Accountant/Client Privilege

In 1998, Congress added section 7525 to the Internal Revenue Code, creating an accountant/client privilege. Like the privilege that already exists between attorneys and their clients, it extends to tax advice but not tax return preparation. A recent decision by the Seventh Circuit Court of Appeals examined the scope of this privilege.

Taxpayers Randolph and Karin Lenz, and their corporation, KCS Industries, were under IRS investigation. They hired Richard Fredrick, an attorney and accountant, to represent them. The IRS issued summonses to Fredrick asking him to turn over hundreds of documents. Fredrick refused to do so. The district court ruled that some of the documents were not protected by privilege. He appealed the decision.

Result. For the IRS. This case presented a number of different privilege-related issues. The first question the Seventh Circuit addressed was whether numerical information was subject to privilege. The court held that, although rare, it was possible for such information to be privileged. It used as examples an attorney’s estimate of damages or the amount a client stole. Based on these examples, it appears few, if any, of an accountant’s numerical workpapers will be eligible for privilege.

The second issue the court considered concerned dual-purpose documents—those an attorney or accountant creates for use in preparing a client’s tax return, as well as for use in litigation or providing tax advice. The Seventh Circuit concluded that such dual-purpose documents are not privileged.

The Seventh Circuit also considered documents an attorney or accountant creates in connection with an IRS audit. The court said these documents could be privileged in certain situations. If the documents are used to determine the client’s tax liability or the accuracy of the filed return, they are not privileged. If the documents discuss statutory interpretations or case law, they are privileged. As indicated above, if the attorney or accountant uses them for both purposes, they are subject to IRS summons.

Although the case itself involved issues related to attorney/client privilege, the Seventh Circuit also addressed the scope of the new accountant/client privilege. The court said the latter privilege covers only communications between the client and his or her accountant, not the accountant’s work product. If other courts accept the Seventh Circuit’s conclusions, section 7525 will provide a very limited benefit to taxpayers and accountants.

• U.S. v. Richard Fredrick, 99-1 USTC 50, 465, 83, AFTR 2d 1870, CA-7.

—Prepared by Edward J. Schnee, CPA, PhD, Joe Lane Professor of Accounting and director,
MTA program, Culverhouse School of Accountancy, University of Alabama, Tuscaloosa.