Townsend & Jones to Sponsor UH
Lecture on Tax Law Developments
As a commitment to the students of the University of Houston School of Law and to tax professionals">
| Townsend & Jones to Sponsor UH Lecture on Tax Law Developments |
| Tax Return Preparation and the Attorney-Client Privilege |
| IRS Appeals Division Redesigned |
| Tax Court Denies Jurisdiction in Penalty Case |
Townsend & Jones to Sponsor UH Lecture on Tax Law DevelopmentsAs a commitment to the students of the University of Houston School of Law and to tax professionals, Townsend & Jones is pleased to again underwrite the Annual Corporate & Taxation Law Society Lecture on Current Tax Law Developments. The lecture will be on November 8, 2000, at 9:00 a.m., in Krost Hall Auditorium of the University of Houston School of Law. Tax practitioners are invited and will be able to obtain continuing education credits.
This year's distinguished speaker will be The Honorable Juan Vasquez, Judge of the United States Tax Court. President Clinton appointed Judge Vasquez to the Tax Court in 1995. Nineteen judges serve on the Tax Court. The Tax Court decides controversies between taxpayers and the Internal Revenue Service involving underpayment of federal income, gift, and estate taxes.
Prior to his appointment, Judge Vasquez was a trial attorney in the IRS District Counsel Office in Houston from 1978 to 1982 before entering private practice, where he represented clients before the Internal Revenue Service and the Tax Court. He received his undergraduate degree at the University of Texas at Austin and his law degree from the University of Houston School of Law. Judge Vasquez earned his LL.M. in tax law from New York University in 1978.
The Corporate & Taxation Law Society is a student organization at the University of Houston School of Law that focuses on corporate and taxation issues. Jack Townsend of Townsend & Jones is an Adjunct Professor at the University of Houston School of Law, where he teaches Tax Procedure each fall semester and Tax Fraud and Money Laundering every other spring semester.We will have more in the next newsletter about signing up for this opportunity.
Tax Return Preparation and the Attorney-Client Privilege
By Jack Townsend
In the 1998 IRS Restructuring and Reform Act, Congress enacted Section 7525 which allows a taxpayer to assert a privilege for communications with a federally authorized practitioner ("FAP") for communications that would have been privileged if they had been made to an attorney. For purposes of this article, I will use the FAP acronym to mean federally authorized practitioners other than attorneys and specifically use the acronym to include accountants and enrolled agents. This new privilege sounds great, but let's talk about its limitations specifically in a tax return preparation context that accountants most frequently encounter. In discussing the issue I will also address some recent cases.
The first limitation is that the privilege may be asserted only in a noncrimiinal proceeding. In a criminal tax investigation or prosecution, the privilege is not available to the FAP. The normal attorney-client privilege would have been available if the communication had been with an attorney rather than a non-attorney FAP such as an accountant. Hence, when the taxpayer needs a privilege the most – when his liberty is at stake rather than just his money – Section 7525 is not available. Since a taxpayer never knows, even in relatively innocent situations – ever thought of innocence as relative? -- when the IRS might at least start a criminal investigation, the taxpayer assumes considerable risk by relying only on the Section 7525 privilege. For taxpayers not willing to assume that risk, I have discussed in a prior newsletter (The Accountants' Role -- and Risks -- in Koveling (May 2000)) how the normal attorney-client privilege may cover the FAP's efforts, so that the communications to an FAP are not subject to the limitations of Section 7525.
I focus in this article on another limitation inherent in Section 7525 that is also present in the normal attorney-client privilege. Remember Section 7525's construct is to make the communication privileged only if it had been privileged if it were made to an attorney. In order to qualify for the normal attorney-client privilege, the communication has to be to between the client and the attorney in order to obtain or give legal advice, respectively. This creates a threshold conundrum in the statute. In order to qualify for the normal attorney-client privilege, the communication must have been to seek or give legal advice, for that is the only communication that is privileged between attorney and client. FAP's (including accountants) cannot render legal advice, so perforce the communication between the client and the FAP could not have been to seek or give legal advice. With that threshold text problem, it would appear that Congress achieved absolutely nothing in enacting Section 7525; in order to avoid the conclusion that Congress did nothing, I shall assume that, for purposes of the Section 7525 privileges accountants are rendering legal advice the sine-qua-non to the normal attorney client privilege which is, in turn, the sine qua non to the Section 7525 privilege. (This assumption may not be a good one, since it is most unclear that Congress can authorize non-attorneys to give legal advice; bear with me on this one.)
