By Lawrence R. Jones">
| A Look at the New IRS |
| The Accountants' Role -- and Risks -- in Koveling |
| IRS Initiatives and Congress' Pandering - An Editorial Comment |
By Lawrence R. Jones, Jr.
In the future the IRS will not have District Directors. There will be no Examination, Collection or Customer Service Divisions, either. During this year, as the new IRS "stands up," these components of the old IRS will reorganize. The pending changes have given rise to many questions about what the IRS will look like.
The first national conference on IRS Modernization, The New IRS Stands Up: What the Modernized Agency Means for You, took place in Washington, DC on January 13_14, 2000. The material that was distributed at the conference gives more insight as to the IRS reorganization can be found at http://www.irs.ustreas.gov/hot/latnews.html.
Instead of having a District Director heading up functional divisions that serve all taxpayers in a particular geographic area, there will be four nationwide operating divisions designed to serve different types of taxpayers, and each nationwide operating division will have an organization that covers the entire country. The four operating divisions are: wage and investment income (W&l), small business and self-employed (SBSE), large and mid-size business (LMSB), and tax exempt and government entities (TEGE). Each of these divisions will have a presence in Texas.
Each operating division will have a Commissioner and a structure tailored to meet the tax administration needs of the taxpayers it serves, and each will be responsible for providing "end-to-end" service to its taxpayers, including pre-filing, filing, and post-filing activities. IRS will continue examinations, collecting back taxes, and providing service, but it will be done out of each of the new IRS divisions in a manner tailored to the situations of the different groups of taxpayers.
There will also be Counsel, Appeals and Taxpayer Advocate Service, each with a nationwide organization and a significant presence in Texas.
While we do not know what all of Texas will look like, the Operating Division presence in Southeast Texas is somewhat set. However, expect changes as the IRS continues with its plans.
In the area that currently makes up the Houston District, the IRS will have-
—Five SBSE territory managers who will report to an area manager in Dallas. Each territory manager will oversee a number of work groups. Most of the IRS revenue officers, grade-12 revenue agents, and tax auditors will be in SBSE. Just as practitioners work directly on taxpayer cases today in contacts with representatives of Examination and Collection, in the future these IRS people will be in SBSE, with the same access.
—An SBSE territory office for taxpayer education and communications, dedicated to small business and self-employed taxpayers. It is envisioned that most liaison, educational and related activity with the practitioner community will be performed through this office.
—W&l field assistance sites to provide face-to-face services to taxpayers, and taxpayer education groups to develop and implement education and outreach programs for wage earners. These W&l activities in southeast Texas will report to a W&l area manager in St. Louis.
—A toll-free tax assistance call site. The W&l management structure of the toll-free telephone system is a bit different. Field call sites are linked to the ten Customer Service Centers, which report to the national W&l office in Atlanta. The Customer Service Center serving Texas is in Austin, formerly the Austin Service Center, which recently split, as did all ten service centers, into a customer service center and a submission processing center. The Houston call site is a branch of the Dallas site, which is under the Austin Customer Service Center. Case and account related contacts previously with the Austin Service Center will now be with the Austin Customer Service Center.
—A TEGE office that reports to a TEGE area manager in Dallas, similar to the prior EPEO "key district" structure.
—A nationwide director for the Natural Resources industry segment of LMSB, along with a field operations director and territory manager. Bobby Scott has been selected Natural Resources industry director. Paul Cordova will be field operations director for LMSB natural resources industries located in the southeastern states and all states west of the Mississippi River. Houston will also have a natural resources territory manager who will report to Cordova.
—An LMSB territory manager for the Heavy Manufacturing, Construction and Transportation industry segment, which is nationally headquartered in New Jersey.
—LMSB agents assigned to the other three industry offices, which are: Retailers, Food & Pharmaceuticals headquartered in Chicago; Financial Services and Healthcare headquartered in Manhattan; and Communications, Technology and Media headquartered in the San Francisco area.
