Tax Advisors (Attorneys/CPAs) who render tax advice to a taxpayer for offshore accounts (or other tax matters) may have no attorney-client privilege and may themselves be subject to criminal penalties.
US Taxpayers with undisclosed offshore accounts face a myriad of civil and criminal tax penalties. In addition, the Taxpayer may not have the attorney-client privilege for confidential communications if the professional services from legal counsel was for tax advice and the IRS investigates taxpayer for criminal tax evasion.
Under IRC Sec. 7525 (effective date 7/22/98), there is no attorney-client privilege for tax advice rendered if the IRS pursues a criminal tax investigation. The implications for the US Taxpayer and advisors include the following:
1. US Taxpayers with undisclosed offshore accounts and/or unreported income (from offshore or domestic accounts) may not be able to assert an attorney-client privilege if questioned by the IRS;
2. Their tax advisor (i.e. Attorney or CPA), who rendered tax advice to them, may be unable to refuse to answer IRS inquiries or produce Taxpayer records;
3. Under 18 USC Sec. 371(conspiracy to commit tax evasion) when 2 or more parties collude to evade taxes due they may be held liable for a criminal tax conspiracy and face felony charges (5 years in jail), known as a “Klein conspiracy”;
4. Under Treasury Dept. Circular #230 (the rules governing tax practice before the IRS), Sec 10.21 requires a tax practitioner, who is aware that a taxpayer is non-compliant with federal tax law to advise the taxpayer of both the taxpayer tax non-compliance and the penalties for continued tax non-compliance, or the tax practitioner faces suspension or disbarment for their tax practice before the IRS.
5. Under 18 USC Sec. 4, Misprision of a Felony: “Whoever has knowledge of actual commission of a felony…. must refer the matter to a judge or other civil or military authority… or is subject to “be fined, or imprisoned not more than 3 years or both (effective 6/25/48).
The term “tax advice” means advice given by an individual with respect to a matter that is within the scope of an individual’s authority to practice (IRC Sec. 7525 (a) (3) (B). Under IRC Sec. 7525 (a)(1): “with respect to tax advice, the same common law protections of confidentiality, which apply to a communication between a taxpayer and an attorney, shall also apply to a communication between a taxpayer and any federally authorized tax practitioner (“FAPT”), to the extent the communication would be considered a privileged communication if it were between a taxpayer and an attorney”.
A FAPT (federally authorized tax practitioner) means an individual authorized under federal tax law to practice before the IRS where the practice is subject to federal regulation under 31 USC Sec. 330 (IRC Sec. 7525 (a)(3)(A). The term FAPT includes an attorney, CPA, an enrolled agent, or an enrolled actuary. The FAPT does not apply to accountants who are not CPAs (unless the accountant qualifies as an enrolled agent). See Treasury Dept Circular 230, IRS Pub 947).
Under IRC 7525 (a) (2), unlike the attorney-client privilege, the FAPT privilege does not apply in criminal tax matters and may only be asserted as a privilege in “noncriminal tax matter before the IRS” and in a “non-criminal tax proceeding in a Federal Court brought by or against the US”. The legal effect is that tax advice rendered has a limited attorney-client privilege only for “non-criminal tax matters”.
The FAPT privilege only applies to communications made on or after 7/22/98. The privilege does not apply to any written communication before 10/22/04 between a FAPT and a director, shareholder, officer, employee, agent, or representative of a corporation in connection with the promotion or the direct or indirect participation of such corporation in any tax shelter (the term tax shelter is defined in 26 USC Sec. 6662 (d) (2) (C).
IRC Sec. 7525 was amended by the American Jobs Creation Act of 2004, so that the privilege does not apply to written communications made on or after 10/22/04, involving a federally authorized tax practitioner with respect to the participation of any person (not just a corporation) in a tax shelter (Pu. L. No. 108-357).
The FAPT privilege applies only to tax advice not general business consultations or personal financial planning advice. The tax advice must be treated as confidential to be covered by the privilege. If the communication is divulged to 3rd parties, then, it is not confidential.
Current case law indicates that a communication in connection with tax return preparation is not covered or protected by the FAPT privilege. In US v. Gurtner (474 F.2d 297 (9th Cir. 1973) the US 9th Cir. Ct. of Appeals held that tax return preparation does not involve giving or receiving legal advice. In US v. Cote (456 F.2d 142 (8th Cir. 1972), the US 8th Cir Ct. of Appeals held that tax returns are not privilege based on the rationale that tax returns are intended for disclosure to a 3rd party (IRS) so there can be no expectation of confidentiality which defeats the claim that the tax return or pertinent communication is privileged.
Regarding the the rules of confidentiality of tax returns and tax return information held by the IRS or tax practitioner (IRC Sec. 6103, 7213, 7213A, 7216) the confidentiality protections in those rules do not render the communication confidential for purposes of the FAPT privilege.