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

It seems like every other client we talk to has read some blog post online that claims that an attorney must prepare the tax returns if they’re making a streamlined submission or voluntary disclosure.

The attorney is marketing to high net-worth clients with unreported assets. They want to pitch their “flat fee” which includes tax preparation and even audit defense. Very cute.

The problem is that not all clients have $20K to pay for a basic streamlined filing. For many of our clients, those unreported foreign assets are hard-earned savings, and we’d rather not add to their costs of coming into compliance any more than necessary to complete the disclosure.

Yes, we’ve occasionally prepared tax returns for streamlined clients when they specifically stated they did not want to work with a CPA firm (again, due to this false information being circulated online). But it is absolutely not necessary for an attorney to prepare the tax returns that are submitted under the streamlined procedures. The attorney should handle the disclosure but the tax preparation can be completed by an accountant.

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

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

Joe Blow then requests Bob to provide his foreign bank account statements. Bob forgets to provide statements for a Swiss account.

Two years later, the IRS audits Bob and summons Joe Blow to provide all records and documents relating to Bob’s tax returns. Joe Blow 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.

Joe Blow files motion to quash the summons. 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, many courts have held that the preparation of income tax returns are not 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!

If the court determines that the attorney-client privilege has been waived with regards to all communications relating to that tax return, the government may enforce the summons and receive Bob’s organizers, bank statements, and emails relating to the tax return. Bob then could very well face charges for providing false statements and 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 (even unwittingly) could make it very difficult for the IRS to prosecute tax crimes such as filing false statements.

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, the IRS’ position as stated in 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.

In conclusion, you should not feel the need to pay several thousands of dollars for income tax preparation on the premise that your tax returns will be protected by attorney-client privilege. If anyone makes that claim, you should have it produced in writing to you.