For many of us our tax return is the most important document we will create in the year, and the document fraught with the most potential peril. Any return beyond a simple short-form wage earner document can make us nervous.
Am I being too aggressive? Am I claiming something that the IRS may view as over the top? Do I have exposure for past years, and would amending past returns make the situation better or worse?
Perhaps the most important question of all is one that many people don’t think about: How much can I safely tell my accountant, and how much can I reveal in writing without fear it will be used against me?
It is a little-known fact that all IRS approved tax preparers, whether a CPA, accountant, Registered Agent, or anyone who has a Preparer Tax Identification Number actually owes their allegiance to the IRS—NOT YOU THEIR CLIENT. In fact, each of them signs a written agreement with the Internal Revenue Service that declares they will act in the “best interest” of the IRS!
You must sign tax returns under penalties of perjury. The numbers you report must be true—they’re not an opening offer. Given the wide disparity in education and experience amongst tax preparers, you are really at their mercy. Since the tax laws are frequently nuanced, one preparer might interpret them differently from another.
Taxes are complex, and the line between creative tax planning and tax evasion can be less clear than you might think. What is good planning, what is over the line? Do you have non-cash items on your return? What about foreign investments and offshore accounts? What is fraud, and how long do you have to worry?
Anything you tell your CPA can be demanded by the IRS. If you make statements or provide documents to your accountant, he/she can be compelled to divulge information to them no matter how incriminating.
This is not the case if you use an attorney to manage the preparation of your business and personal tax returns. Thanks to attorney-client privilege, if you tell a lawyer secrets (say you are hiding money offshore), the IRS cannot make your lawyer talk.
The IRS generally can’t make your lawyer produce documents. The attorney-client privilege is strong precisely so that clients (in both civil and criminal cases) will be forthcoming with their lawyers.
In the interest of complete disclosure it is worth noting that there is a statutory “tax preparation” privilege. It was added into the tax code (IRC Section 7525(a)(1)) in 1998. But it is quite narrow, and is completely inapplicable to criminal tax cases. That makes it of little value. In contrast, attorney-client privilege is worth a great deal and provides enormous protections under the law.
What is the answer: A Kovel letter.
A Kovel letter is named after United States v. Kovel and works like this. You hire a tax lawyer, and your tax lawyer hires an accountant. In effect, the accountant is doing your tax accounting and return preparation but reporting as a subcontractor to your lawyer. Properly executed, this end-run bestows attorney-client privilege to the accountant’s work and communications.
While this may seem too good to be true, the Kovel letter has withstood numerous legal challenges. There have been isolated and very specific cases (United States v. Richey and United States v. Hatfield) where partial disclosure was mandated by the court.
Overall, the Kovel letter has withstood the test of time, the mere fact that a Kovel arrangement in place can make it unlikely that the IRS will push for disclosure around the edges. Having a Kovel agreement can make accountants more comfortable and more responsive as well.
Pre-existing relationships between the accountant and the ultimate client can be prickly. A Kovel arrangement is premised on the notion that the accountant’s communications were “made in confidence for the purpose of obtaining legal advice from the lawyer.” (See United States v. Adlman.) The attorney is the client in a Kovel engagement so the accountant should address all correspondence to the lawyer.
It is our standard policy here at US Tax Relief to have a Kovel letter with all of our clients. Regardless of the size of your return or the nature of your claim for relief, our attorneys will manage all aspects, supervising any of our accounting professionals on your behalf.
This will not only benefit you during the time we are negotiating with the IRS on your behalf. If you continue to work with us and we are preparing future returns you are assured that what you share is protected behind the strong firewall of attorney client privilege.