It is imperative for accountants and their clients to understand that even though some states have statutory protection for certain communications between a client and her accountant, these statutory privileges are inapplicable to federal cases. There is a federally recognized privilege under IRC §7525 (Confidentiality Privileges Relating to Taxpayer Communications) that applies to communications between a taxpayer and a federally authorized practitioner. Although the privilege applies to communications that would be considered a privileged communication if made between the taxpayer and an attorney under common law, the privilege is limited in two ways. First, and most significantly, the privilege only applies to noncriminal tax matters (and then only before the IRS or in Federal court where the United States is a party). Second, communications regarding corporate tax shelters are not within the scope of the privilege.
This lack of direct privilege between a client and her accountant does not mean that communications between these parities cannot be privileged. If the matter communicated is incident to litigation (actual or potential), it may be proper for the accountant and client to communicate under the privilege of the client’s attorney. However, the accountant must be rendering services to the attorney (not the client) and conversations with the client must be held solely in furtherance of such assistance.
A brief history of the attorney-client privilege is useful in understanding the current state of the protection. The direct privilege between attorney and client originated under the Tudors in England and encompassed only the attorney personally and the client.
However, as the practice of law grew more complex, requiring additional individuals to be involved in handling information that was traditionally privileged between only the attorney and client, the privilege expanded. The initial expansion was to individuals acting in a ministerial or administrative capacity as part of the lawyer’s services and, generally, as part of the lawyer’s staff. Since these individuals were viewed as extensions of the attorney herself, they were included in the attorney’s privilege.
The extension of the privilege to these individuals was well recognized prior to the turn of the twentieth century. In 1961, the United States argued in the now famous Kovel case that attorneys and their administrative staff should enjoy the privilege but not other professionals brought in to assist the attorney in providing services to the client. However, the Second Circuit held that the privilege is not confined to ministerial employees but should cover an accountant (Louis Kovel) working for an attorney providing litigation-related services to a client.
Louis Kovel was an accountant and a former IRS agent. He was hired by a law firm to assist the firm with client matters. Kovel met with one of the firm’s clients who was under investigation at the time for tax fraud. After being subpoenaed by a grand jury in the case, Kovel refused to disclose information about the client and was sentenced to a year in prison for contempt. The contempt citation was reversed in the Second Circuit Court of Appeals due to the finding that accountants were among the group of professionals who could assist lawyers in providing legal services and, therefore, would fall under the lawyer’s privilege.
Now, it is commonplace for accountants to work at the request of an attorney in dealing with client matters where privilege is an important issue. This third party privilege is often integral to complete and competent representation. The importance of this application of the attorney-client privilege mandates that professionals know of and use current best practices in relying on this privilege.
As a threshold matter, it is important that the accountant is providing services either for an actual litigation or in anticipation of potential litigation. The fact that the underlying matter is one directly involving actual or potential litigation is important—it is not enough that the information provided be litigation-related if the underlying matter is something else, such as business or tax advice. In fact, some attorneys do not refer litigation-specific matters to the client’s regular accountant for fear of jeopardizing the privilege. However, this approach may be extreme if the attorney has objective evidence documenting that the accountant is providing litigation-specific services to the attorney for the attorney’s use in servicing her client. If the accountant is the client’s regular accountant, however, it is best to ensure that the accountant is not providing other, non-litigation services to the client while working under a Kovel relationship with the attorney.
In furtherance of the process of documenting this type of objective evidence, whether the accountant used is the client’s usual service provider or one brought in specifically for litigation services, the role of each of the parties should be specified as early as possible in a writing between the accountant and attorney. For instance, if during the course of representing a client the attorney determines she needs to bring in an accountant for professional services related to actual or potential litigation, the attorney should make clear that the accountant is being hired by the attorney and not the client. The attorney can set out the details of the attorney-accountant relationship in a letter (referred to as a Kovel letter) or, more effectively, in an engagement letter that sets forth the business responsibilities and obligations of each of the attorney and accountant. As part of this relationship, the attorney should specify that all materials generated by the accountant should not only be delivered to the attorney, but are, in fact, property of the attorney. Additionally, the accountant should be instructed to bill the attorney only even if the accountant’s bill is a line item expense that will be forwarded directly to the client. Finally, the accountant should accept and agree to this relationship in an objectively determinable way (such as signing the engagement letter agreeing to assist the attorney).
The basic principles discussed above all apply when a business entity is the client. However, business entities present a special set of considerations when determining how the attorney-client privilege will apply to communications made to an accountant acting at the request of an attorney. Business entities have the ability to assert the attorney-client privilege in much the same way that an individual does. However, because business entities act through their agents, it may be more difficult to assert the privilege based on communications with an accountant that was hired by in-house counsel. Therefore, it may be of benefit for corporations to consult outside counsel to determine if an accountant should be brought in to provide support for actual or anticipated litigation.
