Curing Non-Compliance: Practical Factors to Consider in the United States - Part 2

2. Limitation on Tax-Related Communications

   Although tax engagements and tax-related communications between

   attorneys and clients are generally protected by the same set of

   privileges as communications between attorneys and clients

   generally, no privilege extends to protect communications related

   to the preparation of a client's tax return by an attorney. The

   general rule is that where a client transmits information so that

   it might be used to prepare his tax return, such transmission

   generally defeats any expectation of confidentiality. That is, the

   attorney-client privilege and work product privilege protect only

   those communications that are legal in nature, such as those made

   to enable the preparation of a brief or opinion letter, and

   generally do not extend to protect communications related to the

   preparation of a client's tax returns.52 Thus, for

   example, while advice relating to the tax consequences of a

   proposed transaction, when rendered by an attorney, is generally

   considered legal advice protected by the privileges, such

   information generally will not be protected from disclosure if it

   is ultimately used to prepare the client's tax

   return.53

   In addition, there is no Common Law accountant's or tax

   preparer's confidentiality privilege similar to the

   attorney-client privilege or work product privilege.54

   Indeed, the rationale for not extending these privileges to tax

   preparation work appears to be that, since there is no Common Law

   tax preparer's privilege, a taxpayer must not be permitted to

   hire an attorney to do the work that an accountant or the taxpayer

   himself normally would do, in order to obtain greater protection

   than a taxpayer who did not use an attorney as his tax preparer

   would be entitled to.55

   This limitation on the application of the confidentiality

   privileges can pose a significant problem for clients with

   potential criminal tax exposure, since such clients often need both

   legal and accounting expertise to manage their risk. For example,

   in order to make a "voluntary disclosure," a client must

   properly report his or her liability on an amended or delinquent

   return, which would generally require a tax preparer's general

   and accounting expertise. One method of resolving this problem is

   by using a "Kovel agreement" to engage an

   independent accountant to perform the necessary tax preparation

   work.

3. Kovel Agreements

   The Kovel agreement derives its name from the Second

   Circuit case of United States v. Kovel,56 the

   leading case that originally recognized the attorney-client

   privilege when an accountant is engaged to assist in providing

   legal services to a client. The basic premise of the Kovel

   arrangement is that the accountant so engaged is acting as an

   "agent" of the attorney for the purpose of assisting with

   the provision of legal advice and, therefore, information

   transmitted to the accountant must fall under the protection of the

   attorney-client privilege.57

   Although oral agreement may be permitted by law, as a practical

   matter, practitioners should document a Kovel arrangement

   in writing, specifically defining the scope of the accounting

   services to be provided and responsibilities to be managed by the

   accountant or accounting firm in the engagement. An accountant or

   accounting firm engaged under the Kovel agreement is

   generally considered to work directly for the attorney as an

   independent contractor and is considered to work only indirectly

   for the client as part of the legal team rendering legal services

   to the attorney's client, even if the accountant's fees are

   paid directly by the client.

4. New Standards of Conduct for Tax Return Preparers

   Effective generally for tax returns prepared after May

   25, 2007, the Small Business and Work Opportunity Tax Act of

   2007 (the "2007 Act"),58 amended several

   provisions of the Code to (i) extend the application of the income

   tax return preparer penalties to all tax return preparers, (ii)

   alter the standards of conduct which must be met by tax preparers

   to avoid imposition of penalties, and (iii) increase the applicable

   penalties. The Treasury Department and IRS intend to issue

   regulations to implement the changes under the 2007 Act and, on

   December 31, 2007, released Notice 2008-1359 to be used

   as interim guidance by tax return preparers.

   Although the 2007 Act extends the return preparer penalties to

   preparers of all tax returns and not just to preparers of income

   tax returns, Notice 2008-13 clarifies that preparers of many

   information returns will not be subject to the new penalty

   provision unless they willfully understate tax or act in reckless

   or intentional disregard of the law. The Notice further explains

   the application of the new rules to specific

   returns?e.g., the preparer of a Form 1065 may be

   deemed to be the preparer of any of the partners' individual

   income tax...