Introduction

In order for your CPA to provide you or your company complete and accurate tax advice, you must be able to convey relevant information to him or her about the issue at hand. You may be reluctant to divulge intimate financial information (in addition to your thoughts and concerns) if you are concerned that your CPA could be compelled to disclose such information to others, the IRS, or the public in the case of a lawsuit or hearing. Therefore, it is important to know if your CPA has the legal authority to protect your information from disclosure.

We will examine the protections afforded under the attorney-client privilege recently extended to the relationship between CPAs and their clients. We will point out some commonly unappreciated limitations to the scope of the attorney-client privilege.

One of the most powerful legal means of preserving client confidentiality is the assertion of the attorney-client privilege. The attorney-client privilege is, as the name implies, the privilege of confidentiality of conversations and documents exchanged between the attorney and the client relating to the request for and rendering of legal advice. This privilege belongs to the attorney’s client and may be asserted directly by the client or by the attorney on behalf of the client.

Many taxpayers, at least initially, seek tax and business advice from their CPA. This makes sense and is often the most cost efficient manner to obtain such advice. After all, the CPA is on the “front line” of the tax return and financial statement preparation and generally has more frequent contact with the client than other professionals, such as the client’s attorney. Moreover, accounting firms have aggressively pursued tax consulting and planning services; some even hiring tax attorneys as part of their professional staff. To acknowledge this development and to level the playing field between attorney tax advisors and CPA tax advisors (as well as certain other tax professionals), the attorney-client privilege has been recently extended in very narrow circumstances to clients’ dealings with their CPAs and other non-attorney tax advisors authorized to practice before the IRS.
The new law (Section 7525 of the Internal Revenue Code) enacted July 22, 1998, provides generally that with respect to tax advice, the same common law protections of confidentiality that apply between an attorney and a taxpayer shall also apply to a communication between a CPA and a taxpayer to the extent the communication would be considered a privileged communication if it were between a taxpayer and the taxpayer’s attorney.

The law does not expand on or change the attorney-client privilege, it simply narrowly extends its application to include CPAs and their clients.

The Attorney-Client Privilege

In order to appreciate the application and limitations of the extension of the attorney- client privilege to the CPA-client relationship, it is imperative to understand the scope of the attorney-client privilege rules and its limitations..

Requirements for the Attorney-Client Privilege:

(1) the privilege is asserted by the client, not the attorney;
(2) the person to whom the client communicated was an attorney or an employee or agent of the attorney; (3) the communication relates to the legal advice sought by the client or prospective client;
(4) the client communicated the information to the attorney without the presence of strangers for the purpose of securing the professionals services and not for the purpose of committing a crime; and
(5) the client has not waived the privilege.

Communications between the attorney and client must take place outside the presence of third parties who are not subordinates or agents of the attorney. Moreover, statements to an attorney must be made to the attorney when he or she is acting as an attorney. Statements to an attorney acting as a trust officer, or to a CPA, are not privileged, except for the extension of the privilege discussed above. Failure to reasonably secure privileged documents which end up in the hands of third parties will generally not be protected by the privilege. Accordingly, it is imperative that the attorney and the client be aware of the surroundings in which they are communicating and the security of such communications to prevent unintentional waiver of the privilege. Meetings in restaurants or other public places or correspondence transmitted by facsimile or e-mail without taking proper security precautions could inadvertently waive the privilege.

Communications between attorneys and the employees of corporations, partnerships, trusts, or other entities, are also covered by the privilege in limited circumstances. The privilege, which belongs to that entity and not the employee, generally extends to (1) statements that were made to counsel for the entity at the direction of the entity’s superiors to speak with the attorney in order to secure legal advice from the attorney; (2) the attorney had questioned the employees in order to advise management; (3) the communications related to matters within the scope of the employee’s job and the employees were aware that they were being questioned to obtain information that would help the attorney render legal advice; (4) the information that the employees disclosed was not available from other sources in the corporation; and (5) the information was kept confidential by the entity.

Communications between employees of an entity and the entity’s counsel regarding matters that are outside the scope of the entity’s business, could create a privilege between the employee and counsel. However, rendering legal advice to the entity’s employee could result in a conflict under the rules of professional ethics and generally should be avoided by the attorney. The employee can claim an individual attorney client privilege where (1) the employee approached the attorney to obtain legal advice; (2) the employee made it clear to the attorney that she was seeking legal advice in her individual capacity and not as an employee of the entity; (3) the attorney chose to communicate with the employee in her individual capacity and not as an employee; (4) their conversations were confidential; and (5) their conversations did not concern the entity.

Not all communications between the attorney and client are protected by the attorney- client privilege, even when confined between the attorney and the client. To benefit from the privilege, the communications must be within the scope of the legal advice sought or rendered. Not all advice rendered by an attorney is legal advice. Some situations which are generally not covered by the attorney-client privilege include: (1) rendering business or investment advice; (2) keeping custody of corporate records; (3) coordinating lobbying efforts; (4) conducting business negotiations; (5) client identification or fee arrangements; and (6) working papers used to prepare tax returns.

Legal advice generally does not include the preparation of tax returns and the documentation used to prepare such returns, even if the attorney prepares the returns or hires a CPA to prepare them for the client. Tax return preparation is generally considered an accounting service and not legal advice. However, if the attorney is rendering legal advice with respect to particular return positions, or to the application of certain tax laws to the client’s facts, such communications will probably be privileged.

