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October 29, 2015 Points to Remember

‘Just Add SaLT!’ When and How to Consider State Tax Ethical Issues in Advising Clients

By Professor Michael B. Lang, Chapman University Dale E. Fowler School of Law, Orange, CA, and Rachel L. Partain, Caplin & Drysdale, Chartered, New York, NY

This material was initially presented as part of a panel discussion of the State and Local Taxes Committee co-sponsored by the Standards of Tax Practice Committee at the ABA Section of Taxation's May Meeting held in Washington, DC on May 8, 2015.  The authors were panelists, as was Marilyn Wethekam, Horwood Marcus & Berk Chartered, Chicago, IL; the moderator was Phillip Pillar, Grant Thornton LLP, Philadelphia, PA.

Lawyers who practice in the state and local tax (SaLT) area have unique ethical concerns given that their clients' legal matters often involve multiple jurisdictions.  This article discusses several ethical rules particularly relevant to SaLT lawyers.  It is vital that lawyers consider these issues when commencing an engagement and throughout the representation: a violation of an ethical obligation could jeopardize a lawyer's ability to collect fees for services and potentially result in a malpractice or disciplinary action.

SaLT Representations Involving Multiple Jurisdictions: Ethical Implications of the Attorney-Client Relationship

A SaLT lawyer is often engaged to provide advice to clients about the tax laws of several states, including states other than the lawyer's state of licensure.  This practice raises at least three important ethical concerns: (1) unauthorized practice of law, (2) competence, and (3) communication with the client.

In general, a lawyer may not practice law in a state in which she is not admitted to practice.1   Model Rule 5.5(a) also makes it a violation of a state's rules of licensure to practice law in another state in violation of the other state's rules (or to assist someone else in doing so).2   As a result, a lawyer who practices law in a state other than her state of licensure without being admitted may be subject to discipline by either jurisdiction.3

What is meant by practice of law "in a state" may vary from jurisdiction to jurisdiction.4   However, since state Bars perceive themselves as protecting their own citizens, practice of law in a state is most likely to arise when a lawyer (1) represents citizens or businesses of the state in legal matters involving the application of the laws of the state, or (2) spends substantial time in the state dealing with in-state persons, courts, agencies or businesses on behalf of out-of-state clients.5   If a lawyer that is not licensed to practice in a state represents a client who resides or has its principal place of business outside of that state, and merely advises the client on the state's tax laws, the lawyer's activity is unlikely to be regarded as the practice of law in that state.  Thus, a SaLT lawyer licensed in Ohio should be able to provide advice to Ohio clients on the laws of other states without the risk of being charged with unauthorized practice of law.

In addition, it should be noted that in some states it may not be necessary to be a lawyer to represent someone before a state revenue agency.  Accordingly, an out-of-state SaLT lawyer appearing before a state revenue agency in such a state may not be engaged in unauthorized practice of law as such, although some activities related to the representation might be so characterized.  Similarly, in states in which representing a client in a mediation or arbitration is not regarded as the practice of law, a lawyer who does so outside his state of licensure may not be regarded as engaging in the unauthorized practice of law.6   Note that, in either circumstance, an out-of-state lawyer is prohibited from setting up an office or maintaining a continuous presence in those states.7

The general rule barring practice in a state in which a lawyer is not licensed is subject to a number of exceptions that permit an out-of-state lawyer to provide legal services in a state on a temporary basis.  Under the Model Rules,8 these exceptions include (1) providing services in association with a locally licensed lawyer who actively participates in the matter, (2) providing services in or reasonably related to a pending or potential proceeding before a tribunal if the lawyer or one assisting the lawyer is authorized by law or order to appear in such proceeding or reasonably expects to be so authorized, or (3) providing services in or reasonably related to a pending or potential arbitration, mediation, or other alternative dispute resolution proceeding if the services are reasonably related to the lawyer's practice in a state of licensure and are not services for which pro hac vice admission is required.9   These exceptions reflect the long-time practice in many jurisdictions.

