The Importance of Referring a Client to an Attorney To Protect the Client Against a Future IRS investigation

Preserving privilege is essential. Client walks into CPA office for initial consultation during which client (a US person) informs CPA that she has undeclared bank accounts and/or income and it is determined that the accounts have been controlled and maintained by the client for several years.

At this point the accountant is in a bit of a conundrum. Yet he has several options. One often overlooked issue here is that without the benefit of an attorney and a Kovel letter the Government very well may be in a position to issue an IRS summons, or worse yet, a grand jury subpoena, to the CPA to obtain the CPA work papers and communications with the client. State law privileges between accountants and clients are broad. For example Florida Rule of Evidence 90.5055(c) states that:

(2) A client has a privilege to refuse to disclose, and to prevent any other person from disclosing, the contents of confidential communications with an accountant when such other person learned of the communications because they were made in the rendition of accounting services to the client. This privilege includes other confidential information obtained by the accountant from the client for the purpose of rendering accounting advice.

But in the context of an investigation which may contemplate criminal liability at some point in time and which involves the IRS – as opposed to a state tax regulator or agency — a broad state law privilege may become virtually meaningless. This is because  there is no confidential accountant-client privilege under federal law, and no state-created privilege has been recognized in federal cases,” United States v. Arthur Young & Co., 465 U.S. 805, 817 (1984) (quoting Couch v. United States, 409 U.S. 322, 335 n.1 (1973)). And, even though there is a federal statute recognizing such a privilege (26 U.S.C. Section 7525) between clients and accountants, that statute  has significant limitations. It does not extend to criminal matters before the IRS or federal criminal proceedings; does not protect work product; does not apply to “written communications” related to a “tax shelter” and is waived if the communication is shared with any person outside the practitioner-client relationship.

In practice what this means is:

1. A CPA should refer a prospective client to a competent criminal tax attorney if and when he suspects that the client may, at any point in time in the universe, have some criminal exposure.
2. A CPA desiring to remain involved in representation of the client should enter into a Kovel letter arrangement with the law firm representing the client to ensure that communications and work papers are protected by the attorney client privilege. In this scenario, the services of the CPA should be sufficiently related to the legal services that will be provided to the client and it should be made crystal clear that the accountant will be an agent of the attorney and will be retained to enable the attorney to provide legal advice to the client.
3. The CPA should not adopt a “go it alone” approach unless the CPA is willing to risk the possibility of receiving a court order to produce the clients work papers and communications which has occurred in more than a few reported federal decisions.