determine its privilege.

The second element that determines whether communication is protected is confidentiality. The privilege is essentially waived if the communication takes place in the presence of third parties. 9 The same is true if the information is intentionally disclosed to a third party. 10 Similarly, a client does not acquire protection of previously disclosed information by submitting it to an attorney. Information imparted to an attorney or federally authorized tax practitioner that is intended to be imparted to others is not protected, and information that is already in the public domain (e.g., SEC filings) cannot be considered privileged. In general, determining whether the communication satisfies these requirements requires asking “who, what, and when?” Carefully monitoring these factors may preserve the privilege.

Who?: Since only communication between the client and tax practitioner is privileged, the source and the addressee of any written communication is significant. For example, documents have been found to be unprotected when no recipient was specified, because, without recipients, the documents were not communications. 11 In addition, correspondence or emails with copies sent to third parties clearly imply a waiver of the privilege. This means that tax opinion letters and discussions of alternative strategies or hazards of litigation are all subject to disclosure unless they are directed to, or in discussion of, a specific client.

What?: The delineation between legal or tax advice and common business advice or services is not always a bright line. The Court of Federal Claims has noted that a court must “make close, factually-intensive distinctions…in which business planning, tax return preparation and legal advice tend to coalesce.” 12 The communication itself must evidence the request or delivery of legal advice between attorney and client.

In BDO Seidman, 13 the court determined that communication with counsel that sought guidance regarding various Code provisions and regulations was “classic attorney-client material.”14  In another case, discussion of Sec. 199 deductions, advance-pricing agreement calculations, and interpretation of a partnership agreement were considered advice and thus protected. 15 In some circumstances, names and numbers have been considered privileged when they revealed aspects of attorney-client communication 16  However, documents or communications that contain both privileged and nonprivileged content do not cause the nonprivileged information to become protected. While a communication may be privileged, the underlying facts are not. 17  Facts do not become protected because they have been included in a privileged communication. So while a taxpayer does not have to disclose what has been communicated, he or she can still be compelled to acknowledge facts that were part of the communication. For example, consider a situation in which a client seeks advice regarding a related-party transaction. Although the exchange between the client and tax practitioner is privileged, the fact that the transaction involves a related party does not become privileged simply because it was included in the practitioner-client communication.

Generally, when the government challenges the claim of privilege, the taxpayer is expected to provide a privilege log listing the documents or communications that have been summonsed and indicating the rationale for claiming the item is privileged. The court will often conduct an in camera review to judge the appropriateness of the claim for each item. Thus, both the addressee and content of the communication may be the first impression the court receives in deciding whether such items are privileged.

When?: The timing of the communication is also relevant. Because tax planning generally takes place before the fact, it is likely to be deemed tax advice. An adviser’s recommendation on how to structure a transaction to minimize taxes and comply with tax rules or estimation of the tax cost of various alternatives is likely to be viewed as advice. At this stage, the claim of privilege is often stronger than for communication after a transaction. An adviser’s subsequent analysis of the reporting of a completed transaction is less distinct from return preparation, and the claim of privilege may be weaker.

By:   Linda Burilovich, Ph.D., CPA The Tax Adviser Practice & Procedures, 04/01/13

Edited and posted by Harold Goedde CPA, CMA, Ph.D.

Footnotes

¹ Hickman v. Taylor, 329 U.S. 495 (1947).

² Fed. R. Civ. P. 26(b)(3).

³ S. Rep’t No. 105-174, 105th Cong., 2d Sess. 70 (1998).

⁴ Sec. 7525(a)(3).

⁵ S. Rep’t No. 105-174 at 70.

⁶ Sec. 7525(a).

⁷ S. Rep’t No. 105-174 at 71.

⁸ Upjohn Co., 449 U.S. 383 (1981).

⁹ Some exceptions allow the presence of a party with a common legal interest (e.g., a co-defendant) or certain agents of the attorney (e.g., secretary or unlicensed associate).

¹⁰ Santander Holdings USA, Inc., No. 09-11043-GAO (D. Mass. 8/6/12).

¹¹ Pasadena Refining System, Inc., No. 3:10-CV-0785-K (BF) (N.D. Tex. 4/26/11).

¹² Evergreen Trading, LLC, 80 Fed. Cl. 122 (2007).

¹³ BDO Seidman, LLP, No. 02 C 4822 (N.D. Ill. 6/29/04), aff’d in part, 492 F.3d 806 (7th Cir. 2007).

¹⁴ Id., slip op. at 4.

¹⁵ Pasadena Refining System, Inc., No. 3:10-CV-0785-K (BF) (N.D. Tex. 4/26/11).

¹⁶ For example, in Evergreen Trading, LLC, 80 Fed. Cl. 122 (2007), certain page numbers were redacted since the “numbering system itself could reveal aspects of plaintiffs’ counsel’s understanding of the case” (slip op. at 18).

¹⁷ Upjohn Co., 449 U.S. 383 (1981).