-- Houston will continue to have a Taxpayer Advocate to help practitioners resolve clients’ problem situations. The Taxpayer Advocate Service has already reorganized, and the Houston Taxpayer Advocate office reports to Dallas.
—Counsel will have four attorney groups in Houston. Two will deal with LMSB issues and will report to an LMSB Area Counsel located in Houston. The other two groups will be for SBSE issues and will report to an SBSE Area Counsel in Dallas. Additionally, there will be two criminal tax attorneys reporting to a criminal tax Counsel supervisor in Dallas.—Appeals, like Counsel, also will be structured along customer segment lines. For example, there will be five Appeals area offices nationwide for LMSB taxpayers, and under each of those area offices will be a number of Appeals teams. Houston will have one of those five Appeals area offices for LMSB. Houston will also have Appeals teams for SBSE that report to an area manager in Dallas. The organization of Appeals for W&l is not yet resolved.
The changes resulting from reorganization are significant. One is that the layers of management that currently exist between the IRS Commissioner and the front line will be cut in half. Another is that the "customer defined" divisions will be able to specialize and better focus on the needs of particular types of taxpayers, and, in the case of LMSB, different industries. The benefits intended are improved management accountability and responsiveness to the public, increased pre-filing education, outreach and issue resolution, and quicker resolution of post-filing issues that arise.
THE ACCOUNTANTS’ ROLE -- AND RISKS -- IN KOVELING
By John A. Townsend
Clients with potential criminal tax exposure often need both legal and accounting expertise to assist in managing the risk. Criminal tax exposure arises when a taxpayer has filed a fraudulent return (either false as to the amount of tax reported or false as to some material item required to be disclosed on the return) or has failed to file his or her return timely. Once a fraudulent return has been filed or a return is delinquent, the traditional way to avoid criminal tax exposure is to make a “voluntary disclosure” by filing an amended return or delinquent return, as appropriate. Voluntary disclosure is a separate topic that we shall address in a separate article later. Suffice it to say here that voluntary disclosure requires that the taxpayer properly report his or her liability on an amended return(s) or delinquent return(s). That requires tax preparer expertise, and, usually, accounting expertise to develop the information for reporting on the return.
Attorneys advising clients on how to mitigate or eliminate their criminal exposure usually engage independent accountants to perform the accounting and tax return preparation. The construct of the engagement is that the accountants assist the attorneys in rendering legal services to the attorneys’ client. The reason this construct is used is to infuse the accountants’ activity with the attorney-client privilege to the extent possible. The leading case that originally recognized the attorney-client privilege when accountants are engaged to assist in rendering legal services to a client was named Kovel, hence the accountants so engaged are referred to as Kovel accountants. The courts reason that, in the complex and sometimes arcane tax area, accounting expertise is often required in order for the attorneys to provide adequate legal representation. The same theory could apply to other disciplines necessary for legal representation (e.g., environmental engineers in legal representation related to environmental matters). But we here focus on the Kovel accountants because that is the expertise most frequently encountered in tax representation.
The nuances of “Koveling” accountants are many and multifaceted. We can deal here only with the highlights and then in a way that simplifies (at the risk of oversimplification) a complex subject. We have decided to present the discussion in a question and answer format, with a hypothetical accountant asking the questions.
Q. Why is “Koveling” important after Congress passed the practitioner privilege in Code Section 7525?
A. The Section 7525 practitioner privilege may only be asserted in noncriminal matters. The Kovel agreement is important only because there is risk of criminal exposure. If the IRS seeks to investigate or prosecute for tax crimes, Section 7525's practitioner privilege is not available. Accordingly, it is important to take extra steps to preserve the privilege for the type of information (particularly communications to and from the client) to which the accountants will have access during the scope of assisting the attorney render legal services.
