PROTECTING PRIVILEGES DURING AN IRS EXAMINATION
A better-equipped IRS has been able to ferret out potentially sensitive issues in a manner often compromising the relationship between a taxpayer and his own tax representative.
If there are potentially sensitive issues, the taxpayer should be interviewed by counsel to determine whether there is a need to fully preserve potentially privileged information. In turn, counsel should consider engaging the accountant to coordinate the examination on behalf of the taxpayer. Under the doctrine of United States v. Kovel,1 the investigative accountant may be clothed with an extension of the attorney’s privilege.
If asked, the taxpayer will often state that he gave everything to his return preparer and that he doesn’t understand why the return preparer failed to appropriately report it. Remember, clients do not make mistakes. Better to get this cleared up between the taxpayer and counsel than to have the taxpayer make such statements(if untrue) to the government. Counsel’s engagement of the accountant should be in writing, and should indicate that the accountant is acting under the direction of counsel in connection with counsel’s rendering of legal services to the client.
Under a Kovel arrangement, communications between the accountant and the client are confidential and are made solely for purposes of enabling counsel to provide legal advice; the accountant’s work papers are held solely for counsel’s use and convenience and subject to counsel’s right to demand their return; and the accountant is to segregate his work papers, correspondence, and other documents gathered during the course of the engagement and designate those documents as property of counsel.
The statutory privilege for civil “tax advice” to a federally authorized tax practitioner set forth in IRC section 7525 is not available when truly needed the most — when a civil tax proceeding moves into the criminal arena. It also may not be available in some state-related tax proceedings or in nontax civil litigation. However, if the accountant is appropriately engaged by counsel under Kovel, the common-law attorney-client privilege should apply to all communications rendered in furtherance of the legal services being provided to the client, both during the investigative stages of the audit and, if necessary, during any subsequent civil or criminal litigation. This privilege does not extend to the actual return preparation. The critical inquiry is often whether counsel should retain the taxpayer’s prior accountant or a new accountant.
Some representatives prefer to engage a new accountant to avoid the necessity of delineating between non-privileged communications (communications preceding counsel’s engagement of the accountant), and privileged communications appropriate communications following counsel’s engagement of the accountant). However, the particular facts and circumstances should be fully explored by counsel before making a determination regarding the engagement of the investigative accountant to assist counsel.
1United States v. Kovel, 292 F.2d 18 (2d Cir. 1961).