Attorney-Client Privilege and Tax Return Preparation in Streamlined Offshore Procedures

Seems like every other client we talk to has read an article online that claims that an attorney must prepare your tax returns if you’re making a streamlined submission or voluntary disclosure.

What is attorney-client privilege?

The attorney-client privilege is established by common law on the basis that a lawyer is able to provide better legal advice if a client is able to speak freely with his attorney, including providing incriminating information (subject to the crime-fraud exception).

Legal advice provided by an attorney to a client, including a prospective client, is privileged, and an attorney cannot disclose those communications to any 3rd party, including the IRS. That privilege belongs to the client and only the client may waive it.

What’s considered “legal advice” is important, as it determines what communication is protected under the attorney-client privilege.

Example

This is a hypothetical. Bob goes to Attorney Silverman to come into compliance with his offshore accounts. Attorney Silverman convinces Bob to let him handle the entire process, including the tax returns, on the basis that all communications will be privileged.

Silverman then requests Bob to provide his foreign bank account statements and to fill out an organizer. Bob forgets to include a Swiss account.

Two years later, the IRS audits Bob and summons Silverman to provide all records and documents relating to Bob’s tax returns. Silverman claims the documents are protected by attorney-client privilege. The IRS asserts that tax return preparation does not require a law license, and therefore is not considered legal advice.

Silverman and the IRS hash it out in court. Who wins?

The circuits are split on this issue. While a small minority do recognize attorney-client privilege when tax preparation is provided in connection with significant legal advice, most courts believe that the preparation of income tax returns are never legal advice.

In fact many courts have held that when an attorney prepares a return and provides it to a 3rd party (e.g., the IRS), it creates a subject-matter waiver of all communications. That means all your communications with your attorney relating to that tax period and tax return are now non-privileged!

The court determines that the attorney-client privilege has been waived with regards to all communications relating to that tax return. The government enforces the summons and receives Bob’s organizers, bank statements, and emails relating to the tax return. Bob then faces charges for providing false statements and is assessed willful failure to file FBAR penalties.

When does attorney-client privilege apply in tax?

There are a few situations in tax where an attorney can provide advice that will almost always be privileged:

  1. Pre-transaction tax planning and advice
  2. Tax litigation
  3. Pre-litigation

But why not tax returns you may ask?

Courts have generally been unwilling to allow taxpayers to use attorneys for tax preparation for the sole purpose of later invoking the privilege. Otherwise, unscrupulous taxpayers and attorneys could make it very difficult for the IRS to prosecute tax crimes such as filing false statements.

The House of Representatives’ Committee Report (H.R. Rep. No. 105-599) which clarifies IRC 7525 states that if

an attorney is retained to prepare a tax return, the attorney-client privilege [and its proposed accountant-client privilege] will not automatically apply to communications and documents generated in the course of preparing the return.”

Should your attorney prepare your tax returns in an offshore compliance matter?

In a Ninth Circuit case, United States v. Abrahams, the court held that communications made “to acquire legal advice about what to claim on tax returns may be privileged.” So there are some limited roles that an attorney can play in the tax preparation process that will be privileged, but the tax return and the workpapers used to create a return are not typically protected under attorney-client privilege when the attorney prepares the tax return.

And, finally, from the IRS in IRM 35.4.6.3.3.3.1:

The attorney-client privilege does not apply to information relating to the preparation of tax returns.

I’m not saying its NEVER OKAY for an attorney to prepare tax returns in connection with the streamlined process. Sometimes clients prefer to have a single point of contact, and the client has the money to pay for an attorney’s time to prepare tax returns. However, you should not pay for that premium under the assumption that your tax returns will be protected by attorney-client privilege.