We focus here on the attorney-client privilege, because, where applicable, it is absolute. It preserves the confidentiality of the information in all contexts, criminal, civil or otherwise. There is one other privilege potentially applicable in this type of tax engagement. This is the work product privilege which is a qualified privilege, meaning that it generally applies, but if the opposing party (here the Government) could show a compelling need for the information, a court could order it disclosed. The work product privilege applies if the work is performed in anticipation of litigation (the possibility of litigation, not the certainty of litigation). The Kovel accountants’ work in the context discussed here will qualify for the work product privilege. However, we do not focus on it here because it, like the Code Section 7525 privilege, is not an absolute privilege. Having said that, it should not be ignored in a Kovel engagement, and you and the attorneys should take the steps necessary to insure that it is available if needed (belt and suspenders approach).
Q. Who am I working for if I enter a Kovel agreement?
A. In the Kovel relationship, you work directly for the attorneys as an independent contractor. You do not work for the client except indirectly as part of the legal team rendering legal services to the attorneys’ client. You are not practicing law, but simply rendering accountant and tax preparation expertise to the attorneys so that they can deploy that expertise in delivering legal representation to the client. You will frequently deal directly with the client in developing the underlying information required for you to render your accounting and tax preparation services, but you will do so as an agent of the attorneys.
Q. How can the privilege apply if I prepare the tax return (either amended or delinquent) that is then filed with the IRS.
A. You have raised an excellent question and one as to which there is some gray area because of the dearth of cases. The law generally is that there is no attorney-client privilege for tax return preparation services. To illustrate by a simple example, if a taxpayer engages an attorney to prepare a simple return and the attorney does nothing more than do what an ordinary tax return preparer would do, the attorney-client privilege does not apply. The privilege applies only to the rendition of legal services. Mere return preparation is not, ordinarily, the rendition of legal services. If, however, traditional legal services are provided in addition to mere return preparation, the privilege will apply to the legal services rendered. For example, if the presentation on the return is based upon legal advice as to whether a reorganization qualifies as a tax-free merger under Section 368(a)(1)(A)), then that portion of the underlying services and communications between the client, on the one hand, and the attorney or Kovel accountants, on the other, should qualify for the privilege. In a Kovel agreement, where major criminal tax concerns drive the preparation and filing of the return, significant areas of the work will relate to the rendition of legal services (as opposed, for example, to the mere compilation of data for presentation on the return). These are our conclusions as to the division between services to which the privilege applies and services to which it does not apply. In any given case, the dividing line may be hard to discern, but the foregoing is a very rough guide for discerning the line. The concept is that, as tax return preparer in the Kovel engagement, the Kovel accountants’ services may ultimately be privileged as to some portions and not privileged as to others. Suffice it to say that, because the cases are few and the IRS has not attempted to press these matters in close cases, we do not have specific authority as to where the lines will be drawn. We think, however, that for purposes of addressing your concern, the foregoing is a good working summary.
We should note that there is one way to add some strength to the attorney-client privilege in this context, but it adds additional costs that the client may or may not be willing to incur. The Kovel accountants may work with and for the attorneys in developing the underlying return information and reporting strategies. After that information is developed, the Kovel accountants will not then prepare the return. Rather, the attorneys will present the information to a separate, independent accountant, who has not been Kovelized, for the actual return preparation. There are no cases addressing whether splitting the responsibilities and work efforts in this fashion will prevent the Government from blowing out the privilege for communications with the Kovel accountants, but we think this offers an additional argument that, in an appropriate cases, may be worth the cost. In the final analysis, the attorneys advise the client on the additional costs involved, the potential benefits that might be achieved, the projection of the likelihood of prevailing in court if the IRS were to press the matter, the projection of the likelihood that the IRS would press the matter (an issue separate from how a court may resolve the issues), and the risks if the taxpayer does not incur the additional costs. In short, the attorney helps the client consider costs, benefits and risks in making the decision whether to take this additional step and incur the additional costs. We have found that, usually, clients make the call not to take this additional step, but it is important that the client receive good advice and judgment based on considerable experience in making his or her decision. After all, it is the client’s whose liberty and property are at stake.
