GPSolo Magazine - September 2004
Privilege and the Work Product Doctrine in Tax Cases
Tax practitioners are becoming increasingly conscious of the importance of raising privilege and work product doctrine claims when the Service seeks information about taxpayers’ transactions pursuant to a summons or in the course of discovery.
In tax cases, privilege is governed by federal law. According to Wigmore’s definition of the attorney-client privilege, “when legal advice is sought, from a professional legal adviser in that capacity, the communications relating to that purpose, made in confidence, by the client, are at his instance permanently protected, from the disclosure by himself or by the legal adviser, except the protection be waived.” The attorney-client privilege exists for the purpose of encouraging full and truthful communication between an attorney and his client and “recognizes that sound legal advice or advocacy serves public ends and that such advice or advocacy depends upon the lawyer’s being fully informed by the client.” An attorney’s advice to a client is privileged only to the extent that the disclosure of that advice would disclose the client’s confidential communications. The privilege does not extend to communications between a taxpayer and an attorney relating to the preparation of a tax return.
If information is communicated to an attorney by someone other than the client or his agent, it is not generally privileged. However, under the Kovel doctrine, a client’s communications to a third party, e.g., accountant, investment banker, etc., hired by the attorney, are privileged if the third party is necessary to interpret or translate the information for the attorney to enable the attorney to provide legal advice.
If the communications are disclosed to a third party, the privilege generally has been waived. In tax cases involving the assertion of penalties, raising reliance on the advice of an attorney as a defense to penalties results in a waiver of the attorney-client privilege. In some instances a waiver may be limited. In Long-Term Capital Holdings v. United States, the taxpayer obtained a tax opinion from King & Spalding relating to certain aspects of a transaction. Without specifically disclosing the opinion letter itself, the taxpayer revealed to its tax accountant that it had a “more likely than not” opinion with respect to the allowability of a deduction as a result of the transaction. The disclosure of the existence of the opinion, and that it was a “more likely than not” opinion with respect to allowance of deduction, disclosed the gist of opinion, and such disclosure was a waiver of those portions of the opinion letter reflecting the matter actually disclosed, but not of the entire subject matter.
There is no accountant-client privilege under federal common law. This rule has been modified by section 7525, which creates a limited privilege for non-attorney tax practitioners by extending the common law attorney-client privilege to “tax advice” for taxpayer communications with a “federally authorized tax practitioner.” The section 7525 privilege does not apply, however, to tax advice regarding “corporate tax shelter.” The section 7525 privilege may be asserted only in noncriminal tax matters before the Service and in noncriminal tax proceedings “brought by or against the United States” in federal court.
The identity of a client and the fact that a given individual has become a client are matters that an attorney normally may not refuse to disclose. In a few instances, however, a client’s identity may be privileged. In Baird v. Koerner, the Ninth Circuit allowed the privilege to be claimed where the client’s identity might have been “the link that could form the chain of testimony necessary to convict an individual of a federal crime.” Client identity also was protected by the Seventh Circuit in Tillotson v. Boughner, on the grounds that the government already knew so much about the transaction that revealing the client’s identity would be tantamount to revealing the client’s privileged communication to the attorney.
Client identity privilege has been asserted in several recent high-profile cases involving tax shelters, but these claims have not been sustained. The most notable of these cases is United States v. BDO Seidman, in which the Seventh Circuit affirmed a district court’s determination that tax shelter investors failed to establish that a confidential communication would be disclosed if their identities were revealed. Disclosure of their identities would disclose to the Service only that they had participated in one of the tax shelters described in the summonses, but no confidential communication could be inferred from that information alone. The court distinguished Tillotson and similar cases as situations in which “the Government already knew much about the substance of the communications between the attorney and his unidentified client,” from the BDO Seidman case, where “the IRS knows relatively little about the interactions between BDO and the investors, the nature of their relationship, or the substance of their conversations.” In a sweeping conclusion, the court held that the tax shelter disclosure rules of section 6112 virtually preclude assertions of identity privilege by tax shelter investors.
Client identity privilege claims also were rejected in Doe #1 v. Wachovia Corporation. The Service served an administrative summons on Wachovia, which had marketed the tax shelter investments, seeking investor lists, documents, and other information relating to potentially abusive tax shelters pursuant to the regulations under section 6112. Investors intervened, arguing that disclosure of their names would disclose privileged information provided by them to the accounting/consulting firm KPMG (section 7525 privilege) and to the law firm Jenkens & Gilchrist (J&G) (attorney- client privilege), both of which had participated in designing the transactions or had provided opinions regarding the transactions.
The court found no attorney-client relationship between the investors and J&G. There was no evidence that any investor “ever had so much as a conversation with an attorney at J&G,” there was nothing uniquely tied to the individual investors’ financial situations, and the package contained no confidential information.
In addition, the section 7525 privilege did not apply with respect to KPMG. First, the privilege only applies in cases by or against the government and before the Service, and Wachovia involved a suit by investors seeking an injunction against Wachovia, not a proceeding by or against the United States. Second, section 7525 provides that the privilege does not apply “to any written communication between a federally authorized tax practitioner and a director, shareholder, officer, or employee, agent, or representative of a corporation in connection with the promotion of the director in indirect participation of such corporation in any tax shelter,” which the court found precisely described the circumstances of the case—KPMG’s communications were with Wachovia, a corporation. Finally, KPMG’s advice was in the context of tax return preparation, which is not privileged.
The increasing number of instances in which attorney-client privilege and the section 7525 privilege have been asserted when the Service has sought to obtain communications from tax advisors to their clients and other related documents emphasizes the importance of understanding the scope of these doctrines not only at the controversy stage, but also at the planning stage, when these documents are being created. Both practitioners and their clients need to be aware of the extent to which potential communications are privileged.
Martin J. McMahon Jr. is the Clarence J. TeSelle Professor of Law at the University of Florida College of Law. He can be reached at email@example.com.
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- This article is an abridged and edited version of one that originally appeared on page 11 of News Quarterly, Winter 2004 (23:2).
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Effectively Representing Your Client Before the “New” IRS: A Practical Manual for the Tax Practitioner with Sample Correspondence and Forms; Sales and Use Tax Deskbook ; The State and Local Tax Lawyer; Property Tax Deskbook; A Comprehensive Analysis of Current Consumption Tax Proposals; State and Local Taxation of Banks and Other Financial Institutions; Value Added Tax: A Model Statute and Commentary.