By Mark L. Lubin, CPA, JD, LLM, and Philip Karter, JD, LLM

Tax practitioners are familiar with the substantive aspects of tax planning and advice, but considerations regarding the confidentiality of tax analysis and taxpayer communications are sometimes overlooked. This blog highlights some pitfalls that may result in an unintended “audit roadmap” on those transactions for which tax planning advice has been provided. This blog only covers (and generally discusses) privileges that commonly apply for federal tax purposes. It does not address state tax rules and nuances.

Privilege Protections

The IRS has broad power to obtain information to administer the tax laws.¹ However, that power is not unlimited. Taxpayers can invoke certain privileges against IRS action to obtain information, such as the following:

• Common law attorney-client privilege, which generally protects confidential communications between attorneys and clients in connection with the provision of legal services, including tax advice and controversy resolution.
• The attorney work product doctrine, which applies to certain documents prepared in connection with litigation.²
• Internal Revenue Code (IRC) Section 7525, which covers tax advice between taxpayers and nonattorney advisers (including CPAs) authorized to practice before the IRS, but it does not apply to  criminal proceedings, state or local tax matters, any nontax proceedings, or communications regarding the promotion of tax shelters.³

Privilege generally applies only to communications and documents that are intended to be confidential. It can be waived by disclosure to persons not necessary to the protected function. Moreover, a party wishing to invoke privilege has the burden of proving that it applies. Thus, practitioners and clients should take steps to establish which communications and documents are within the scope of privilege, and then make efforts to ensure that privilege isn’t inadvertently waived.

Privilege Scope

As indicated above, protection can be established when a communication or record is within the scope of an applicable privilege. However, heightened exposure exists when an adviser acts in multiple capacities. For example, tax planning assistance is generally recognized as potentially eligible for protection, but business advice and financial statement and tax return preparation are generally nonprivileged. So, any communication that is mixed in content may inadvertently waive a confidentiality privilege.

The following practices can help establish that communications remain within the scope of privilege:

• Segregate communications and documents prepared for protected and nonprotected purposes.
• Use separate engagements (with separate filing and billing) for protected and nonprotected matters. Because engagement letters and attorney invoices may not be protected, confidential information (such as descriptions of technical issues) should not be included in those documents or associated records.
• Be cautious with emails. Privilege can be inadvertently compromised relatively easily by copying/forwarding emails and adding attachments. Good practice includes limiting emails to a single topic/transaction, applying a legend that content is intended to be confidential, avoiding nonessential recipients,⁴ and deleting extraneous material from existing email chains.

Kovel Arrangements

Because the attorney-client privilege is broader than IRC Section 7525 protection, it is common to use so-called Kovel arrangements for matters that involve both attorneys and accountants.⁵ Under such arrangements, accountants are retained by a client’s attorney to provide interpretive assistance to the attorney providing legal advice to the client.

A Kovel arrangement presents particular hazards:

• The arrangement must be consistent with the attorney using the accountant to assist in the attorney’s rendering of legal advice. Indications that an accountant’s role was not integral to legal advice being rendered may cause communications with the accountant to lose privileged status.⁶ Moreover, the attorney should direct the engagement and render the advice directly to the client.  
• Because the attorney-client privilege generally does not apply to records and communications generated before an attorney-client relationship is established, the Kovel arrangement should typically be established as early in an engagement as possible. Earlier accountant communications should be approached with caution.  
• While it is generally permissible for the accountant to directly bill the client, appropriate measures — both formal (e.g., language in engagement letters) and in substance — should be established and maintained when using a Kovel arrangement. For example, the accountant should generally communicate with the client through the attorney. Memoranda from the accountant should be addressed to the attorney, rather than to “files” or the client.

Avoiding Waiver

After communications subject to confidentiality protection have occurred, it is important to avoid inadvertently waiving such protection. Here are a few steps that can minimize that risk:

• Avoid disclosure (including post-engagement) to unnecessary third parties. Clients and nonattorney personnel should be advised/reminded at the outset and conclusion of engagements to avoid such disclosure.  
• When post-engagement disclosures seem likely to become necessary or tactically beneficial, create separate confidential and nonconfidential documents. For example, a simple description of transaction steps can be prepared to assist with tax return preparation, and a separate memo can be prepared to describe tax exposures or positions that might be taken in a later tax controversy.
• Analyze potential “subject matter” waiver exposure before making disclosures. For example, using a tax opinion for penalty protection may result in loss of privilege for other communications regarding the same subject.  

It is important to remember that the attorney-client privilege belongs to the client. Accountants and attorneys can only claim privilege on the client’s behalf at his or her direction. If disagreements arise about whether or when to disclose a privileged communication, it is ultimately the client’s decision.

The attorney-client privilege will likely continue to evolve. For example, shortly before publication, the Supreme Court heard arguments on a case concerning the level of protection afforded dual-purpose communications that contain both legal and nonlegal advice.

¹ That power includes summons authority to compel testimony and record production. (IRC Section 7602)
² The work product doctrine is not an absolute privilege (i.e., the IRS can obtain attorney work product where it can show substantial need). Moreover, some courts limit the doctrine to documents prepared for specific litigation, whereas others allow it for documents prepared in anticipation of potential litigation.
³ Communications occurring after a tax shelter transaction (e.g., during an audit of the transaction) are not excluded from Section 7525 protection. See, e.g., Salem Financial Inc. v. U.S., 102 Fed. Cl. 793 (2012).
⁴ This consideration also applies to meetings (virtual and in person) involving confidential topics. Caution should be exercised in attaching confidential documents to electronic invitations for meetings that may cover multiple topics.
⁵ 296 F.2d 918 (CA-2, 1961). Kovel arrangements can also be used between attorneys and other experts (e.g., actuaries, engineers, and valuation experts) whose assistance can help an attorney render legal advice. The considerations described in the text also apply with respect to those professionals.  
⁶ That might occur if an accountant is viewed as providing the substantive tax expertise in an engagement.  

Mark L. Lubin, CPA, JD, LLM, is special counsel at the law firm Chamberlain Hrdlicka in Philadelphia. His practice focuses on tax planning and complex business transactions. He can be reached at mlubin@chamberlainlaw.com.

Philip Karter, JD, LLM is managing shareholder of Chamberlain Hrdlicka’s Philadelphia office. His practice focuses on tax controversy and tax litigation work. He can be reached at pkarter@chamberlainlaw.com.

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