Q. Is it necessary to have a written contract?
A. The legal answer to the question is no. A Kovel agreement is simply a contract, and the law permits oral contracts. The practical answer to the question is YES. Proving the nature and parameters of an oral contract invites controversy and risks that can be easily and cheaply avoided. HAVE A WRITTEN KOVEL AGREEMENT. Moreover, having a written agreement provides a handy and objective reference for the attorneys and the Kovel accountants to periodically review their respective responsibilities.
Q. When can I start work?
A. Anytime after we enter a Kovel Agreement. Of course, there may be preliminary discussions between you (the potential Kovel accountants) and the attorneys in determining whether to enter a Kovel engagement, and some information may be shared at that stage. Generally, by analogy to attorney engagements, those preliminary discussions should be covered by the privilege, but it is the better part of wisdom to have some preliminary understanding that there is an limited engagement at the beginning of the discussion, for which no charge will be made in the event a formal Kovel engagement is not entered. In all events, before the accountants set out on substantive work on the engagement, the Kovel Agreement should be entered.
Q. What administrative actions are required by me as a Kovel accountant that I might not otherwise do in the normal course of my practice?
A. Broadly speaking the attorney-client privilege applies only if the attorney-client communications are not divulged outside the scope of the persons having a need to know in the legal representation. This means that the information must be available only to the client, the attorneys and any person assisting the attorneys in the representation. The accountants must take action to insure the integrity of the files that the accountants maintain in the matter. Those files should not be available for access by accounting firm personnel not working on the engagement. We suggest that the Kovel accountants keep the files in red-ropes or other containers clearly marked that they are for limited access only and, if at all possible, be stored in a secure area of the accounting firm. Furthermore, it is important that the accountants be sensitive in discussing the engagement either with his colleagues in the accounting firm or with outsiders. Keep in mind that colleagues within the firm should only be told such information as they have a need to know in furtherance of the legal representation of the client. This means that, on a routine basis, no information can be shared with colleagues.
There is one exception. The client’s name can be shared within the accounting firm in order to permit it to run a conflicts check. There is a nuance here. You will recall that I said above that the accountants are working for the attorneys, not for the attorneys’ client. Technically, attorneys are the Kovel accountants’ client. However, well-designed conflict checks usually include other parties in interest and, of course, the ultimate client (the taxpayer) is a party in interest. In an attorney-client relationship, the name of the client is usually not considered a confidential attorney-client communication, so disclosing the name of the ultimate client of attorneys posses no risk at least in terms of the Kovel accountants doing an internal a conflict check (including consulting with colleagues as to any potential conflict).
We have encountered a second area of potential concern. Some, perhaps all, accounting firms do internal and external peer reviews of work performed. These reviews are performed by persons having no direct relationship to the delivery of services to the attorneys and the attorneys’ delivery of legal services to the attorneys’ client. There is some conceptual risk that such reviews could blow the privilege. We think, however, that a good argument can be made that such reviews do not blow the privilege. Basically, in the accounting environment, such reviews are a usual and needed (if not technically necessary) part of the rendering of services and those persons performing the review should be within the scope of the privilege. We think that there are policy reasons that mitigate strongly against the Government asserting that the mere disclosure to such review personnel would blow the privilege.
Q. Let’s talk about the money. Who pays me and how can I be sure I get paid?
A. The attorneys pay you. The construct is that the Kovel accountants work for the attorneys. Consistent with that construct, the Kovel accountants should render the statement(s) for services to the attorneys. The attorneys, of course, do not bear the ultimate economic cost for your services. Rather, the attorneys passes on those costs to the client, usually as an expense item on the attorney’s statement to the client for services rendered.