The question therefore is when the communication relates to the seeking or giving of legal advice so that, if it had been made between the taxpayer and an attorney, it would have qualified for the attorney-client privilege. The parameters of the discussion are well known and have been repeatedly affirmed by the courts. Legal advice and tax return preparation are perceived as different animals. Simply because an attorney prepares a return – as some tax attorneys do – does not make the communications upon which the return was based privileged attorney-client communications. Return preparation is accountant's or preparer's work, not attorney's work, so the courts reason. Accountants cannot render legal advice, so that when the attorney is simply doing what the accountants do, the communications are not seeking or giving legal advice. In United States v. Frederick, 182 F.3d 496 (7th Cir. 1999), Judge Posner reasoned:
There is no common law accountant's or tax preparer's privilege, * * *, and a taxpayer must not be allowed, by hiring a lawyer to do the work that an accountant, or other tax preparer, or the taxpayer himself or herself, normally would do, to obtain greater protection from government investigators than a taxpayer who did not use a lawyer as his tax preparer would be entitled to. * * * *. To rule otherwise would be to impede tax investigations, reward lawyers for doing nonlawyers' work, and create a privileged position for lawyers in competition with other tax preparers--and to do all this without promoting the legitimate aims of the attorney-client and work-product privileges. The attorney-client privilege is intended to encourage people who find themselves involved in actual or potential legal disputes to be candid with any lawyer they retain to advise them. * * * *. The hope is that this will assist the lawyer in giving the client good advice (which may head off litigation, bring the client's conduct into conformity with law, or dispel legal concerns that are causing the client unnecessary anxiety or inhibiting him from engaging in lawful, socially productive activity) and will also avoid the disruption of the lawyer-client relationship that is brought about when a lawyer is sought to be used as a witness against his client.
Communications from a client that neither reflect the lawyer's thinking nor are made for the purpose of eliciting the lawyer's professional advice or other legal assistance are not privileged. The information that a person furnishes the preparer of his tax return is furnished for the purpose of enabling the preparation of the return, not the preparation of a brief or an opinion letter. Such information therefore is not privileged.
Having recognized the obvious general proposition that communications between attorney and client that are not for the purpose of seeking or giving legal advice are not privileged, Judge Posner then turned to another component of the elements of the attorney-client communication – that the communication must be confidential. Information that the client supplies the attorney for the purpose of including the information on the tax return is not confidential, for the client has no expectation of confidentiality with respect to the communication.
But there is much information that must be supplied that is not for the purpose of including the information on the return. Judge Posner reasoned:
We do not, however, accept the government's argument that there is no issue of privilege here because the information was transmitted to a tax preparer with the expectation of its being relayed to a third party, namely the IRS. It is true that "if the client transmitted the information so that it might be used on the tax return, such a transmission destroys any expectation of confidentiality." * * * *. That is, the transmittal operates as a waiver of the privilege. But the tax preparer here was also the taxpayers' lawyer, and it cannot be assumed that everything transmitted to him by the taxpayer was intended to assist him in his tax-preparation function and thus might be conveyed to the IRS, rather than in his legal-representation function. * * * *.
So there you have the parameters. Communications between attorney who is preparing the return and the client do not lose the privilege simply because they may be incident to the attorney's preparation of the return. The seeking and giving of legal advice can be involved, and the context may indicate that, in seeking and giving such legal advice, the client did not waive the privilege if the client did not intend that the communication be included on the return, thus waiving the privilege because the communication was not made with an understanding of confidentiality.
The generalities in these parameters is easy to state but may be difficult to apply. An important point to note at this point is that doubts as to the application of the facts to these general parameters are resolved against the application of the privilege. In a more recent case following on the heels of Frederick, the Seventh Circuit has noted (In the Matter of Grand Jury Proceedings Involving William Thulen and Kenneth Dvorak, F.3d (7/18/2000) ("In re Grand Jury"), the Court said:
Although the violation of the attorney-client privilege is a serious matter, our case law has recognized consistently that the privilege is in derogation of the search for the truth and, therefore, must be strictly confined. * * * * In applying this principle, we have held that material transmitted to an attorney or the attorney's agent for the purpose of using that information on a tax return is not privileged. The preparation of tax returns is an accounting service, not the provision of legal advice. See Frederick, 182 F.3d at 500-01; * * * *. On the other hand, information transmitted to an attorney or to the attorney's agent is privileged if it was not intended for subsequent appearance on a tax return and was given to the attorney for the sole purpose of seeking legal advice. See Frederick, 182 F.3d at 500-01. Documents used in both preparing tax returns and litigation are not privileged. * * * *.
Let's look at the specific facts of In re Grand Jury for further understanding of the nature of the underlying problems. In 1994, the IRS began a criminal investigation for the years 1985 - 1993. The taxpayer engaged a law firm (Law Firm 1) which in turn hired an accounting firm (Accounting Firm 1) for, as the accountant subsequently testified, the sole purpose of preparing tax returns. Law Firm 1 and Accounting Firm 1 then provided returns for those years to the IRS. (The case does not say whether they were delinquent original or amended returns.) The investigation then apparently turned into a civil audit, with the taxpayer then apparently avoiding criminal prosecution for those tax sins.
