The Internal Revenue Service (IRS) has broad statutory authority to investigate and audit taxpayers. Often, the IRS attempts to fulfill this statutory authority by seeking communications made between taxpayers and third parties, such as tax return preparers and certified public accountants (CPAs). The IRS is typically authorized to obtain these communications.
Taxpayers undergoing scrutiny by the IRS face numerous challenges, particularly when it comes to safeguarding sensitive financial and legal information. Understanding the differences between attorney-client privilege and accountant-client privilege is not just a key to protection, but also a source of empowerment, providing taxpayers with crucial knowledge and a sense of control over their situation.
While conversations with an attorney are generally shielded from disclosure to authorities under attorney-client privilege, communications between taxpayers and their accountants are not afforded the same protections.
However, this limitation can be effectively overcome through the use of a Kovel agreement. This unique mechanism extends attorney-client privilege to communications with accountants when an attorney employs them to assist in providing legal advice, offering much-needed relief to taxpayers facing IRS scrutiny and providing them with a profound sense of reassurance in a challenging situation.
What is a Kovel Accountant?
Simply put, a "Kovel accountant" is an accountant or CPA whom an attorney uniquely hires to provide legal advice to a client, particularly in matters related to taxes. This distinct role is what sets them apart and allows for the extension of attorney-client privilege to their communications.
The Kovel accountant's primary function is to assist the attorney in understanding complex financial and tax matters, thereby enabling the attorney to provide comprehensive legal advice to the client.
By engaging a Kovel accountant, the attorney can ensure that the client's communications with the accountant are also protected by the attorney-client privilege, which can be crucial in certain tax investigations or legal proceedings.
This arrangement, established in the case United States v. Kovel, extends the attorney-client privilege to communications between the taxpayer, the attorney, and the Kovel accountant. The privilege protects these communications from disclosure, even to the Internal Revenue Service (IRS).
What is a Kovel Agreement?
A "Kovel agreement" is a crucial legal tool. It extends the attorney-client privilege to communications involving third-party professionals, like accountants, when they are assisting an attorney in providing legal advice. This extension is crucial in protecting sensitive communications from disclosure, providing taxpayers with a sense of security in their dealings with the IRS.
The purpose of this arrangement is to ensure that communications between the taxpayer, attorney, and the accountant are protected from disclosure, similar to communications between the taxpayer and the attorney. This protection under a Kovel agreement provides a profound sense of security to taxpayers, making them feel more secure and protected.
Kovel agreements are typically used in situations where a taxpayer is facing tax controversies or investigations, and the taxpayer needs both legal and accounting expertise to navigate these complex matters. In tax matters, accountants often possess specialized knowledge that enables them to understand their clients' situations better and provide effective legal advice to attorneys.
When done properly, federal courts have recognized that communications amongst these parties are not subject to disclosure under the theory that the attorney-client privilege protects such communications.
Attorney vs. Accountant-Client Privilege
Attorney-client privilege is one of the most established protections available under U.S. law. It ensures that any communication between a client and their attorney, made in confidence for the purpose of seeking legal advice, cannot be disclosed in legal proceedings. This privilege encourages clients to be transparent with their attorneys, enabling them to understand their situation and receive appropriate representation.
However, conversations with accountants generally do not enjoy the same protection. Historically, federal courts have not recognized a common law privilege for accountant-client communications.
Although Congress introduced a statutory accountant-client privilege under Section 7525 of the Internal Revenue Code in 1998, it's important to note its limitations. This privilege only applies to non-criminal tax matters. It does not extend to criminal cases, state-level proceedings, or other federal cases in which the government is not a party to the proceedings.
It's essential to have a written engagement letter between the attorney, the client, and the accountant, outlining the scope of the Kovel agreement and the accountant's role.
The Kovel privilege generally applies when the attorney hires the accountant to assist in providing legal advice, not just for general accounting or tax preparation services. However, there are exceptions to the attorney-client privilege, including the "crime-fraud" exception.
This exception could potentially waive the privilege if the attorney or the client is involved in fraudulent activities. In such cases, the privileged communications could be disclosed to the authorities. If the client discloses privileged information to the government (e.g., by filing amended returns), it could potentially waive the privilege for related information.
What Does Federal Law Say?
Title 26 U.S. Code 7525 - Confidentiality privileges relating to taxpayer communications says -
(a) Uniform application to taxpayer communications with federally authorized practitioners.
(1) General rule
With respect to tax advice, the same common law protections of confidentiality which apply to a communication between a taxpayer and an attorney shall also apply to a communication between a taxpayer and any federally authorized tax practitioner to the extent the communication would be considered a privileged communication if it were between a taxpayer and an attorney.