Of greater controversy is Model Rule 5.5(c)(4), which excepts from the general rule the provision of services "arising out of or reasonably related to the lawyer's practice" in the lawyer's state of licensure.10   Comment 14 elaborates on this vague language, mentioning factors that may be relevant in applying the "reasonably related" standard, including whether (1) the lawyer previously represented the client, (2) the client is resident in or has substantial contacts with the jurisdiction of the lawyer's admission, (3) the matter has a significant connection to the jurisdiction of the lawyer's admission, (4) a significant aspect of the matter may involve the law of the jurisdiction of admission, and (5) multiple jurisdictions are involved.11   The Comment then adds that "the services may draw on the lawyer's recognized expertise developed through the regular practice of law on behalf of clients in matters involving a particular body of federal, nationally-uniform, foreign, or international law."  The "nationally-uniform" language probably provides some limitation on what subjects may fall within this section; however, given the general approach of Comment 14, that limitation is unlikely to be highly restrictive.

Thus, under Model Rule 5.5(c)(4), a SaLT lawyer who is a leading expert on the state taxation of the gambling industry may be permitted to provide services regarding the state tax laws applicable to the gambling industry, even if none of the relevant jurisdictions is one in which the lawyer is admitted to practice.  If the same out-of-state SaLT lawyer does this too often for clients in the same state, at some point she will cross the "temporary" line and be in violation of the state's rules, but it is not clear how this line is drawn.

It should be clear that a SaLT lawyer can do a great deal for out-of-state clients without implicating a violation of unauthorized practice of law provisions.  The other ethical concerns relating to a multiple-jurisdiction representation, competence and communication with the client, become most important when the lawyer's actions fall into an exception to the restrictions on the unauthorized practice of law.

Competent representation requires that the lawyer possess, inter alia, the legal knowledge and skill "reasonably necessary for the representation."12   For a SaLT lawyer, this means knowledge not only about the relevant state tax laws but also about other relevant state laws and even federal laws.  Of particular importance in this vein may be state laws governing real property and other areas where state laws have considerable variation.

A lawyer has a duty to communicate with a client, including a duty to "explain a matter to the extent reasonably necessary to permit the client to make informed decisions regarding the representation."13   In the context of advising a client about the tax laws of another jurisdiction, the lawyer should explain what the lawyer can and cannot do, how the lawyer's expertise may be limited, and note the fact that the lawyer is not admitted in the other jurisdiction as well as any disadvantages that this may entail for the client.

SaLT Representations Involving Multiple Jurisdictions: Ethical Implications of Co-Counsel Arrangements

Given the considerations discussed above, SaLT lawyers often work with co-counsel, particularly local counsel.  In such situations, a common concern is fee-sharing agreements.  Model Rule 1.5(e) governs fee sharing: (1) the aggregate fees paid by the client to the lawyers must be reasonable, (2) the division of fees between the lawyers must be proportional to the services performed by each (or each lawyer must assume joint responsibility for the representation), and (3) the client must consent in writing to the division of fees between co-counsel.14   A fee-sharing agreement that does not comply with these rules may be treated as unenforceable, potentially impacting both lawyers' abilities to collect their fees. An agreement that fails to comply may also lead to disciplinary proceedings.

Although not specified in the Model Rule or the comments, a best practice is to obtain written consent to the fee-sharing agreement as soon as it is contemplated that co-counsel will become involved in a matter.

SaLT Representations Involving a Single Jurisdiction

While SaLT lawyers may advise clients on the laws of several states, a SaLT lawyer may also advise a particular client solely on the laws of a single state.  An important ethical issue in this situation is defining the scope of representation.  This issue is of particular concern in SaLT practice, given that SaLT clients frequently have related legal matters in multiple jurisdictions.  In some cases, the scope of representation issue will be obvious.  For example, a prospective client might have open tax examinations in several different states and might engage a California SaLT lawyer solely in connection with the client's California Franchise Tax Board examination.  In other cases, the fact that the lawyer is being engaged by a client on essentially a limited-scope basis may not be apparent.

Express Limitations on the Scope of Representation

A client with multiple matters in different jurisdictions may choose to retain an attorney for a specific matter.15   Similarly, an attorney may "limit the scope of the representation if the limitation is reasonable under the circumstances and the client gives informed consent."16

In the best-case scenario, a lawyer will have recognized any known or potential related matters with respect to a particular client in advance of retention and clearly delineated the scope of representation in the engagement letter.

