You Can’t Handle The Truth

What you tell your CPA can be used against you.

Can you confide in your CPA? Are your conversations about your business protected? In reality, the law affords those conversations about as much protection as an umbrella in a hurricane. There is a privilege for federal tax preparers that applies to memos, opinions or other documents pertaining to your actual or potential tax liability, but the privilege does not apply to any work papers used to prepare the tax return. Your CPA may also be forced to reveal his knowledge in matters involving state, local or any jurisdiction other than the IRS, and any criminal matter including criminal tax matters. Recent court decisions further weaken any perceived protection. So, when it comes to protecting conversations regarding your business, what are your options? First and foremost, utilize a competent tax preparer to handle tax compliance chores (tax returns and financial statements), but seek the advice of an attorney for business and tax planning strategies. Also, consider the following scenarios and strategies.

A license to practice

Who can represent you in front of a judge? States determine the requirements for attorney licensing. All states require graduation from law school and admission to the respective state bar. For example, in order to be licensed to provide legal advice in Illinois, a person must have graduated from a law school accredited by the American Bar Association, have passed the Illinois Bar Examination and have undergone an examination by the Character and Fitness Committee of the Illinois Supreme Court.

Two exceptions exist allowing non-licensed individuals to act as legal counsel within the court system. First, an individual may represent himself or herself in a legal matter. Pro-se representation has been granted to individuals since the Judiciary Act of 1789 was signed into law by President Washington.

Second, in tax matters, the Internal Revenue Code (IRC) Section 7452 allows non-attorneys to represent taxpayers in tax court, as regulated by the Chief Counsel of the Internal Revenue Service. To represent a taxpayer in tax court (or in another IRS proceeding), a non-attorney must pass an examination.

Attorney-client privilege

In the movie “Primal Fear,” moments after Richard Gere’s attorney character victoriously defeats the prosecution, freeing his altar boy client accused of murder, he visits him in the jail cell. After a conversation with the newly-freed man, the attorney walks away, now realizing not only is his client guilty, but that he is the only person with the knowledge of this truth, and that he is bound to secrecy. So, if an attorney discovers his client has indeed committed a heinous crime, why can’t he turn the client over to the authorities? The reason is because the attorney-client privilege protects the communication made between the client and the attorney in the scope of representation. Most importantly, this privilege is held by the client, not the attorney.

Aside from the educational difference between attorney and non-attorney representation (in a tax matter), there is also a difference with regards to where the privilege ends. IRC Section 7525 extends clients the protection of the privilege even when represented by a non-attorney in a civil tax matter. The general rule extends the same “common law protections of confidentiality that exist between a taxpayer and attorney between a taxpayer and any federally authorized tax practitioner.”

However, if the tax matter eventually results in a criminal prosecution or a tax shelter argument, the privilege may no longer be asserted by the client with a nonattorney representative. Instead, the nonattorney representative may be called as a witness for the criminal case. In contrast, a client may still assert the privilege if his or her representative is an attorney, which is an obvious and unarguable benefit of engaging an attorney as legal representation over a non-attorney even when tax matters may permit the option.

Unauthorized practice of law

In the blockbuster hit “The Rainmaker,” Rudy Baylor enters the courtroom to take on a swanky insurance company defendant targeting low-income clients and denying their well-founded claims. He enters the courtroom, having recently passed the bar exam, but without a license. He is thrown out of the courtroom, being threatened with severe sanctions of “unauthorized practice of law without a license.”

The practice of law is defined in Illinois as “the giving of such advice or rendition of such service requires the use of any degree of legal knowledge or skill.” People ex rel, Illinois State Bar Association v. Schafer, 404 Ill. 45, 87 N.E.2d 773, Ill.1949. Every jurisdiction has a different interpretation on the practice of law.

Lawyer and non-lawyer alike can suffer repercussions from the unauthorized practice of law. Depending on the jurisdiction, the violator can be charged with a crime or even sued for malpractice. When an unlicensed person holds himself or herself out as a lawyer, the law of frauds is violated. People v. Schreiber, 250 Ill. 345, 95 N.E. 189, Ill. 1911. Unlicensed individuals are often held at the same standard of care, and therefore, can often be sued for malpractice. Example see Biakanja v. Irving , 49 Cal.2d 347, 320 P.2d 16, Cal. 1958.

Multidisciplinary practice

Alternatively, although an individual may in fact be a licensed attorney, he or she may not be practicing law. Attorneys are not permitted to “practice law” if part of a multidisciplinary firm, such as an accounting firm. However, even absent the actual practice of law for his or her clients, the benefit to obtaining an attorney, even if bound not to practice law, is his or her expertise of the law.

Adept in legal research, attorneys have been trained to not only find the applicable laws, but also interpret their controlling order. When faced with the IRC, revenue rulings, revenue procedures and court precedent of various jurisdictions, having expertise with the interpretation of the federal and state tax laws is beneficial. More often, a professional not adept in the order or interpretation of law will conduct incomplete research and potentially make a mistake in a client recommendation, or more likely, omit all or a portion of the client’s current or deferral tax opportunities.

Another benefit of engaging an attorney, or a multidisciplinary team with an attorney, is the other areas of expertise obtained. For example, estate planning, benefits planning and retirement planning are other areas affected by tax law, but also overlay into other areas of the law. A closely-held business owner should consider these areas when creating a proactive tax plan. The interpretation of laws in one of these areas overlaps into the next. Exhausting all areas interdependently produces a synergistic result.

For example, benefits planning affects the owner’s tax situation because he or she is the owner of the company (type of benefit determines the deductibility by the company), as well as an employee (benefit may or may not be included in personal income depending on the type of benefit). The business owner should consider the tax consequences of the benefits he or she offers prior to putting the plan in place. The ability to expertly identify which benefits may fall into a tax-advantaged category may require a tremendous amount of legal research. For example, this research may involve studying court cases from a given jurisdiction to discover what was upheld as deductible and what was held not to be deductible. Again, the attorney-team’s expertise in legal research is beneficial, as is past litigation experience.

Many popular movies portray the inexperienced solo-team rookie underdog winning the trial, as Hollywood certainly loves a story of the exception rather than the rule! However, it is important to remember that the true winner is the client who never ends up in the courtroom in the first place. By utilizing an expert team of attorneys with an array of experience and backgrounds, a proactive comprehensive tax plan can be devised to reduce a taxpayer’s risk, increase business and personal asset protection, explore valuable deferral and retirement opportunities and produce a synergistic benefit for a closely-held business owner.