IRC Sec. 7525 Federally Authorized Tax Practitioner Privilege of Confidentiality

Introduction

On July 22, 1998, President Clinton signed into law the IRS Restructuring and Reform Act of 1998, Public Law 105-206. The legislation included IRC Sec. 7525, Confidentiality Privileges Relating to Taxpayer Communications. IRC Sec. 7525, generally effective for communications made on or after July 22, 1998 between a taxpayer and a “federally authorized tax practitioner,” provides for the uniform application of confidentiality to taxpayer communications with professionals who practice before the IRS with respect to clients seeking tax advice.

Prior to the enactment of IRC Sec. 7525, the privilege of confidentiality which is based on common law principles only applied where an attorney advised a client on legal matters. For example, the privilege of confidentiality did not apply where an attorney provides business advice to a client or prepares and files a tax return on behalf of a client. The advice sought by a client must be for legal advice. The attorney-client privilege of confidentiality or an equivalent privilege did not apply at the federal level to CPAs, enrolled agents (EAs), enrolled actuaries, or other professional authorized to practice before the IRS prior to the enactment of IRC Sec. 7525.

In their considerations of IRC Sec. 7525 the U.S. House of Representatives and U.S. Senate ultimately believed that a right to privileged communications between a taxpayer and a federally authorized tax practitioner should be available in certain proceedings before the IRS provided that the advisor is authorized to practice before the IRS. The conference agreement followed the U.S. Senate’s amendment with certain modifications and clarifications which provided that the privilege of confidentiality (1) would not apply in connection with promoting a tax shelter; (2) may be asserted in noncriminal tax proceedings before the IRS and in the federal courts with regard to a noncriminal proceeding where the United States is a party; (3) may be waived by a taxpayer in the same manner as the attorney-client privilege; and (4) may not be asserted by a taxpayer in matters before other regulatory bodies in an administrative or court proceeding.

Statutory Language of IRC Sec. 7525

The statutory language in IRC Sec. 7525, which essentially follows the conference agreement, provides “With respect to tax advice, the same common law protections of confidentiality which apply to communications between a taxpayer and an attorney shall also apply to a communication between a taxpayer and any federally authorized tax practitioner to the extent the communication would be considered a privileged communication if it were between a taxpayer and an attorney.”

The plain language in IRC Sec. 7525 protects documents that are communications. The tax practitioner privilege protects only communications and not work product.¹ Therefore, a document, i.e., an email or other forms of correspondence or communication that fails to specify a recipient is not a communication that would come within the plain language of the statute.

Consistent with the limitations stated in the conference agreement, the privilege of confidentiality “may only be asserted in (A) any noncriminal tax matter before the Internal Revenue Service; and (B) any noncriminal tax proceeding in Federal court could be brought by or against the United States.”²

Federally Authorized Tax Practitioner

A “federally authorized tax practitioner” is an individual who is authorized under federal law to practice before the IRS if such practice is subject to federal regulation under 31 U.S.C. 330.³ The regulations promulgated by the IRS to implement 31 U.S.C. 330 are in Treasury Department Circular No. 230, Regulations Governing Practice before the Internal Revenue Service, (Rev. 6-2014), The rules governing practice before the IRS apply to attorneys, certified public accountants, enrolled agents, enrolled actuaries,⁴ and other persons authorized to represent taxpayers before the IRS.

Consistent with the common law privilege of confidentiality between an attorney and client with respect to legal advice a client seeks from an attorney, communications between a federally authorized tax practitioner and a client must be based on the facts a client communicates to the tax practitioner for the purpose of obtaining tax advice. For example, if the client retains a tax practitioner to prepare his or her tax return, the privilege of confidentiality will not automatically apply to communications, information obtained or documents prepared or relied upon to file a tax return because a tax return is intended to be filed with the IRS, a third party. The act of filing a tax return waives the privilege of confidentiality with respect to the tax advice the tax practitioner’s client sought to obtain.

The Meaning of “Tax Advice” in IRC Sec. 7525

The term “tax advice” means advice given by an individual with respect to a matter which is within the scope of the individual’s authority to practice before the IRS as a federally authorized tax practitioner⁵ with respect to matters under the Internal Revenue Code.⁶

Tax advice includes communications regarding tax planning advice. However, communications regarding return preparation are not considered tax advice.⁷ Neither are documents related to a tax opinion letter issued by an accounting firm if they are written for return preparation purposes;⁸ nor are documents that substantiate, or support items reported on a federal tax return privileged.⁹

Limitations on Federally Authorized Tax Practitioner Privilege of Confidentiality

Based on the common law principles applicable to the attorney-client privilege, IRC Sec. 7525 is intended to apply to the extent the communication would be considered a privileged communication if it were between a taxpayer and an attorney. Accordingly, there is a limited privilege of confidentiality for the tax practitioner where the privilege may provide confidentiality to communications between tax a practitioner and client with respect to tax planning advice.

As stated above, the privilege may only be asserted in a noncriminal tax matter before the IRS and a noncriminal tax proceeding in federal court brought by or against the U.S. On October 19, 1999, the IRS issued Chief Counsel Advice 200008006.¹⁰ In this advice the IRS stated that the privilege of confidentiality does not apply in a criminal tax matter or proceeding even if the subject communication between a federally authorized tax practitioner and client originated in the context of a civil matter or proceeding.

