Congress finally granted tax practitioners the ability to enjoy privileged communications with clients in much the same manner as attorneys with the enactment of Sec. 7525 in the IRS Restructuring and Reform Act, P.L. 105-206, passed by Congress in 1998. For tax advice, Sec. 7525 says that
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 to the extent the communication would be considered a privileged communication if it were between a taxpayer and an attorney.
This ability to have a confidential, open, and honest conversation with a client regarding tax matters was at first considered a giant stride for tax professionals, making it much easier for practitioners to learn all the relevant facts needed to provide their clients with an opinion on the tax consequences of a given transaction or a proposed transaction. However, CPAs were quick to discover that the benefits of privileged communications were not without correlative burdens.
In order to understand the limitations on the privilege granted tax practitioners in Sec. 7525, a practitioner needs to have a good understanding of the privilege granted to attorneys. This privilege originated in ancient Rome and later was recognized in the English common law. Privilege was provided to communications with attorneys so that clients would feel safe in providing information to them, thus making it more likely that attorneys would be able to properly represent their clients without the impediment of not knowing the full story. The basic rules are as follows:
- The person asserting the privilege must be a client or someone attempting to establish a relationship as a client;
- The person with whom the client communicates must be an attorney and be acting in that capacity;
- The communication must be between the attorney and client exclusively;
- The communication must be for the purpose of securing a legal opinion, legal services, or assistance in some legal proceeding and not for purposes of committing a crime or fraud; and
- Only the client may claim or waive the privilege.
It should be noted that these elements of the privilege can vary among jurisdictions. Sec. 7525 applies the federal interpretation.
Sec. 7525, as enacted, is applicable to communications between a taxpayer and a federally authorized practitioner and may be asserted only in noncriminal tax matters (Sec. 7525(a)(2)). The Sec. 7525 privilege does not apply to communications regarding tax shelters (Sec. 7525(b)). (See Tax Trends, 40 The Tax Adviser 558 (August 2009), for a thorough discussion of the applicability of the tax shelter exception.)
There is also the return preparation exception, which has been around since long before Sec. 7525 extended the attorney-client privilege to federally authorized practitioners. Under the exception, certain documents and communications used in the tax return preparation context are not protected (see Lawless, 709 F.2d 485 (7th Cir. 1983); KPMG LLC, 237 F. Supp. 2d 35 (D.D.C. 2002)). Some practitioners and courts have concluded that because any tax advice is rendered in the context of preparing a tax return, no privilege exists for tax advice. For a discussion of this exception, see Pease-Wingenter, “Does the Attorney-Client Privilege Apply to Tax Lawyers?” 47 Washburn L.J. 699 (Spring 2008).
Most states do not protect as privileged communications between CPAs and their clients in a manner similar to that offered by Sec. 7525. Thus, states have the ability to compel the production of the content of any communications with clients. Outside of the return preparation exception, any information released in any state judicial or administrative hearing is available to the IRS. It may well be argued in a federal proceeding that this information, otherwise excludible by the federal privilege, can be disregarded, but this may be a difficult argument.
Remember that the tax adviser’s privilege under Sec. 7525 extends only “with respect to tax advice,” so unlike the attorney-client privilege, many communications with a CPA are not protected. In some situations, an accountant’s tax accrual workpapers, which are often used in the return preparation, are made available in court. Also, unlike attorneys, who studied the attorney-client privilege in law school and continue to analyze the issue on a daily basis, most tax practitioners do not have the background and training to easily know when they might be able to apply the Sec. 7525 principles.
At the end of the day, the privilege—while it sounds like a great opportunity for the CPA to be able to discuss openly all facets of a transaction or situation to give the client a thorough analysis—is troublesome. Practitioners really cannot count on the confidentiality of the communications being protected by the privilege. If the IRS were to assert that these communications relate to a tax shelter or to return preparation, the Sec. 7525 privilege specifically would not apply. The CPA needs to be ever mindful of the fragility of the Sec. 7525 privilege and may be better off treating it as if it did not exist.
John Miller is a faculty instructor at Metropolitan Community College in Omaha, NE. Robert Moïse is with WebsterRogers, LLP, in Charleston, SC, and is a member of the AICPA’s IRS Practice and Procedures Committee. For further information about this column, contact Mr. Miller at firstname.lastname@example.org.