When Does My Client Need a Tax Attorney?
By Peter D. Anderson, Steven M. Burke, Beth L. Fowler, John E. Rich, Jr., Richard M. Stone
Published in NH Society of CPA’s Connection (5/12/2014)
CPAs are very often a business owner’s most important advisor. Meeting with a client multiple times per year, accountants provide a wide range of tax and advisory services well beyond tax return preparation, including sophisticated tax, business and financial planning. The role of a tax attorney is often more episodic, but no less important. Tax attorneys often focus on some of the finer details of tax law and IRS procedure, and can help your client in matters ranging from tax litigation, to estate and asset protection planning, to executive compensation and pre-transaction planning.
Clients often misunderstand the role of a Certified Public Accountant versus a tax attorney. A CPA, a client supposes, knows everything he or she needs to know about tax code under the law, so he or she must be able to work out any discrepancies the client or the client’s company may have with the IRS, and advise the client on tax strategies. The following are just a few examples of common situations where retaining a tax attorney may be a good idea.
Your client is being audited by the IRS or a State Tax Authority and Matters Have Become Serious. Dealing with the IRS and state tax authorities is loaded with challenges and traps, especially when it involves complex and sophisticated services provided by CPAs. Clients may receive a Summons, an Information Request, a visit by investigators, a phone call, or a letter asking for documents and information concerning them or perhaps others. Some of that information could lead to fraud or criminal charges. CPAs may become aware of fraudulent activities and may want to protect confidential client information during a civil audit (called an “eggshell audit”). Some civil audits, called “reverse eggshell audits”, are actually disguised criminal audits, and are used by tax authorities to discover criminal tax evasion. Simultaneous (“parallel”) civil and criminal investigations are possible. Even in a routine audit context, tax authorities could be seeking information that clients view as “private and confidential”. How to protect confidential information is always an important issue.
There is an “accountant/client” privilege in the Internal Revenue Code (§7525), but it is very limited and is always subject to attack by the IRS. The privilege does not apply in criminal proceedings, to information communicated to third parties, and to tax shelters.It may not apply to communications between a client and a CPA unless the CPA is licensed in the state where the client resides, does not cover business or financial planning advice, and may not cover tax return preparation advice. In addition, the privilege is a federal privilege, and most state tax audits are not covered.
CPAs often try to protect tax work papers, but several recent cases make it clear that only work papers prepared in anticipation of litigation, not those prepared in the usual course of business, are protected.
Tax attorneys can help protect clients’ confidential information. Constitutional protections at the right time can be crucial. In addition, the attorney/client privilege is still very strong, and it applies in civil, criminal, and all tax matters. When any suspicion of fraud, misconduct or other problems exists, whether in an audit situation or otherwise, tax attorneys can represent a client and create a so-called “Kovel” arrangement where the CPA is engaged to help the attorney represent the client. This arrangement cloaks the CPA with the attorney’s privilege and protects information communicated to the attorney and CPA after the Kovel documents are signed. It does not protect prior communications, so it is crucial to create the arrangement early in the audit process. Producing confidential records to the IRS that could have been protected may waive constitutional protections and may result in a lawsuit by a client against the CPA.
Protection of information and protection of taxpayers’ rights must always be paramount.
The IRS is pursuing criminal charges against your client. When a client is under audit by the IRS, there are times that certain items of unreported income or deductions have the potential for a fraud referral to the Criminal Investigation Division.
It is essential in situations where the potential for fraud referral exists, that communications with the client be cloaked within the Attorney Client Privilege and that the client be advised of his or her 5th Amendment Right against self-incrimination during the audit process.Simply put, it is better for a client or client representative to say nothing at all than to make either damaging admissions or misstatements that can compound problems in the audit or result in a fraud referral to the Criminal Investigation Division.
You need someone experienced in communicating with the IRS to convene on your clients’ behalf. When the IRS is calling, it may well be in your clients’ best interest to settle the matter as expeditiously as possible. If you do not have established relationships with trusted tax attorneys you can call on a moment’s notice, now is the time to set them up. Educate your clients as to benefits of having experienced tax counsel on their side, when warranted. Take the steps they recommend, and rely on their expertise to put the matter to rest. Do not wait.
There are other many less urgent, but no less critical events that should trigger a call to a tax attorney. These are areas when a CPA and tax attorney can work hand in hand to best serve the client’s needs.
Your client is asking about ways to attract and retain the best talent with sophisticated executive compensation packages. In addition to the tax aspects of executive compensation arrangements, tax attorneys are familiar with the legal and business issues associated with these compensation programs.These programs require knowledge of corporate and securities laws, ERISA, Tax Code Section 409A, and the other applicable Code sections. The right executive compensation program depends on numerous factors including ownership’s desire to share equity, existing benefit programs and compensation structure, industry practice, and ownership’s strategic plan for the business.
Your client is considering the establishment of a new business. A good tax attorney can help business startups that have complicated tax or entity requirements. There is no one size fits all structure for entity formation. Whether forming an LLC, corporation, or partnership, each new business will face unique tax consequences, as will the officers, employees and owners of the business.Careful formation planning will result in tremendous tax efficiencies for the business and its owners for years to come. Failure to carefully plan at the outset of the establishment of an entity structure may saddle the business with a tax burden that could significant damage future performance.
Your client is concerned with asset protection planning, beyond what is achieved by basic incorporation. Successful clients often fear losing much of what they have created because of an unexpected lawsuit or tragedy that was not covered by insurance. The advice of a tax lawyer can be critical for clients with significant assets, complex investments or other unique requirements. Various asset protection approaches may be appropriate, including self-settled (“asset protection”) trusts, spendthrift trust, life insurance trusts, dynasty trusts and family limited partnerships.
Your client is considering business succession planning, possible through the sale of the business. Given the combined effect of federal and state tax rates, your client could pay over 50% of the proceeds from the sale of their business to the IRS and state taxing authorities. Proper pre-transaction planning could significantly reduce that tax burden. Pre-transaction tax planning is much more than the calculation of estimated tax.Proper structuring of your client’s business is critical. The creation of a proper organization structure, the use of trusts, the establishment of an employee stock ownership plan (“ESOP”), charitable lead or remainder trusts, and many other approaches will allow your clients to keep a significant amount of the value they have created. Proper planning takes time, and should begin well before the sale process is in full swing.
In sum. The truth is, every day, CPAs encounter complex tax, business planning, and business succession situations that require the help of a tax attorney. Maybe a client has fallen behind in paying his taxes, or has made an oversight that prompts an IRS investigation. Maybe a client has shared secrets the CPA has no privilege to protect. Maybe he needs to appeal an IRS audit in tax court.Perhaps a client wants to implement an executive compensation package to retain valued employees, wants to expand into a new line of business or wants to plan for an orderly transition of business ownership. These are no longer tax issues; they are legal issues and require the expertise of a tax attorney. There will certainly be days that you will be glad to have a trusted tax attorney on speed dial.