Recognition of Accountant-Client Privilege for Federal and State Tax Purposes

Recognition of Accountant-Client Privilege for Federal and State Tax Purposes

In light of recent cases, such as U.S. v. Textron, Inc., 577 F. 3d 21 (1st Cir. 2009), cert. den. No. 09-750, May 24, 2010, and Comm. of Revenue v. Comcast Corporation & Continental Teleport, Inc., 453 Mass. 293; 901 N.E.2d 1185; 2009 Mass. LEXIS 31 (March 3, 2009), practitioners are faced with the reality of determining the extent to which privilege, whether attorney-client privilege or work product privilege or accountant-client privilege, will be recognized. Because courts will generally construe issues of privilege as narrowly as possible and statutes allowing for privileges are often strictly interpreted, understanding when privilege may be claimed and will be recognized can seriously impact the outcome of a case.

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Federal law allows for a limited accountant-client privilege.

The IRS Restructuring and Reform Act of 1998 included provisions allowing for a limited accountant-client privilege... under IRC § 7525 protects federally authorized tax practitioners, including CPAs, attorneys, enrolled agents, and enrolled actuaries, against compulsory disclosure of tax advice. The privilege extends only to advisors authorized under federal law to practice before the IRS, and is restricted to non-criminal (i.e., civil) tax matters litigated in federal court. It does not apply to any communications regarding corporate tax shelters. However, distinguishing between protected tax advice and unprotected business advice can be difficult.

States' laws vary with respect to recognition of accountant-client privilege.

Unlike the federal law, which provides consistent treatment across all states for practitioners, the states provide varying levels of protection or recognition of privilege.

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Even in states that recognize the accountant-client privilege, some specifically provide that, like the federal privilege, the privilege does not apply to criminal prosecutions. In State v. O'Brien, for example, the Arizona Court of Appeals held that the statutory language specifically prohibits its application to criminal prosecutions. The states vary in their interpretation of this restriction. States such as Florida and Nevada adhere to a "knew or should have known" standard to prohibit assertion of the privilege. The actual knowledge is not relevant and the law provides that the privilege does not apply when the accountant was consulted or hired "to enable or aid anyone to commit or plan to commit what the client knew or should have known was a crime or fraud."

In some states, the laws specifically provide that the privilege does not protect a disclosure to law enforcement if the accountant has a reasonable basis for believing that the client violated federal, state, or local laws... Other states, such as Indiana, Georgia, Missouri, Pennsylvania, Tennessee, and Texas, do not specifically restrict the application of privilege to non-criminal (i.e., civil) tax matters...

Using the attorney-client privilege as a springboard for accountant-client privilege.

In US v Kovel, 296 F2d 918 (2d Cir 1961), the Second Circuit extended common law attorney-client privilege to an accountant through an agency relationship between the attorney and accountant. The taxpayer's attorney may, through use of the Kovel doctrine, attempt to interpose himself or herself between the client and the preparer by retaining the preparer as an expert. In this way, the taxpayer's attorney may be able to extend the taxpayer's attorney-client privilege to the preparer through an agency relationship between the attorney and the preparer. The accused taxpayer's attorney attempts to do this by presenting the accountant or tax professional with a Kovel letter. The letter indicates that all of the work product generated by the accountant or tax professional is prepared at the direction of the attorney, and that all supporting work papers belong to the attorney's law firm and must be surrendered to the firm at its request. The letter provides that the accountant or tax professional is prohibited from maintaining copies of the work product. State appellate courts have adopted the Kovel doctrine in state criminal proceedings.

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