There appears, however, to be a tension between the duty to communicate and the scope of representation.  Even when a lawyer diligently documents the scope of representation at the commencement of an engagement, it is unclear whether the duty to communicate requires the lawyer to advise the client of matters that lie outside that scope of representation.  As discussed above, the duty of communication requires a lawyer to explain matters "reasonably necessary" for the client to make an informed decision regarding the representation.17

As an example, if an engagement letter clearly states that the scope of representation involves handling only a state tax examination, does the lawyer nonetheless have an obligation to inform the client that any adjustments agreed to in the state examination may affect the client's federal tax liability as a result of information sharing between the IRS and several states?18   A client who agrees to haircut certain Schedule C deductions for state tax purposes could potentially incur an aggregate federal and state tax liability of 5 times or more the amount of the agreed-upon settlement with the state.  Further, should the lawyer affirmatively advise the client that interest on any federal underpayment runs from the due date of the return and that the client should consider making a deposit of tax to stop the running of interest?19

Another example is the reverse situation.  Certain states require taxpayers to provide notice of any adjustments to their federal tax liability within a certain number of days of the change.20   A failure to notify the state results in the suspension of the statute of limitations on assessment.  Does a SaLT attorney representing a client solely in a federal tax examination have an obligation to communicate the state reporting requirements to the client?

If a lawyer interprets the duty to communicate broadly and informs a client of matters clearly outside of the scope of representation that may be affected by the decision the client makes with respect to the representation, there is a risk that the client or a disciplinary authority could view the scope of representation as having been expanded.  In such a case, the lawyer likely would be subject to increased obligations to the client.

One method to resolve these concerns may be for the lawyer to mention, generally, that state changes may have repercussions at the federal level or with other states while clarifying that providing advice regarding any such consequences is beyond the scope of engagement.  Alternatively, the lawyer might include in her first discussions with the client an express statement that the lawyer will not communicate about matters outside the scope of representation and that there may be material risks to the client of such a limitation on the duty to communicate.21

Imprecise Scope of Representation

The preceding discussion was based on a clear delineation between covered and not covered matters in the scope of representation.  In contrast, an engagement letter with an imprecise scope of representation implicates an exponential number of ethical issues.

The scope of representation may be imprecise if the lawyer does not draft the engagement letter well or fails to consider the client's other matters that are related to the covered matter.  In some cases, a lawyer intentionally drafts the scope of representation broadly in the hope of representing the client on additional matters in the future.  Under general contract principles, an imprecise scope of representation in an engagement letter may be construed against the lawyer as drafter.

An imprecise scope of representation implicates several important ethical rights and obligations, including the fees the lawyer is entitled to receive.  Model Rule 1.5(b) requires that the basis or rate for the lawyer's fees be clearly communicated to the client, preferably "in writing, before or within a reasonable time after commencing the representation."22   When the scope of representation is imprecise, the lawyer's right to fees for the representation may be unclear.  A lawyer may be unable to collect fees for any additional services that are ultimately construed to be within the scope of representation.

This is especially true when a flat fee or other alternative fee arrangement is used.  For example, suppose a lawyer who is retained to handle an IRS examination drafts an engagement letter that states that the scope of representation covers "tax matters" for a flat fee in the amount of $150,000.  A few months after the completion of the examination, the client receives a notice from New York State indicating that additional state tax is due.  In this situation, under Model Rule 1.5(b), there is a real risk that the client might demand (and a state Bar would agree) that the New York State matter be treated as within the scope of representation.  As a result, the lawyer may be unable to charge additional fees for handling the matter.

If the scope of representation is construed to be broader than the lawyer originally envisioned, the lawyer may also have breached duties owed to the client with respect to the additional matters, such as avoiding conflicts of interest.23


This article has addressed how SaLT lawyers might (or rather, should) consider some of the many ethical issues that typically arise in SaLT representations.  As for when these issues should be considered: "early and often" would certainly be a good practice. ■

2  See id.

3  Model Rule 8.5(a).  For the choice of law rule, see Model Rule 8.5(b).

5  See Birbrower, Montalbano, Condon & Frank v. Superior Court, 949 P.2d 1 (Cal. Sup. Ct. 1998) (significant time and effort in California representing California-based corporation).

8  Not all states follow the Model Rules.  California, for example, has more restrictive rules.

19  If the lawyer does inform the client of the federal tax implications of a state settlement, has the SaLT lawyer now become subject to Treasury Circular 230?  See Treasury Circular 230 § 10.37 (written advice standard).

20  See, e.g., N.Y. Tax. Law § 659 (within 90 days).