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

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

There is quite a bit of misinformation on this topic and hopefully this post will help clear things up.

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 to come into compliance with his offshore accounts. Attorney Joe  handles the entire process, including the tax returns, on the basis that all communications will be privileged.

Attorney Joe 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 Attorney Joe to provide all records and documents relating to Bob’s tax returns. Attorney Joe claims the documents are protected by attorney-client privilege. The IRS asserts that communications with the primary purpose of tax return preparation are not privileged.

Attorney Joe 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.

So there’s a slim chance that a court would find that tax return workpapers and communications regarding the tax return are privileged in connection with a streamlined filing. There is a greater chance of risking the privilege status of “dual purpose” communications or a waiver of all communications regarding the tax return.

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, it 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 even when the attorney prepares the tax return.

And, finally, the IRS’s 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.

It probably wouldn’t hurt to have an attorney prepare your tax returns in a streamlined filing, but claims made about attorney-client privilege in regards to preparation of tax returns are dubious. In addition, having a law firm prepare your tax returns will increase costs by up to several thousand dollars as opposed to using a CPA for that portion. It is unnecessary in our opinion.