Don’t Lose Your Privileges: What You Should Know To Protect Your, Or Your Clients’, Privileged Information From Unintended Disclosure To The Government


by Matt Ottemann

Ottemann, Matthew

mottemann@mcgrathnorth.com
(402) 341-3070

It is a fundamental principle of American court proceedings that parties should generally be able to discover and utilize evidence which supports their case. However, courts have also recognized that certain relationships are of such societal importance that sacrificing evidence which may be learned from persons in those relationships is justified. Based upon this principle, courts have developed and recognized the attorney-client, marital and physician-patient privileges.

While taxing agencies and courts generally recognize these privileges, there is typically another professional who is critical to concerning tax matters – the client’s accountant. In light of the accountant’s role in tax matters, it is important for both clients and advisors to understand when communications between a client and an accountant are privileged and when they are not.

Communication With An Accountant

While accountants are trusted and important advisors to their clients, many courts have not yet recognized an accountant-client privilege. Largely for that reason, Congress enacted a statutory accountant-client privilege within the Internal Revenue Code. The key statute reads, in pertinent part:

“With respect to tax advice, the same common law protections of confidentiality which apply to a communication between a taxpayer and an attorney shall also apply to a communication between a taxpayer and any federally authorized tax practitioner…”

At first read, this statute appears to provide broad protection to communications between accountants and clients. But there are some significant limitations, including the following:

  1. Application only to a “federally authorized tax practitioner.”  Attorneys, Certified Public Accountants, Enrolled Agents and Enrolled Activities qualify as “federally authorized tax practitioners.”
  2. The Privilege Only Applies To Noncriminal Matters.  This privilege only applies to noncriminal tax matters before the IRS and noncriminal tax proceedings in federal courts. So, this provides an incentive for the IRS to convert a civil proceeding to a criminal tax controversy.
  3. The Statute Only Applies To Discussions Made In Connection With The Rendering Of Tax Advice.  This statutory privilege generally does not include communications made for the purpose of filing a tax return or for the purpose of preparing an audited financial statement.

One potential way to have communications with an accountant be privileged is to first engage an attorney who, in turn, would engage the services of an accountant using a specific engagement letter. This may, with certain limitations, cause the client’s communications with the accountant to become privileged under the attorney-client privilege.

Communications Made For The Purpose Of Filing A Tax Return

As a general rule, communications made to a practitioner for the purpose of filing a tax return or preparing an audited financial statement are not privileged.

Some cases have even held that communications to an attorney, made for the purpose of preparing a client’s tax returns, were not subject to the attorney-client privilege. In other words, a client cannot convert documents which were used for return preparation – and thus were not privileged – into privileged documents simply by hiring an attorney to prepare the return.

Furthermore, if a document would be used both in preparing for litigation, as well as for return preparation, some courts have held that this document would not be privileged because of its nonprivileged use in return preparation. In essence, the nonprivileged use waives the privilege protection.

There have been a number of cases within the last few years regarding whether tax accrual workpapers are privileged. Tax accrual workpapers are generally prepared by a client or the client’s attorney and are reviewed by the client’s accountant for purposes of preparing an audited financial statement. The workpapers generally list, and calculate the likelihood of success regarding, each debatable item in a tax return. This is done to allow the auditor to properly estimate the company’s tax expense for financial statement purposes. The law regarding the privileged status of tax accrual workpapers is not currently settled, so clients should be aware that such workpapers may not be privileged.

State Tax Investigation

Practitioners should be aware that the statute quoted above which imposes an accountant-client privilege is a federal tax statute which governs only the IRS and federal courts. States are free to impose their own rules regarding privilege. As an example, Nebraska has not yet recognized an accountant-client privilege by statute.

Therefore, practitioners may need to be aware of the privilege rules for both the IRS and whatever state taxing authority may have jurisdiction over a client or transaction.

If you, or your client, would like to discuss privilege in tax matters further, feel free to contact any member of the McGrath North Tax Group for more details.

 

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