CPA-client confidentiality, the new federal accountant-client privilege

Attorney-CPA, The, 2000 by Yarbrough, Donald A

The Internal Revenue Service Restructuring and Reform Act of 1998 gives taxpayers a privilege regarding written or verbal tax advice from a CPA. The new legislation covers all Federally authorized tax practitioners, including CPAs, attorneys, enrolled agents, and enrolled actuaries. IRC (sec) 7525 provides a Federal statutory privilege of confidentiality and protection against compulsory disclosure of tax advice provided by a Federally authorized tax practitioner. The new Federal privilege is distinct from and unrelated to the state law privilege contained in Florida Statute 473.316. The state privilege is a broader privilege than the Federal privilege. The state privilege covers nearly all communications between a CPA and a client. The state privilege is applicable to CPAs only, not all Federally authorized tax practitioners (hereinafter all references to CPAs include Federally authorized tax practitioners). The Federal government, including the IRS, is not bound by state law and consequently the broad coverage regarding communications contained in the Florida state law privilege cannot be asserted against the IRS.

Applicability of the Privilege

The privilege may be asserted in any non-criminal tax matter before the Internal Revenue Service and is applicable in any non-criminal tax proceeding in Federal Court brought on behalf of the United States or against the United States. Prior to the enactment of the statutory privilege, the IRS could subpoena the CPA and demand the CPA's written and verbal tax advice to the client, and the CPA would be legally required to produce this information. For tax advice rendered on or after July 22, 1998, a taxpayer has a Federal statutory privilege which may be asserted by and through the CPA to prohibit the disclosure of those communications regarding tax advice. "Communications" is not defined in the statute and the IRS has not yet issued regulations under IRC (sec) 7525. The statute refers to communications "between" the CPA and the client, consequently, both the CPA's tax advice and the client's statements and documents provided to the CPA for the purpose of obtaining tax advice would be privileged. Tax advice is defined by the statute to include any advice that is within the scope of the CPA's authority to practice.

When the CPA is retained in an engagement to specifically provide tax advice, for example, in a tax planning engagement or representation in a tax controversy, the CPA should highlight the applicability of the privilege, both for the CPA's staff and the client, by preparing a separate engagement letter which informs the client of the privilege. For sample engagement letters, see the AICPA's Confidentiality Privileges Relating to Taxpayer Communications-Practice Guide, ref erenced below.

A CPA would be well advised to insert an indemnity clause in the engagement letter which would compel the client to reimburse the CPA for legal fees and any other costs incurred by the CPA in the assertion of the privilege on behalf of the client. Otherwise, the CPA could incur substantial legal fees in asserting the client's privilege and may have little or no contractual recourse against the client for the CPA's legal fees and costs.

The privilege belongs to the taxpayer not the CPA. The CPA, however, is often the object of a broad IRS subpoena seeking all client documents in the CPA's possession. The CPA, upon receipt of an IRS subpoena, should not produce the information regarding tax advice without the client's express waiver of the privilege. Some documents in the CPA's possession may not relate to tax advice. These documents may not be privileged and, after careful review and the advice of counsel, the CPA may wish to comply with the IRS subpoena and produce these non-privileged documents. If the CPA provides privileged information to the IRS, the client's privilege is waived and the IRS can then use the documents and information against the client. The CPA may then be subject to malpractice liability for the improper disclosure of privileged documents. The IRS has publicly announced that their employees will continue to seek the same information in the same manner as they did before the statute was enacted (see "IRS Regs in Plain English", IRS website). The advice and aid of counsel is recommended at this juncture because the statute is new and there are no regulations or case law that dictate with precision what documents constitute tax advice.

The client's waiver of the privilege is a legal decision, not a tax or accounting issue. Because of the possible adverse consequences of disclosing otherwise protected information to the IRS, the client may not want to intentionally waive the privilege without the prior advice of the client's own legal counsel.

Preservation of the Privilege

The privilege is not automatic. Any privilege held by the client must be asserted to preserve the confidentiality of the tax advice. The CPA should inform the client of the existence of the privilege and suggest how the client may avoid waiver of the privilege through the client's inadvertent disclosure of privileged information. If the client discloses the CPA's tax advice to third parties, such as a banker or outside contractor, the privilege would be waived.