Dual-Purpose Communications

There are times when communications between a federally authorized tax practitioner and client might have a dual purpose. For example, communications might include tax planning advice on the one hand and tax return preparation or business advice on the other. The issue that must be answered in order to determine whether the privilege of confidentiality applies to dual-purpose communications between a federally authorized tax practitioner and client is to demonstrate the “primary purpose” of the communication. The same rule applies under the common law privilege between an attorney and a client to determine whether the primary purpose of the communication is to obtain legal advice, business advice or tax advice. In communications between an attorney and a client, the primary purpose of the communication must be for the client to obtain legal advice from the attorney. In communications between a federally authorized tax practitioner and a client, the primary purpose must be for the client to obtain tax advice versus business or tax return preparation advice.

With respect to a client’s communication with a tax practitioner seeking to obtain tax advice, in order for the communication to qualify for the privilege of confidentiality, the primary purpose of the communication must be to obtain tax advice about a particular question or issue unrelated to a tax practitioner preparing a tax return.

IRC Sec. 7525 Privilege of Confidentiality versus Kovel Accountant¹¹

As stated above, the privilege of confidentiality with respect to communications between a federally authorized tax practitioner and a client is limited to tax advice.

In situations where an attorney retains a (CPA or an EA who is knowledgeable about federal and state income tax issues to (1) assist the attorney to provide legal advice to a client; (2) work under the attorney’s direction; an (3) report directly to the attorney pursuant to a Kovel agreement,¹² all communications between the CPA or EA and the attorney and client will be regarded as confidential and made solely for the purpose of assisting counsel in providing legal advice to the client.

A CPA or EA retained by an attorney as a Kovel accountant contemplates services of character and quality which will be a necessary adjunct to an attorney’s services in providing legal advice to a client. “Contemplated services” do not include preparing and filing tax returns on behalf of the attorney’s client because filing tax returns would be a waiver of the privilege of confidentiality. In limited and fact specific circumstances, the CPA may at the request of the attorney prepare and file the attorney’s client’s tax returns. In such a case, the attorney’s client agrees to waive their privileged of confidentiality.

Best Practices and Recommendations

Although IRC Sec. 7525 does not require a written agreement between a taxpayer and a federally authorized tax practitioner, in order to show that a taxpayer has a reasonable belief that a confidential relationship exists with the tax practitioner, best practices recommend a client and tax practitioner should execute a written agreement or engagement letter setting forth the terms and conditions of retaining the tax practitioner to provide tax advice to the client.¹³ Best practices recommend tax consulting and return preparation should be in separate engagement letters with firm A providing the tax advice and firm B preparing the tax return. IRC Sec. 7525 has virtually no application when the tax advice and tax return preparation are provided in the same firm.
In order for IRC Sec. 7525 to apply, the information or documents communicated by a client to the tax practitioner must be made to the tax practitioner acting in his or her capacity as a federally authorized tax practitioner.

If the client retains a tax practitioner to prepare a client’s tax return, a separate engagement letter should be executed. However, if the tax advice provided by the federally authorized tax practitioner pursuant to IRC Sec. 7525 is an issue reported on the client’s tax return, then the tax advice will no longer be considered confidential and privileged since the advice would be reported on a tax return and disclosed to a third party.

Conclusion

Since its enactment on July 22, 1998, IRC Sec. 7525 generally has been relied upon by federally authorized tax practitioners in matters pertaining to providing tax advice to clients especially where the client has not retained a tax practitioner to prepare the client’s tax return. When a client seeks tax advice where the client intends for the tax advice to remain privileged and confidential as in the case of the common law privilege between an attorney providing legal advice to a client, a client should consider consulting with and obtaining the tax advice from a federally authorized tax practitioner who has not been retained to prepare the client’s tax return.

As a general rule and with limited exceptions, attorneys retain Kovel accountants based on their knowledge, skill and training to assist the attorney to provide legal advice to a client without the intention to disclose communications to a third party such as would be the case in the event the Kovel accountant also prepared and filed a client’s tax return.

Simply stated, IRC Sec. 7525 provides a limited privilege that would only apply to communications between a CPA, EA, or enrolled actuary and the tax practitioner’s client with respect to tax advice if, and only if, the communication would have been privileged had it been between an attorney and an attorney’s client.

¹Evergreen Trading, 80 Fed. Cl. at 134
²IRC § 7525(a)(2)
³IRC § 7525(a)(3)(A). 31 U.S.C. 330 provides for the Secretary of the Treasury to regulate the practice of representatives of persons before the Department of the Treasury and, before admitting a representative to practice, require that the representative demonstrate (A) good character; (B) good reputation; (C) necessary qualifications to enable the representative to provide persons with valuable service; and (D) competency to advise and assist persons in presenting their cases.
⁴Senate Report No. 105-174 (PL 105-206) p. 70
⁵IRC § 7525(a)(3)(B)
⁶Senate Report No. 105-174 (PL 105-206) p. 70
⁷U.S. v. BDO Seidman LLP, (2003, DC IL) 91 AFTR 2d 2003-1016; U.S. v. KPMG LLP, (2002, DC Dist Col) 91 AFTR 2d 2003-317.
⁸U.S. v. KPMG LLP, (2002, DC Dist Col) 91 AFTR 2d 2003-317.
⁹U.S. v. KPMG LLP, (2004, DC Dist Col) 93 AFTR 2d 2004-2106.
¹⁰Chief Counsel Advice 200008006.
¹¹U.S. v. Kovel, 9 AFTR 2d 366 (296 F.2d 918), (CA2), 12/05/1961
¹²A Kovel agreement is a written agreement between an attorney and a CPA or EA that sets forth the terms and conditions under which the attorney retains the CPA or EA, i.e., Kovel accountant, to work under the direction of the attorney. As such, communications between the attorney, his or her client, and the CPA or EA are protected by the privilege of confidentiality.
¹³Valero Energy Corp v. U.S., (2007, DC IL) 100 AFTR 2d 2007-6473.

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