The Tax Practitioner-Client Privilege: What You Say May Hurt You

 by David M. Roth

Fall 1999

As part of the Internal Revenue Service Restructuring and Reform Act of 1998, Congress added Internal Revenue Code (IRC) §7525, "Confidential Privileges Relating to Taxpayer Communications," which provides as follows:

"(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 IRS; and

(B) any noncriminal tax proceeding in Federal court brought by or against the United States ." (emphasis added)

This provision became effective July 22, 1998. While this new law is intended to extend a confidentiality privilege to certain communications between a taxpayer and his or her non-attorney tax advisors (including CPA's, enrolled agents and enrolled actuaries), a variety of limitations apply.

The privilege covers the giving of "tax advice." "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" with respect to matters under the Internal Revenue Code. Whether a particular communication meets this definition is subject to interpretation, and may be challenged by the IRS. Arguably, conversations regarding general business advice, investment advice, etc. are not protected. Giving "tax advice" regarding matters under a state tax system is also unprotected, unless the state has a parallel privilege. To date, only 17 state have an accountant/client privilege.

The privilege is based on the attorney/client privilege, and as a result, only applies to the extent that the communication would be privileged if it were between a taxpayer and an attorney. Generally, information disclosed to an attorney for the purpose of preparing and filing a tax return is not protected by the attorney/client privilege. Accordingly, this type of information would not be privileged under §7525 if disclosed to a CPA, enrolled agent or enrolled actuary.

Questions regarding circumstances in which a taxpayer may waive the privilege are also likely to arise. For example, a conversation held in the presence of a nonprivileged person may not be confidential and may not be protected. Also, disclosure to other governmental agencies, such as the SEC, the Small Business Administration or state taxing authorities may waive the privilege with respect to the materials or communications disclosed.

Practitioners should note that the §7525 privilege belongs to the client. Thus, it is the client's decision whether or not the privilege should be waived. This is supported by a statement appearing on the IRS Internet home page, as follows:

"The statute grants a new privilege which does not arise automatically but must be asserted by the taxpayer. (IRS) Employees may still seek the same information in the same manner as before the statute. The only difference is that taxpayers may now assert, in noncriminal proceedings, a confidentiality privilege for communications made after the date of enactment to federally authorized tax practitioners concerning tax advice sought or received." ( emphasis added ).

In light of the above, tax practitioners and clients should carefully consider how communications are handled, as mishandling may effectively limit application of §7525.