IRS Restructuring Act Includes CPA/Client Privilege

The landmark Internal Revenue Service Restructuring and Reform Act of 1998, which President Clinton signed into law on July 22, 1998, includes a provision that creates a confidentiality privilege between clients and the CPAs who represent them before the IRS in most matters.

The provision gives taxpayers uniform confidentiality protection for most tax advice they receive from CPAs and other federally authorized tax practitioners in noncriminal matters before the IRS. It also applies in cases before the federal court in which a federal tax authority is involved. It would not curb the ability of the IRS to investigate criminal behavior or to obtain information necessary to determine whether a tax return is correct.

The IRS currently has broad authority under Internal Revenue Code section 7602 to summon any information the agency believes is relevant to an examination. While tax advice received from an attorney is often protected under common-law privilege, the IRS can compel disclosure of the same advice if it is received from a CPA or an enrolled agent or from an attorney who is providing advice in the role of a tax practitioner rather than that of a legal adviser.

“CPAs often provide clients with a list of options when planning a tax strategy,” said Les Brorsen, managing director, government relations, Ernst & Young, Washington, D.C. “The IRS can obtain the list of options, as well as the CPAs evaluations of the options, under a summons and use it against the taxpayer during an examination,” said Brorsen. “Under the new law, that list would be protected in most cases to the same extent it could be protected under the attorney-client privilege.”

Other items that would be protected include

• Tax advice on the complexities of estate tax exclusion rules and related succession planning.
• An opinion on the variety of expenditures that qualify as deductible medical expenses; for example, a taxpayers payments to a nursing home for an incapacitated parent.
• An opinion on the tax implications for alternative structures of a proposed deferred compensation plan for employees.
• An opinion on various planned expenditures that would qualify as start-up expenses for a new business and related implications for alternative structures such as an LLC or S-corporation.

“This allows taxpayers seeking tax planning advice to work with their CPA—not just attorneys—and obtain the confidentiality protection they expect,” said Brorsen.

One last-minute change to the law removed the CPA/client privilege for documentation related to the promotion of corporate tax shelters. Although this is limited to corporate taxpayers, the definition of tax shelter is extremely broad; therefore, it likely will take some time to understand the full implications of this limitation.

The confidentiality provision was supported by the American Institute of CPAs, the National Association of Enrolled Agents, the National Taxpayers Union, the National Federation of Independent Business, the U.S. Chamber of Commerce and many other state and national business organizations.