The attorneys are, in every sense, the client for your services even though the attorneys pass the costs to the attorneys’ client. Hence, the attorneys have the right to review your fees to determine whether they are consistent with the kind and quality of services for which the attorneys engaged you. Indeed, as you may know, an attorney has an ethical obligation to render fair fees to the client based on the services rendered. Since the Kovel accountants’ fees, when approved by the attorneys, will be passed to the client, the attorneys have an ethical obligation to review the Kovel accountants’ statement for services rendered to insure that they are fair before passing them on to the client. Usually, in the initial Kovel agreement (to which the client is either a party or has consented to in writing), the client will have approved the accountants’ hourly rate and other charges, so the attorneys’ responsibility will be to insure that the services being charged for were within the scope of the engagement and were of the kind and quality for which charges should be made. This means that the attorneys should require the accountants to render to the attorney a detailed statement showing time spent, the nature of the work performed during the time and the charges for the time, and similar information for the accountants’ expenses that are charged on the fee statement. This is the type of information that a reasonably well-run accounting firm accumulates anyway, so this should not be a significant burden on the accounting firm.
Q. Can I be a Kovel accountant if I am the taxpayer’s regular accountant and/or tax return preparer?
A. The legal answer is yes. The practical answer is NO.
The reason for this practical answer is that the attorney-client privilege does not apply to communications learned before the agreement is entered. Should the Government summons or subpoena the accountant, the accountants will be allowed to assert the privilege (on behalf of the attorneys’ client) only as to matters that the accountants learned while engaged as Kovel accountants. Our experience is that it is often very difficult, sometimes impossible, to establish what the accountants learned after being Kovelized and distinguish it from what they learned before being Kovelized. Moreover, the taxpayer’s regular accountants may, in fact, have already learned information that could be damaging and that could not be protected if the IRS pressed on the matter. (You are astute, and will have noted that this risk will be present even if new Kovel accountants are engaged, for the Government can summons or subpoena the old accountants who were not Kovelized; nevertheless, the subtle danger of using the old accountants is that, in the process of the Kovel engagement, the old accountants will inevitably learn additional information and nuances that cannot be divorced from their prior knowledge and will thus be difficult to avoid disclosing if the Government presses the issue – in short answering about their prior knowledge will bring with it the information or nuances learned later.) This injects considerable risk into engaging an accountant that was previously involved in the taxpayer’s affairs. The general rule therefore is that a fresh accountant is Kovelized so that everything he or she knows is Kovelized.
Having said that, some taxpayers may strongly desire their regular accountants to do this work. The taxpayers’ desires in this regard are almost always based upon financial reasons. The taxpayers reason that the accountants who already know the taxpayers’ accounting and tax affairs can more expeditiously (and inexpensively) do the job. Our response is to strongly discourage that for the reasons noted. Moreover, if the old accountants are used, extra efforts (and costs) will be required (unless of course the taxpayer directs otherwise) to debrief the old accountants at the beginning of the engagement to establish what they knew (or even might have suspected) prior to the engagement. That debriefing could be inefficient and wide of the mark before the attorneys are aware of the full parameters of the underlying problems. Finally, it is not inconceivable that, in order to better mitigate the taxpayer’s exposure, the taxpayer may have to argue that the old accountants did a sloppy job and thus are responsible (perhaps not criminally responsible, but nevertheless responsible as between them and the taxpayer). That will, in many cases, be a last resort and perhaps even repugnant argument to the taxpayer, even if there is a factual basis for it. Nevertheless, at the early stages of the engagement before the underlying facts and nuances are known, it is highly risky to take action that might foreclose a wholly objective consideration of this potential defense.
For these reasons, we as the attorneys strongly urge that our client not engage his regular accountants. If the taxpayer chooses otherwise, we put our advice in writing (with a litany of all the risks that might be involved) and have the taxpayer (our client) expressly acknowledge our contrary advice and the taxpayer’s knowing decision to proceed against our advice.
Q. What are some checklist items that should be incorporated in the Kovel Agreement?
A. We suggest the following (at a bare minimum, with custom tailored additional provisions as the circumstances warrant):
- Parties. The essential parties to the Kovel accountants agreement are the attorneys and the accountants. The client may also be a party (in a three-way agreement), but if not a formally party, the client should subscribe the agreement to acknowledge his or her consent to the arrangement.