(2) Limitations
Paragraph (1) may only be asserted in
(A) any noncriminal tax matter before the Internal Revenue Service; and
(B) any noncriminal tax proceeding in Federal court brought by or against the United States.
(3) Definitions
For purposes of this subsection-
(A) Federally authorized tax practitioner
The term "federally authorized tax practitioner" means any individual who is authorized under Federal law to practice before the Internal Revenue Service if such practice is subject to Federal regulation under section 330 of title 31, United States Code.
(B) Tax advice
The term "tax advice" means advice given by an individual with respect to a matter which is within the scope of the individual's authority to practice described in subparagraph (A).
(b) Section not to apply to communications regarding tax shelters
The privilege under subsection (a) shall not apply to any written communication which is-
(1) between a federally authorized tax practitioner and-
(A) any person,
(B) any director, officer, employee, agent, or representative of the person, or
(C) any other person holding a capital or profits interest in the person, and
(2) in connection with the promotion of the direct or indirect participation of the person in any tax shelter (as defined in section 6662(d)(2)(C)(ii))."
United States v. Kovel (1961)
Named after a landmark ruling in U.S. v. Kovel (1961), a "Kovel agreement" introduced a pathway to shield certain taxpayer-accountant communications from disclosure. This agreement allows the attorney to hire an accountant to assist in providing legal advice to the client.
By doing so, the accountant effectively functions as an extension of the attorney, enabling their communications with the taxpayer to be protected under attorney-client privilege.
The logic behind this arrangement rests on the principle that legal advice often requires specialized input from other professionals. For instance, in tax controversies, attorneys may need accountants to interpret complex financial data or prepare reports that are critical to building a legal case.
By structuring the relationship through a Kovel agreement, courts recognize that the accountant's work directly supports the attorney's legal services, thus qualifying for privilege.
With respect to tax advice, the same common law protections of confidentiality that apply to a communication between a taxpayer and an attorney shall also apply to a communication between a taxpayer and any federally authorized tax practitioner to the extent the communication would be considered a privileged communication if it were between a taxpayer and an attorney.
Requirements for a Kovel Agreement
To ensure that communications with a Kovel accountant are protected, specific stipulations must be met. Courts scrutinize Kovel agreements and substance matters. Here are the necessary elements for a valid Kovel arrangement:
- Engagement by the Attorney: The accountant must be formally hired by the attorney, not directly by the taxpayer. The attorney retains control of the relationship and supervises the accountant's work to ensure it is integrated into the legal representation.
- Scope of Work: The accountant's work must directly relate to the attorney's provision of legal advice rather than independent accounting functions. For example, helping an attorney understand financial records to address a legal issue falls under this scope, but preparing a routine tax return does not.
- Clear Agreements: The engagement agreement should clearly identify the attorney, not the taxpayer, as the client. The payment structure should also reflect this relationship, with invoices issued to the law firm rather than directly to the taxpayer.
- Confidentiality: All communications involving the accountant, attorney, and taxpayer must be made confidently and for the purpose of obtaining legal advice. Any interaction outside this context could jeopardize the privilege.
When to Consider a Kovel Agreement
While Kovel agreements are not always necessary in civil tax cases, they can be crucial when a taxpayer is under criminal investigation or when sensitive information could expose them to legal liability. Without a Kovel arrangement, communications with an accountant could be subject to disclosure during audits, depositions, or court proceedings, putting the taxpayer at risk.
For example, if an accountant uncovers a potential tax irregularity while representing a client, the absence of a Kovel agreement may require them to disclose this information if subpoenaed. On the other hand, with a Kovel agreement in place, the accountant's findings would likely be protected under attorney-client privilege, shielding the taxpayer from unnecessary exposure.
Protecting Legal Rights
Taxpayers navigating IRS scrutiny must take deliberate steps to protect their communications and safeguard their legal rights. While accountant-client privilege is limited in scope, a Kovel agreement offers a powerful tool to extend the robust protections of attorney-client privilege to an accountant's work when it supports legal advice.
Suppose you're facing tax issues or believe criminal charges may arise. In that case, a skilled federal criminal defense attorney can help you determine whether procuring a Kovel accountant is a good step for you.
In many civil cases, Kovel agreements may not be a suitable option. However, as shown above, Kovel agreements do have their place in effective tax defense, particularly in cases where there is an ongoing or potential criminal investigation against the taxpayer.
In these cases, the taxpayer should ensure that a Kovel agreement has been entered into before making any potentially harmful communications to an accountant or certified public accountant (CPA). Accountants and CPAs should also refrain from representing clients in cases involving criminal tax matters unless a Kovel agreement has been entered into.
For more information, contact our federal criminal defense attorneys, Eisner Gorin LLP, located in Los Angeles, California.
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