In 1996, a grand jury investigation was commenced. The initial scope of the grand jury investigation was to consider allegations that the taxpayer had failed to file returns after the IRS had concluded its earlier audit. (Although not stated, this would presumably include returns for 1994 which were not due at the time the earlier matter was resolved.) The taxpayer then engaged Law Firm 2 to represent him with respect to the grand jury investigation. Law Firm 2 then engaged a separate accounting firm (Accounting Firm 2) for, so that accountant testified, the sole purpose of preparing tax returns. Accounting Firm 2 thereafter presumably prepared and the taxpayer filed the then delinquent returns.
In 1998, the grand jury subpoenaed the records of both accounting firms. The accounting firms produced most of the documents but withheld certain documents. The Government then filed a motion to compel the production of the withheld documents on the grounds that accountants work for return preparation was and could not be within the attorney-client privilege. The district court ordered the documents produced for in camera inspection (meaning that the court reviewed them outside the presence of the Government) and then ordered most of the documents disclosed in their entirety, some disclosed in part (through a redaction process), and the balance not disclosed at all. The court did not, however, explain the basis for disclosing and withholding information or documents. The taxpayer continued to withhold certain document that the court ordered disclosed and appealed. The Government then appealed the portion of the district court's order withholding documents from disclosure.
The Court of Appeals stated the parameters in the part I quoted above, and then stated that the taxpayer asserting the privilege bears the burden of demonstrating all of the elements of the privilege. The Court then stated that the issue of whether the documents or any portion of them are privileged is a fact specific inquiry that can only be resolved by reviewing the documents in context, which may include taking testimony as to the specific documents and information. From this and an earlier citation to Kovel, I infer that both accountants were operating under a formal or informal Kovel agreement (see The Accountants' Role -- and Risks -- in Koveling (May 2000)), because if the accountants' activity were not so infused with some relationship to the attorneys, there would have been no privilege that the accountants could assert. The accountants after all did assert the attorney-client privilege. On the other hand, both accountants testified that they were engaged "solely" to prepare the returns which suggests that they may not have been under a Kovel agreement with the law firms and which would mean that no information was privileged. In the proceedings below, the taxpayer contested the accountants' testimony that they were engaged "solely" for return preparation, thus suggesting that they were also engaged by the attorneys under some type of Kovel arrangement. The court thus assumed the taxpayer's version in recognizing that some documents may be privileged.
The Court of Appeals could not resolve the privilege matter because the district court had not explained its reasons for its conclusions as to which documents or portions of documents should and should not be disclosed to the Government pursuant to the grand jury subpoena. The Court accordingly remanded. In the course of its decision, however, the court did make some general comments that re worthy of analysis and I quote them:
[I]t sometimes may be apparent from the face of a document that it is not privileged because the document contains information that necessarily would have been submitted for the preparation of a tax return. * * * *. However, when the circumstances suggest that a document might be privileged, it is important that the district court consider the totality of those circumstances in making its determination as to whether the privilege must be recognized. For instance, a document that appears privileged may have lost that privilege through disclosure or transmittal to a third party. * * * *. Similarly, the purpose of a document may not be apparent on its face, and it may be necessary to rely on the testimony of those involved in the production and handling of a document to determine the purpose for which it was produced. * * * *. In short, in camera review, although important, often cannot determine definitively whether a document was transmitted in such a way as to destroy any privilege or was created for an unprivileged purpose.
Let's see if we can do some bracketing via the Socratic method (with some comment) in order to understand the nature of the problem. I will assume that, in each of these examples, the accountants have a Kovel relationship with an attorney and that the relationship includes, at least in part, the preparation of delinquent original returns or amended returns.
1. The taxpayer provides the accountants Forms W-2 and 1099. Is or can the Forms be a privileged communication? The forms themselves are not privileged. The information on the Forms is not a taxpayer communication; rather it is the communication of a third party relating certain aspects of its dealings with the taxpayer. (In addition, of course, the third party has already disclosed it to the IRS.) So this question is easy.
2. What about the taxpayer's communications in providing the Forms to the accountants? What if the taxpayer advises the accountants that he never received income reported on a Form 1099 and, based on the representation, the accountants do not report the income to the IRS? Is the taxpayer's communication regarding non-receipt of the income a privileged communication? If the accountants receive a summons or grand jury subpoena can they produce their files which, of course, would contain a copy of the Form 1099 the reported income from which was excluded from the return. Was the fact that the communication from the taxpayer about nonreceipt a communication intended for a disclosed return position – i.e., the return position was nonreceipt with no affirmative disclosure on the return? Further, if the taxpayer merely gives the form to the accountant a communication that the taxpayer received the Form and perhaps a communication that he or she received it timely, so that its omission from the original return was intentional? Is this privileged therefore?