- Nexus to Legal Services. A statement that the accountants’ services are being rendered to the attorneys to permit them to render legal services to the client. I usually define the accountants as “Legal Assistants” and use that term throughout the document.
- Accountants' Actions Consistent with Nexus to Legal Services. A statement that the accountants will take action consistent with preserving the privilege by eliminating or mitigating the risk of disclosures outside the circle of people with a need to know. You can be as detailed as the particular circumstances require here.
- Ownership of Files. A statement that the accountants’ files belong to either the attorneys or the attorneys’ client, and not to the Kovel accountants. The Kovel accountants will likely want to negotiate some protection for the integrity of their work product to guard against any claims that may be made against the accountants. This is a matter of individual negotiation. In practice, the Kovel accountants keep the files as the custodian on behalf of the attorneys, at least until the conclusion of the engagement. At the conclusion of the engagement, the attorneys’ client, the attorneys and the Kovel accountants should decide as to the disposition of the files and the record retention policies to be maintained for any files that are retained by the Kovel accountants as custodian for the attorneys.
- Fee arrangements. The accountants will want to ensure that they will be paid for their services. The attorneys will usually want to make sure that the Kovel accountants are only paid from collections for that purpose from the attorneys’ client. These needs are usually met by requiring the attorneys’ client to deposit into the attorneys’ retainer trust fund an amount that is periodically replenished by the client so that, at any given time, the Kovel accountants are protected for their fees. (This is the procedure attorneys use to insure payment for their own fees.) Technically, of course, the Kovel accountants might be able to sue the client as third party beneficiary of the attorneys’ contract with the client or prevail upon the attorneys to sue for those fees. However, this is generally an area in which there is very high risk that the Kovel accountants are left holding the bag, so the importance of the retainer mechanism cannot be overstated, except where the Kovel accountants have some independent reason for believing that the client will pay the attorneys the amounts with respect to the Kovel accountants services and is thus willing to take the risk of nonpayment.
- Responsibilities if Accountants Summonsed or Subpoenaed. A statement of the Kovel accountants’ responsibilities in the event the accountants are summonsed or subpoenaed to give testimony or produce documents related to the engagement. The client’s and attorneys’ concerns are that the information not be disclosed unless legal compulsion cannot be avoided. They will want the attorney-client privilege to be asserted, so long as it can be done in good faith. The accountants, however, will want to make sure that it is protected if it does the client’s and attorneys’ bidding in this respect and, moreover, that it is compensated for the additional time and expense involved in doing their bidding.
- Liability Issues. The Kovel accountants might want to address liability issues. The Kovel accountants are not rendering legal services to the attorneys’ client, but are rather rendering specialized accounting and tax preparation services to the attorneys. The attorneys, not the Kovel accountants, are subject to legal malpractice risks. The accountants, however, are subject to potential liabilities to the attorneys and the client (the latter as contracting parties or third party beneficiaries of the Kovel agreement) if the services they provide – accounting and tax preparation services – are otherwise actionable. The accountants may have the opportunity to negotiate away some of the risks involved. For example, we have seen Kovel agreements that allocate to the attorneys and/or the attorneys client the risk that the Kovel accountants might be liable for ordinary negligence. If this type of limitation of liability works legally, this still leaves the Kovel accountants exposed for damages arising from gross negligence or intentional misconduct (including fraud). But most accountants know that liability from their work is likely to arise, if at all, from ordinary negligence (this is just to say that ordinary negligence is far more common that gross negligence or intentional misconduct). We don’t know whether such a limitation would ultimately work, but we do think that an analogy is helpful in addressing the issues presented. The Kovel accountant construct is to engage expertise needed for delivery of legal services. This is like an attorney engaging a paralegal to gather, assimilate and analyze data (documents, etc.). A paralegal is normally the attorneys’ employee rather than an independent contractor like the Kovel accountant, but that is only a difference in the nature of the engagement. The paralegal is not normally responsible to the client or the attorneys for errors in his or her work product, but would probably be liable for intentional misconduct and perhaps even gross negligence. It is possible that Kovel accountants could similarly limit some level of potential liability in this way. Of course, the attorneys will remain responsible to the attorneys’ client for any defect in the legal services rendered resulting from the accountants’ negligence, so opening up the issue of limitation of liability, may cause the attorneys to seek Kovel accounting assistance elsewhere. I should note, in this regard, that attorneys cannot ethically ask the client contractually to limit the attorneys’ liability for negligence (at least such a limitation would not be enforceable as between the attorney and the client). But there appears to be no legal or policy reason that the attorneys and client could not waive liability for Kovel accountants’ ordinary negligence in the Kovel agreement. The issue is whether the Kovel accountants can negotiate the limitation.
