Ethics and privilege play key roles in tax, and technology can be a factor to consider, too. To wade into this quagmire, Tax Executive’s senior editor, Michael Levin-Epstein, sat down (virtually) with a recognized expert in the field, Dan Ermel, a partner at RSM US LLP.
Michael Levin-Epstein: Is there a difference in privilege between attorneys and CPAs?
Dan Ermel: Yes, there is a difference, and it’s a very important distinction to consider. The attorney-client privilege applies to confidential communication between a client and legal counsel for purposes of obtaining legal advice. A key emphasis here is related to the term “legal advice.” On the other side, you have Internal Revenue Code Section 7525 that creates a limited tax practitioner privilege that protects certain communication between taxpayers and their CPAs. A side note, I’m using the term “CPA” here in a broad context. Section 7525 applies to any federally authorized tax practitioner that can practice before the Internal Revenue Service. So, it’s important to note that with respect to Internal Revenue Code Section 7525 that privilege is very limited. It applies only to federal tax advice, so if a taxpayer or in-house tax professionals are working with a CPA firm to prepare annual income tax returns, this would generally not be considered tax advice, and there would be no privilege extended to income tax compliance services. Additionally, the privilege under Section 7525 would not apply if the issue at hand was a criminal tax matter or in connection with a tax shelter. So, yes, you can see there’s a significant difference that taxpayers and tax professionals need to consider should privilege be a concern in various communications or interactions with their attorneys versus their CPAs.
Levin-Epstein: What are common issues or considerations related to privilege when working with public accounting firms?
Ermel: I think first and foremost there should be an expectation that there generally is no privilege with tax return preparers. As I mentioned above, Section 7525 only applies to federal tax advice, not tax return preparation. Second, should privilege be a priority related to a certain issue or transaction, there is an opportunity to have the work with a CPA be privileged under what is referred to as a “Kovel arrangement.” A Kovel arrangement occurs when the taxpayer engages an attorney, and then the attorney separately engages a third party to provide tax services to assist the attorney in providing services to the taxpayer. So, the purpose of these Kovel arrangements is to preserve the taxpayer’s claims of attorney-client privilege.
Levin-Epstein: How widespread are these Kovel arrangements?
Ermel: In my experience, they’re fairly limited. In the public accounting setting, it’s not something that is an everyday situation. But they do come up. I would say that they also tend to come up in certain niche areas or with certain niche practices. But in the public accounting setting, many tax professionals may never even see one, depending on what kind of services they provide. But they do tend to pop up every once in a while with the larger firms.
Levin-Epstein: Are there certain issues or limitations related to Kovel arrangements with public accounting firms?
Ermel: It’s important to note that just because a Kovel arrangement is in place doesn’t necessarily mean that the privilege is guaranteed or there won’t be any related issues. There are still important factors to consider, one of which is communications. For CPA firms, remember, under a Kovel arrangement the CPA’s client is the attorney, not the taxpayer. So, all communications between the CPA and the taxpayer—whether it be phone calls or emails—should include the attorney in order to best preserve the privilege. Another factor to consider is if the CPA firm also happens to have an assurance relationship with the taxpayer. In this case, the Kovel arrangement could result in an independence issue. So, if the taxpayer engages the same firm to audit their financial statements and prepare their income tax returns, based on the facts and circumstances of the taxpayer, it may be necessary to consider [engaging] a different CPA firm under the Kovel arrangement. Another limitation related to Kovel arrangements is if the CPA previously prepared the tax returns for the taxpayer. If this is the case, I would consider the expectation of getting Kovel coverage to be questionable due to the inapplicability of any privilege for past tax return preparation. The return preparer could be in a position where they’re compelled to provide testimony regarding the preparation of prior-year returns. So, having a separate CPA engaged under the Kovel arrangement—a CPA that does not have previous knowledge of the taxpayer—is generally a good idea.
Levin-Epstein: Moving on to ethics, what are some ethical issues impacted by the technological advances that practitioners should be considering?
Ermel: I think the current technological advances and flexibility offered by many firms have resulted in tax professionals working in a partially or fully remote environment. And many tax professionals have enjoyed this flexibility and may look to work from various locations while traveling or visiting a family vacation home for an extended period. This could result in a couple of issues, right? The first one is the tax professional needs to consider if they’re now working in a state in which they’re not licensed. Another one would be if the tax professional may be working outside the United States, in which case there could be a significant issue under Internal Revenue Code Section 7216, which addresses the disclosure or use of tax return information. And finally, in today’s remote environment, there are virtual assistants, such as Alexa, Siri, etc. These devices collect sensitive information. So, to the extent confidential information is being discussed, tax professionals may want to consider disabling these devices or consider where they work compared to where these devices are located in their home. Really, to summarize, working in that traditional office environment naturally addressed these issues. Now, with the potential flexibility of working partially or fully remote, there are some new issues for tax professionals to consider.
Levin-Epstein: That’s a really good point. Any final words of advice for taxpayers or in-house tax professionals who are navigating issues where privilege is involved?
Ermel: For the sake of clarity I am not an attorney; I am merely trying to provide insight from a public accounting standpoint. Having said that, if the issue at hand is a criminal issue, or the taxpayer or tax professional isn’t sure, it’s very important that they speak to their attorney or in-house counsel first. Ask what limitations should be considered before taking next steps or having additional discussions with their CPA firm—or any other third party, for that matter. When it comes to privilege, I prefer a belt-and-suspenders approach, and if a taxpayer or in-house tax professional has concerns about privilege, I suggest they consult with their attorney and let the attorney take the lead as to next steps and various communications. They really want to be in a position where any action is at the direction of the attorney.