A lawyer/CPA, when asked what he does for a living, always responds that he practiced “tax.” In the tax area, the lines between attorneys and accountants are often blurred.
Some lawyers prepare tax returns, and many accountants help structure business transactions in order to achieve optimum tax benefits, as well as appropriate business opportunity. Given this ambiguous interplay between the two professions, it is often tempting for accountants to attempt representation, even in areas where the two professions do not intersect. After all, both lawyers and accountants practice “tax,” don’t they?
This common misperception, however, can lead to danger, not only for the practicing accountant, but also for the client the accountant is representing. Perhaps the most crucial distinction between the two professions is the applicability of the attorney-client privilege in situations involving issues of taxation. This distinction impacts both attorneys and accountants.
In some areas, the distinction favors the accounting profession. For example, attorneys preparing tax returns for their clients often do not realize that by signing their names as the tax preparer, they are waiving the attorney-client privilege as to matters disclosed on the face of these returns.
Furthermore, an attorney who prepares a pro forma balance sheet and profit and loss statement for her client in connection with a bank loan or sale of the business runs into similar problems of waiver. Finally, attorneys representing estates now routinely retain accountants to prepare estate tax returns under their supervision rather than to attempt to prepare these very complicated returns themselves.
Conversely, accountants run into trouble when the lines between the two professions are crossed to the detriment of the clients they represent. Perhaps the most obvious situation of where an immediate referral to an attorney is necessary is when the accountant becomes aware that a previously filed tax return omitted large amounts of unreported income or inaccurately reported the existence of deductible expenses.
Even where this omission might possibly be explained as an innocent error, immediate attorney involvement is in the best interests of the client, as well as of the accountant who prepared the inaccurate return. The temptation to attempt to rectify the situation by quickly filing an amended return often results in catastrophe.
First, an amended return constitutes an admission by the taxpayer that the original return misstated the taxpayer’s income and/or expenses. Furthermore, a quick amendment of the return locks the taxpayer into the amended return’s statement of income, deductions, and tax liability.
The Case for Working With an Attorney
A referral to an attorney who concentrates in the area of tax controversy protects the clients from the adverse consequences of a premature amendment of the client’s tax return. A competent tax controversy attorney, working with a forensic accountant hired by that attorney in order to protect the attorney-client privilege, can perform the necessary investigation to determine whether and to what extent income actually was omitted and/or incorrect deductions were taken.
Attorneys can also help determine whether other income might have been omitted on the same return and, perhaps whether there are offsetting deductions, previously unreported, ameliorating the tax effects of the omitted income. The referring accountant should not be retained by the attorney to perform this investigation. Instead, if an amended return is necessary, the referring accountant can file the return after the results of the investigation are revealed to the accountant.
Another situation where an attorney referral is advantageous to clients and accountants is when the accountant discovers that the client has maintained a foreign bank account or other reportable foreign assets and has not disclosed the account or the assets on previous forms 1040 or applicable Treasury Department forms.
The IRS and Treasury Department have instituted several voluntary disclosure programs that are available to taxpayers. Under the supervision of a tax controversy lawyer, an initial investigation should be conducted, and after an appropriate forensic analysis has been completed, preparation of appropriate forms and the amendment of returns can be completed.
Once again, the referring accountant should not perform the forensic investigation. The referring accountant’s role becomes important when it is time to prepare and file amended returns and Report of Foreign Bank and Financial Accounts reports pursuant to these voluntary disclosure programs.
Finally, accountants should consider referring a tax matter to an attorney when the client and the accountant are considering a tax position that might be challenged by the IRS. In such a case, simply relying on the pro forma opinion of the promoter of a tax-advantaged investment or the accountant’s experience in similar situations might unnecessarily expose the taxpayer to penalties.
By seeking a written, legal opinion from a reputable tax attorney, the accountant and client can insulate themselves from being penalized unnecessarily. If an attorney concludes that the tax strategy is a dangerous one and should not be pursued, his advice is protected by the attorney-client privilege. Furthermore, if the tax strategy makes sense and is supported by sufficient precedent, the opinion can be released to the CPA and will provide protection from IRS penalties, both for the taxpayer and the preparer.
In this era where the IRS often uses its Circular 230 as a sword rather than as a teaching tool, it is better for both the accountant and the taxpayer to be safe rather than to be sorry.