Q. Are there any other uses of the Kovel agreement that might apply to my practice as an accountant?
A. Yes. We have discussed above the use in a context involving potential criminal exposure for returns that have already been files or for returns that are delinquent. You might consider the use of Kovel arrangements in other contexts. The most frequently encountered other context will be in tax planning where the tax planning might involve some exposure to civil tax adjustments and penalties, and possibly even criminal tax penalties. You should know that the attorney-client privilege does not protect attorney-client communications in the planning of a crime, but I am sure that you would not engage in such conduct anyway, so I shall here limit my response to tax planning that is not criminal in nature. Setting aside tax planning that is criminal, if the tax planning were done by an attorney, confidential communications between the client and the attorney would be protected by the attorney-client privilege, at least to the extent we noted above that the attorney is acting as a lawyer not as a tax return preparer. If, however, you do the planning as an accountant, you will not qualify directly for the attorney-client privilege. As we noted above, however, recently enacted Section 7525 extends the common law attorney-client privilege to communications between a federally authorized tax practitioner (including, a CPA) and the taxpayer. The Section is subject to some conceptual issues (e.g., the attorney-client privilege applies only with respect to communications incident to rendering legal advice, which non-attorneys are not authorized to do). Nevertheless, it does appear that Congress did not intend a meaningless act and the Section should be read as covering this type of communication by an accountant without any concern as to whether the accountant must first be practicing law with respect to the communication. On that basis, it would appear at first blush that Section 7525 would moot the issue of whether the Kovel arrangement adds some protection not otherwise available after enactment of Section 7525.
But, as we noted above, the Section 7525 privilege applies only to noncriminal matters. The IRS has been known to start criminal investigations into complex tax planning that it did not understand, even if the investigations ultimately fall short of prosecution. The courts have held that the Government cannot prosecute where the underlying legal command is not clear and certain, and this will typically be the case in complex tax planning. That does not mean, however, that the IRS cannot criminally investigate that type of planning. If the IRS were to pursue a criminal investigation, the IRS will not be limited by Section 7525 but would be limited by the attorney-client privilege if a Kovel arrangement is in place.
We mention the facts of a fairly recent case where a corporation through its tax director, a lawyer, engaged its regular accountants (i.e., the accountants doing its audit and tax work) to do complex tax planning for a major transaction. The corporation did not enter a written Kovel agreement. The oral terms of the engagement for the tax planning, if any, did not differentiate the engagement from the corporation’s other tax engagements with the accounting firm. The accountants did not separately bill or otherwise treat the work performed on the engagement differently than its other engagements. The court rejected the corporation’s assertion of the attorney-client privilege, holding that the taxpayer had not established that accountants had served in the rendition of Kovel type advice to the tax director (an attorney). (You will note from the discussion in the preceding paragraph that, had the accountants been qualified to render legal advice, their advice probably would have directly qualified for the attorney-client privilege, without need of a Kovel agreement; but, not being qualified to practice law, the accountants needed a Kovel agreement to assert the privilege for communications.) In short, the corporation failed to document the arrangement satisfactorily to establish that the accountants were acting pursuant to a Kovel agreement. Of course, this case was decided under the law prior to the effective date of Section 7525, so that the advice would likely now be covered by that privilege. (Note that the same concerns about what the accountants know from their other nonprotected relationships with the taxpayer exist in this context, and the well drafted Kovel agreement will establish procedures for establishing that communications pursuant to the Kovel agreement are not otherwise known.) Nonetheless, the advice could be subject to exposure if the IRS were to commence a criminal investigation.