The attorney-client privilege is inapplicable where the client or prospective client seeks legal advice to gain assistance to commit a crime or fraud. This is the case even if the attorney did not know the client’s or prospective client’s intentions.

Representation of more than one client by the same attorney for the same matter could jeopardize the privilege. While the communications between the attorney and the joint clients are covered by the attorney-client privilege with respect to others, as between the clients themselves the communications can be compelled to be disclosed by one or more of the joint clients should they become adversaries.

Extension of the Attorney-Client Privilege to the CPA

The factors regarding the application of the attorney-client privilege discussed above are extended to CPAs and their clients, but in a much more narrow way. The extension is so narrow, in fact, some professional tax advisors (including other CPAs) believe that the new privilege serves only to confuse and mislead taxpayers into disclosing confidential information to non-attorneys in the belief that such disclosure is protected from discovery, only to find that it is not.

In addition to the limitations placed on the attorney-client privilege such as business advice and investment consulting, the privilege extended to CPAs is further narrowed in that it only applies to the rendering of tax advice. The CPA-client privilege does not apply to criminal tax matters, cases not brought by or against the United States, or tax shelters.

Tax advice is but one of the many elements of the legal advice protected by the broader and established attorney-client privilege. For the privilege as extended to CPAs, the definition of “tax advice” is vague; it is hard to get a practical understanding of exactly what falls within this category, and Congress did not define it very clearly. The law simply says that “tax advice” means advice given by an individual with respect to a matter within the scope of the individual’s authority to practice before the IRS. The IRS publishes its rules of practice in Circular 230. Circular 230 simply says that practice before the IRS concerns all matters connected with representations to and communications with the IRS. Based on this definition, it may be that tax advice is not rendered by a CPA until representations or communications with the IRS need to be made. Another interpretation is that tax advice is advice (concerning taxes) rendered by a CPA. Some have even posited that tax advice is not even covered by the new law, notwithstanding that “tax advice” is specifically referred to in the statute (because, under the IRS’ rules, tax advice concerns presentations to and communications with the IRS). Most likely, however, the privilege protects most advice given by an authorized tax professional to a client relating to federal tax matters.

The CPA-Client Privilege

The CPA-client privilege is inapplicable to state and local matters and therefore there would generally be no protection of the client’s confidences in sales tax hearings, ad valorem (property tax) matters, probate litigation, or general civil litigation and other matters not directly against the United States. Other venues where the CPA-client privilege is ineffective include matters before administrative agencies such as the Securities and Exchange Commission or the Federal Trade Commission. While there are some states that have some limited CPA-client privilege, these are generally also ineffective in these matters. Moreover, even to the extent the new CPA-client privilege does apply, it does not cover matters which are outside the scope of the tax advice (whatever the definition may end up being).
The CPA-client privilege is also inapplicable to criminal tax matters. Any communications between the CPA and the client in connection with a criminal tax matter are simply not protected by the CPA-client privilege. In fact, if a civil tax matter later turns into a criminal case, the confidential communications made before the matter became a criminal case, appear to lose their privilege. This is probably the most dangerous aspect of relying on the CPA-client privilege. For example, in preparation for a “run of the mill” IRS audit, the client discloses information and documents to the CPA. During the audit, however, the IRS decides to refer the matter for criminal investigation, without any apparent reason recognized by the CPA or client. The privilege that the CPA and taxpayer thought covered the information disclosed to the CPA is not protected; the CPA can be compelled to testify about these communications.

Neither does the CPA-privilege protect communications regarding tax shelters. Tax shelters bring back memories of the 80's with their accelerated deductions in multiples of investment; these were mostly eliminated by the 1986 tax. However, the legal definition of tax shelter is relatively broad and still causes trouble today. A tax shelter is any entity or plan that has, as a significant purpose, the avoidance or evasion of federal income tax. This is worrisome since tax planning is usually geared toward avoiding (but not evading) federal income tax. This would seem to mean that discussions between and CPA and his or her client about tax planning ideas may not be privileged. While general tax advice may be protected under the CPA-client privilege, communications regarding aggressive or complex tax planning techniques and programs (albeit legal) may find themselves exposed to this tax shelter exclusion, thereby preventing the application of the CPA-client privilege.

The new law blurs the traditional roles of the CPA and tax attorney and has been criticized as being too vague, too limited in scope, and too dangerous to unsuspecting taxpayers and their CPAs. As a taxpayer, you should not assume that this limited privilege replaces the protections afforded by the attorney-client privilege, which itself is subject to numerous limitations. To the extent that the privilege does apply, it only protects communications regarding tax advice. Disclosures made during financial audits or other accounting functions are not protected. The client should question his or her CPA about the systems that the CPA has put in place to protect any CPA-client privilege that may exist. The CPA should be careful to fully explain to clients the limitations of the privilege and be on the lookout for potential criminal or tax shelter issues that specifically are not protected.

Questions

For more information about the CPA-client privilege contact the Texas Society of CPAs at 14860 Montfort Drive, Suite 150, Dallas, Texas 75240-6705, (800) 428-0272, www.tscpa.org or the American Institute of Certified Public Accountants, 1211 Avenue of the Americas, New York, NY 10036-8775, (888) 777-7077, www.aicpa.org.

 

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