ATTORNEY-CLIENT PRIVILEGE ISSUES FOR
ESTATE PLANNING ATTORNEYS IN TAX LITIGATION
Copyright © 2007 by Bessemer Trust Company, N.A. All rights reserved.
A recent case addressed the attorney-client privilege in a summons case involving an estate and gift tax audit about the formation of and transfers of interests in an FLP. U.S. v. Landon, 98 AFTR 2d 2006-7518 (N.D. Calif. Oct. 30, 2006).
Dale Landon and his wife transferred the bulk of his parents’ assets from their revocable trust to a family limited partnership, and made gifts of units of the partnership in highly discounted chunks to Dale and his brother. The interests were transferred without being subject to gift or estate tax. Following the father’s death, the IRS initiated a gift and estate tax audit. The IRS issued a summons to Dale and to the attorney, John Thornton, to answer questions regarding the FLP and subpoenaed associated documents. The stated motivation for the summons was to determine if the decedent’s estate qualifies for the "bona fide sale" exception to §2036. Mr. Thornton and Mr. Landon were interviewed but asserted the attorney-client privilege with respect to many of the questions and requests for documents.
The court’s rulings as to what is privileged can be categorized into three major categories:
(1) Disclose Legal Advice or Nature of Services. Written or oral communications that disclose legal advice or disclose the specific nature of services provided are covered by the attorney-client privilege. Examples of this are requests to disclose a letter faxed from the attorney concerning the formation of the FLP, requests for correspondence from or to the attorney regarding the formation of the FLP, and requesting how many meetings were held with the attorney to form the LP. Those questions are intended to confirm the specific subject matter of the attorney's representation.
(2) Might Implicate Confidential Communication. Questions that might implicate the confidential communication between attorney and client are also privileged. Examples of these types of questions are "How did the idea of forming the LP come about?"
"Who has personal knowledge of your reasons and motivations for the formation and use of the LP?"
"Did you see any calculations or projections of the tax benefits to be achieved by forming the LP?"
Answers to each of these questions may be that the idea, knowledge, or calculations came from confidential consultation with the attorney. The attorney-client privilege would cover such a response because the information would identify the specific nature of services provided by the attorney. However, each of these questions could be refined to ask if the idea arose prior to or independent of consultation with an attorney, if the persons other than the attorney had personal knowledge, or if he received calculations or projections outside his confidential attorney-client relationship. (The effect would be to solicit the information desired by the IRS -- if the individual had not received that information from others, it would be readily apparent that the information came from the attorney.)
(3) Information in Billing Records Regarding Nature of Services. Billing records and invoices are not privileged, but Mr. Landon “may redact any privileged information which speaks to the specific nature or substance of the services provided or reveals client motives or litigation strategy.”
Requests that were not privileged include (many others were also listed; this is just a sampling):
Questions regarding the formation or operation of the partnership that were independent of attorney-client communications.
How the client met the attorney.
Who made the decision to form the LP.
Whether the parents were aware of the LP.
The extent to which other persons (other than the attorney) were involved in the decision to form and use the LP.
Who were present at meetings with the attorney.
Who was present at each meeting about the LP.
Whether the individual took any notes at meetings to form the LP.
Whether the decedent attended or asked any questions at the meetings about forming the LP.
Whether terms of the LP agreement were negotiated among the partners.
Whether the parents were financially dependent on the LP distributions.
The court concluded that none of those questions (or other similar questions) implicate correspondence or other communications with the attorney.
a. Important Roadmap. The Landon case is an important roadmap to the estate planning attorney about the scope of the attorney-client privilege. Not all dealings with a client are privileged.
b. Fact of Representation and Presence at Meetings Discoverable. The fact that there was legal representation can be discovered. The fact that the attorney was present at a particular meeting is fair game. (For example, one estate planning attorney reported that in a current case, he excluded his notes regarding client meetings in the production of documents to the IRS. A litigation lawyer in his firm reviewed the facts and said that the attorney must disclose the date of the meeting and who was present at meeting, but can redact everything else.)
c. Engagement Letter. The engagement letter is discoverable, but the specific nature of the legal services can be redacted.
d. Billing Records. Billing records are discoverable, but anything related to the subject matter of the advice or nature of the representation can be redacted. (This should comfort estate planning attorneys regarding the preparation of billing records.)
e. Nature or Substance of Legal Advice. Anything related to or that even possibly implicates the nature or substance of legal advice is protected.
f. IRS Can Rephrase. Often the IRS can rephrase the question to extract the desired information. The court told the IRS how to rephrase questions to avoid implicating the privilege.
g Waiver of Privilege. The IRS did not allege in Landon that the attorney-client privilege had been waived. The privilege can inadvertently be waived by sending copies to third parties, including the accountant. The attorney will want to cooperate with other planners involved, but do not waive the attorney-client privilege. The attorney must spend a lot of time with clients going over the ramifications of waiving the privilege and what waives it.
In Landon, the court permitted questions that inquired about facts that may have occurred that would have waived the privilege—not the nature of the communications, but WERE there communications? The court appears to bend over backwards to force a response as to whether the taxpayer has waived the privilege.
h. Strategic Decision. John Porter often points out in tax litigation planning seminars that the attorney should assume that everything in his or her file will be discovered during the planning process. Even if the privilege is claimed, as a practical matter, litigation in the Tax Court will result in the same judge who is deciding the substantive issue also being the judge who decides the privilege issues. (In the Schutt case, the attorneys agonized over whether to waive the privilege and produce attorney-client communications. They ultimately decided to do so, and those communications were very helpful to the court in determining that there were “legitimate and significant non-tax reasons” for forming the business trusts involved in that case.)
i. Burden of Proof and Penalties. In Kohler, T.C. Memo 2006-152, the IRS tried (unsuccessfully) to shift the burden of proof to the taxpayer because the taxpayer asserted the attorney-client privilege. Attorneys report anecdotally that the IRS has asserted penalties in audits where the attorney-client privilege was claimed.
j. Business Advice vs. Legal Advice. Some attorneys report that the IRS has argued in some cases that certain advice by counsel is business advice rather than legal advice, and saying that business advice communication is not privileged. Ex.—Discussing the protection from creditors that an FLP may or may not afford. Landon seems favorable to upholding the privilege against that kind of attack. If a communication relates to anything in the nature of legal representation, it is privileged.
k. Communications Prior to Attorney-Client Relationship. Any communications prior to attorney-client relationship are not privileged. So any proposals or writings that predated the engagement of the attorney would appear to be discoverable.