Privilege and tax return preparation

A case decided by the United States Court of Appeals for the Seventh Circuit on April 15, 1999, United States v. Frederick, et al (99-1 U.S. Tax Cases 50,465), dealt with an Attorney-CPA who represented his client in tax matters, including the preparation of income tax returns. The appeal to the Seventh Circuit challenged an order enforcing summonses issued by the Internal Revenue Service (IRS) to Richard Frederick. The IRS was investigating his clients and their company, and directed Frederick to hand over hundreds of documents that may be germane to the investigation. Frederick balked at handing over all of them, claiming that some were protected by either the attorney-client privilege or the work-product privilege.

Tax Return Workpapers Are Not Privileged

The district court judge examined the documents in camera and ruled that some were privileged, but others were not. The fact that some documents were found to be privileged should not be overlooked when reviewing this case. It is hard to tell from reading the opinion exactly what constituted a privileged document and which documents were not privileged. A concurring opinion added clarity to the majority opinion in noting that "Without flagging it, however, the majority has also made an important legal ruling that affected its review: dual-purpose documents are not privileged." "Dual-purpose" documents are those that are related to both tax return preparation and to legal representation not related to tax return preparation. The description as dual-purpose documents in practical application should mean that if a document is related to tax return preparation, it is not privileged regardless of what other purpose it may serve.

The opinion notes that if a client transmits information for use in tax return preparation, such a transmission destroys any expectation of confidentiality. The lack of privilege related to tax return preparation is not news. We should all know that we cannot rely on attorney-client or "federally authorized tax practitioner's" (ATPs) privilege to refuse to produce documents related to tax return preparation. The additional comments of the court recognize that "because the tax preparer was also the taxpayers' lawyer, it cannot be assumed that everything the taxpayer transmitted was intended for use in tax return preparation." That comment should be helpful to us in providing an incentive and reason to keep files clearly and properly labeled and stored. This is simply another iteration of the importance of being clear about the capacity in which we represent a client. We can and often do represent a client in more than one capacity. The court was completely silent regarding the common practice of clients having their attorneys hire accountants rather than having the clients hire the accountants directly. That arrangement is often referred to as a "Kovel" arrangement because of the Kovel case, 296 F.2d 918 (2d Cir. 1961), which sanctioned the appropriateness of such an arrangement to establish privilege that might otherwise not be available.

In the context of this appeal, whether the documents were related to tax return preparation and thus not privileged was referred to as a "mixed question of law and fact." The Court commented that: "The presumption in this circuit is and we hope will remain that the clear-error standard is the proper standard for appellate review of determinations of mixed questions of law and fact." The court's opinion was that there were no clear errors in the district judge's rulings.

On the surface, the opinion does not advance the law related to privilege, but simply reviews and confirms principles previously established. Information is not provided in the opinion to reveal whether the district court judge was able to distinguish documents related to tax return preparation from those not related to tax return preparation. Similarly, information is not provided in the opinion to reveal whether the attorneyCPA clearly separated tax return preparation documents from non tax return preparation documents.

Tax Return Preparation Is Legal Work

One wonders about these issues, though, because the opinion only too clearly conveys a lack of understanding by the court that tax return preparation is legal work that people other than lawyers are permitted to do without violating the rule against practicing law without a license. The court clearly has gotten the situation reversed by commenting that tax return preparation is nonlawyers' work, specifically referring to it as accountants work. Similarly, the court is mistaken in fact and in inference by commenting that "Normally, however, taxpayers in audit proceedings are represented by accountants, or not represented at all, rather than by lawyers. . "

While these apparent misunderstandings may have no significance to the ultimate rulings and opinions of the Frederick case, they do tend to advance misunderstanding in the issues related to the definition of the practice of law, which is important in the multidisiplinary practice discussions which are in progress among and between attorneys, CPAs, their firms and their professional organizations.

The Confidentiality Privileges Relating to Taxpayer Communications-Practice Guide issued by the American Institute of Certified Public Accountants, Tax Division, dated January 1999, explains the new Internal Revenue Code Section 7525, which provides a new privilege of confidentiality to certain communications between CPAs and other FATPs and their clients. I recommend this guide to you as a thorough review of the new law and practical guide to dealing with privilege issues. On page 2 of the Guide there is a misunderstanding similar to the misunderstanding in the Frederick case related to attorneys preparing tax returns. In discussing the scope of the common-law attorneyclient privilege, the Guide correctly states that "The privilege applies only when the attorney is advising the client on legal matters . . . " It goes on to correctly conclude that the privilege does not apply when an attorney prepares a tax return, but incorrectly defines tax return preparation as nonlegal work.

Definitions Are Important

Despite the fact that we are all licensed both as attorneys and as CPAs, it is significant to us to use the proper definitions of the practice of law and the practice of accounting to avoid confusion by our clients, by those who regulate the practices of law and accounting and among ourselves. These definitions may prove to be important in cases in which the availability of privileged communication is an issue.

Copyright American Association of Attorney-Certified Public Accountants 1999
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