3. Assume that the accountants are engaged to prepare amended returns. What about a taxpayer's communication that he or she had an interest or signatory authority over a foreign bank account and had reportable interest from that account, neither of which is disclosed on the original return. The accountants will, of course, have to make both disclosures on the amended return and that taxpayer's signing of the amended return establishes one key point – that the taxpayer omitted the items from the original return. But, what if, in making this communication, the taxpayer also states to the accountants the reason that he or she omitted both from the original return – that he or she didn't think that IRS would ever discover either. Is this a privileged communication? Let's slice and dice this one. Would it make any difference if the taxpayer had made that disclosure only to his attorney and the attorney then made the communication to the accountant that the items should be included on the return without making any disclosure of the reason that the taxpayer failed to include them on the original return? If, as I assume, the accountant is acting under a Kovel agreement, should it make any difference if the reason is stated to the attorney or the accountant? It probably should not make a difference, but obviously the better part of wisdom is to have the taxpayer communicate only with the attorney in making sensitive disclosures and letting the attorney then package only the information the accountant needs to know. This will, of course, limit some of the potential benefits from the Kovel arrangement because the attorney must be more involved in order to prevent the accountant from first hearing the sensitive information directly from the taxpayer and only then brings it to the attorney for vetting. But, depending upon circumstance, context and, of course, budget, this should be considered.
There are many variations on this theme that the foregoing questions should suggest. As the Court noted in In re Grand Jury, it is all context driven and the taxpayer bears the burden of establishing context. This should caution all parties involved to cross t's and dot i's to protect the privilege.
IRS Appeals Division Redesigned
By Larry Jones
As part of the Internal Revenue Service reorganization, the redesigned Appeals Division began work this week. The new Appeals will strive for enhanced customer service through faster case resolution and a variety of initiatives designed to accommodate taxpayer needs.
Appeals has reorganized its staffing into a headquarters and three operating units that align with the larger IRS operating divisions. Appeals Headquarters will address Appeals' strategic needs while the operating units will focus on providing service to different segments of taxpayers. The Appeals operating units are:
Appeals Large and Mid-Size Business (LMSB) Operating Unit
Appeals Small Business/Self-Employed (SBSE)
Appeals Tax Exempt and Government Entities (TEGE) Unit
Appeals Wage and Investment (W&I) Unit (which will not be operational until fiscal year 2002, and which will handle cases coming from IRS service centers)Appeals has revamped its processes and is creating new services for taxpayers. These include the following:
The Mutually Accelerated Appeals Process (MAAP) initiative is designed to reduce the time it takes to resolve Coordinated Examination Program (CEP) cases in Appeals. The IRS says this initiative will improve the efficiency of the Appeals large case program and result in increased customer satisfaction for the large case population that Appeals serves.
Fast Track Mediation (FTM) is a streamlined process designed to expedite disputes involving audits, offers in compromise and trust fund recovery penalties. In this process, Appeals officers will serve as mediators to resolve disputes while cases are still in Compliance. The FTM pilot began on July 1, 2000, in four sites: Denver, Hartford, Houston, and Jacksonville.
Arbitration is a new alternative dispute resolution initiative designed to assist taxpayers and Appeals in reaching a settlement when they were unable to in the normal course of the Appeals process. This program uses a neutral decision-maker who will reach a binding decision on issues that prevented the taxpayer and Appeals from reaching a settlement.
Mediation is an alternative dispute resolution initiative designed to assist taxpayers and Appeals in reaching a settlement. A non-IRS or Appeals mediator is used to facilitate negotiations between Appeals and taxpayers when they were unable to reach a settlement in the normal course of the Appeals process.
Early Referral Procedures allow all taxpayers, whose returns are being examined, to request the transfer of a developed but unagreed issue to Appeals, while Examination continues to develop other issues in the case. The purpose is to resolve cases more expeditiously.Tax Court Denies Jurisdiction in Penalty Case
By Larry Jones
In Estate of Forgey v. Commissioner, 115 T.C. No. 11 (8/16/00), an estate tax return was delinquently filed on behalf of the decedent's estate. The IRS assessed the tax reported on the estate tax return and a late filing penalty. Upon examination of the return, the IRS determined a deficiency and an additional late filing penalty relating to the deficiency. The estate and the IRS settled the issues relating to the estate tax liability. As part of the settlement, the estate agreed to various increases to the taxable estate. However, due to the allocation of a deduction for interest expense, the settlement produced an overpayment.
The estate disputed the late filing penalty assessed by the IRS prior to the issuance of the notice of deficiency. The tax imposed upon the estate did not exceed the amount shown on the estate tax return. Thus, there was no deficiency in tax as defined by Section 6211 of the Internal Revenue Code, and therefore, the Tax Court did not have jurisdiction over this case.
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