Since all this turns upon whether the IRS starts a criminal investigation, you surely are thinking what protection does the taxpayer and/or his accountant have that the IRS will not start a criminal investigation as a pretext for avoiding the limitations of Section 7525? That is a good question.
CAVEAT: The foregoing is intended to introduce the general nature and certain facets of the Kovel accountant arrangement to tax practitioners. Readers are cautioned to seek individual legal advice as to the negotiation, drafting and entering of Kovel agreements.
IRS New Initiatives and Congress' Pandering - An Editorial Comment
By John A. Townsend
Tax rags report that the IRS has floated yet another goofy idea to get some press (ho-hum; we are getting used to this by now). This initiative is to involve Appeals at the Examination stage so that the Taxpayer, Examination and Appeals can assemble in one room to "reason together" to resolve disputes. The details are yet to be worked out (and even critical analysis as to whether the concept is even facially viable is yet to be made). (Parenthetically, if this is a good idea, why not get the Tax Court Judges involved also? Or, better still, let's get the Courts of Appeals and the Supreme Court involved also, then we will have all the ultimate decision makers in one room and both sides can quickly and inexpensively determine what the ultimate answer will be and settle accordingly.) Yet, the IRS officials are out promoting the idea as if it had merit.
We have some advice for the IRS . Quit allowing IRS officials to utter such stream of consciousness thoughts into the public forum until they have been preceded by at least a modicum of reasonable critical analysis. We think the IRS would be better off to settle down and implement the reorganization initiative in process before going to such further questionable initiatives. Our view is that the current reorganization created more problems than it could ever solve and at a cost/benefit ratio that is astronomical, so that these new putative initiatives will just increase the problems. IRS officials could better spend their energies correcting the havoc rendered the current reorganization, than by diverting much needed resources on new ill-considered initiatives.
As our readers -- sophisticated tax professionals-- know, the current IRS reorganization was a misguided attempt to mitigate the political storm created by Senator Roth's much publicized hearings on "abuses" by the IRS. As our readers may not know, however, Congress's own investigative agency -- the General Accounting Office -- investigated Senator Roth's claims of IRS abuses and found them false in virtually every respect. Much of the turmoil in the IRS is due to such wholly meritless Congressional attacks having no other purpose than to pander to a public that the congressional "leaders" -- Hitler too was a leader -- hope is as ill-informed and subject to manipulation as they think it is. It's all show-biz for political gain. Senator Roth lead the charge to trash a fine Government agency which, while certainly not without blemishes, serves its critical mission far better than the congressional leaders who conspired (a wholly apropos word) to trash the agency – Senator Roth is Exhibit 1, the same Senator Roth who led the charge for tax breaks for chicken waste (the polite term). On serving their respective critical missions, I'll take the IRS any day over Senator Roth and his co-conspirators and fellow travelers.
There are, of course, many good congressmen, and they should not be judged by the likes of Senator Roth and those like him desperate enough for votes, power and influence to pander to voters' prejudices and to play fast and loose with the truth and critical institutions of our country. Unfortunately their voices have been drowned out by the bad ones (again Senator Roth is Exhibit 1). By the same token, there are some bad apples in the IRS. Unfortunately, for our republic, however, the percentage of bad apples in the Congress (which has far more power to abuse than the IRS ever had) far exceeds the bad apples in the IRS, but those of us who try to think positively can thank our lucky stars that at least the IRS is not as bad as Congress (that is, until Congress led by Senator Roth et al. succeeds in remaking the agency in its own image).Thank you. .
Return to Townsend & Jones, L.L.P. HomePage