A CPA-attorney, when asked what he does for a living, replies that he “practices tax.”
This is understandable, according to James Mahon, a shareholder in the Tax and Litigation practice groups of law firm Becker & Poliakoff.
“In the tax area, the lines between accountants and attorneys can be blurred. Some lawyers prepare tax returns, and many accountants help structure business transactions in order to achieve optimum tax benefits,” he explained.
But because of the interplay between the two professions, accountants are frequently tempted to represent clients where the professions do not overlap, and this can be dangerous both for the accountant and the client, according to Mahon. “Even though both lawyers and accountants practice in the tax area, there are things that CPAs do that are more appropriate to let them do, especially in the area of preparing tax returns,” he said.
“In some areas, the distinction favors the accounting profession,” he observed. “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 matter disclosed on the face of the returns. Moreover, attorneys who prepare a pro forma balance sheet and profit and loss statement for their client in connection with a bank loan or business sale run into similar problems of waiver.”
“Once you open up a subject matter privilege, the waiver is complete,” he said. “It’s a matter of federal law, and tax returns are federal. Most states also follow that general rule. It’s a better idea for lawyers to do the lawyering and CPAs to do the actual preparation and signing of a return.”
“If there’s a tax issue and it goes to a tax attorney, it becomes a legal opinion,” he said. “If the attorney then prepares the return, the buffer, which is an important part of the privilege, evaporates, so it’s better to have a CPA do the return.”
There are other areas in which the accountant is at a disadvantage and must take special care, Mahon observed.
“Accountants can run into trouble when the lines between law and accounting are blurred, causing a detriment to their clients,” he said. “An obvious situation is where an accountant discovers that a previously filed tax return omitted large amounts of unreported income or inaccurately reported the existence of deductible expenses. Even in situations where this might be interpreted as innocent error, it calls for referral to an attorney. There’s a temptation to try to correct the situation by quickly filing an amended return — but that can be dangerous.”
“An amended return is an admission by the taxpayer that the original return misstated the taxpayer’s income or expenses,” he said. “It further locks the taxpayer into the amended return’s statement of income, deductions and tax liability.”
The first element of tax evasion under Code Section 7201 is omitting income from the return or claiming deductions that have no basis in fact, he noted: “You start with the fact that that’s element one, and then get into an entirely different area, which is voluntary disclosure. For the last 75 years the IRS has had an informal program that if you report the income you miss they often will elect not to prosecute you, but that is an area that should properly be handled by an attorney, rather than an accountant.”
“For example, a CPA firm finds that Mr. Taxpayer omitted $35,000 in income by looking at savings account information and finding deposits that didn’t come from Paychex,” he posited. “The immediate thought is to amend the return and report the income, but the concern I would have is that it may be just the beginning of the problem. It may be that the total amount omitted is really $100,000, rather than $35,000. That requires a forensic analysis.”
By referring the matter to an attorney who concentrates in the area of tax controversy, the client is protected from the adverse consequences of a premature amendment, Mahon indicated: “A competent tax controversy attorney, working with a forensic accountant hired by the attorney in order to preserve the attorney-client privilege, can perform the necessary investigation. They need to determine whether and to what extent income actually was omitted or incorrect deductions were taken, whether other income was omitted, and if there are any unreported offsetting deductions. Where the attorney uses a CPA who works for the attorney, not for the client, anything the client tells the accountant is covered by the accountant-client privilege.”
The same is true with improper deductions reflected in the initial return, Mahon suggested. “The CPA may discover that even though these deductions were wrong, there are other deductions that were not taken and these could offset the erroneous deductions.”
MATTERS OF PRIVILEGE
Code Section 7525 provides a limited privilege between taxpayers and preparers in noncriminal proceedings before the IRS and federal court. It states that, “With respect to tax advice, the same common law protections of confidentiality which apply to a communication between a taxpayer and an attorney shall also apply to a communication between a taxpayer and any federally authorized tax practitioner to the extent the communication would be considered a privileged communication if it were between a taxpayer and an attorney.” Under the code, “federally authorized tax practitioner” means a person authorized to practice before the IRS if their practice is “subject to regulation under Section 330 under Title 31.”
“When investigating prior issues such as omitted income or inflating expenses, be careful what you ask for,” said Gary Shendell of law firm Shendell & Pollock PL, a former CPA and an attorney who represents CPAs in litigation. “You may find out that the problem is far worse than the amended return reveals. It could become a criminal issue or some other legal issue that is a bit more serious. The question becomes one of professional responsibility — to what extent would the accountant be blowing the whistle on his client. One of the issues would be whether to refer out to a lawyer. You would have to determine how deep the problem goes.”
Another situation that may call for the involvement of an attorney is where the problem arises of failure to disclose income earned abroad or the ownership of a foreign bank account or other assets, according to Guy Novo, of counsel at Becker & Poliakoff.
“There are a number of voluntary disclosure programs available which offer taxpayers with undisclosed income an opportunity to get current with their tax returns without incurring the severe penalties that would otherwise apply,” he said. “When you deal with income earned abroad, you also have to deal with foreign tax credits and various tax treaties which may impact the amount of tax owed. They govern how income will be treated in connection with international transactions, and they create rules that usually differ slightly with what the laws of the country might otherwise provide. One of the important considerations is whether [the treaties] have an enforcement mechanism.”
Lastly, accountants might refer an issue to an attorney when the accountant and client are considering a tax position that the IRS might challenge, according to Mahon.
“By getting a written legal opinion from a reputable tax attorney, the accountant and client can insulate themselves from being penalized,” he said. “Where the attorney concludes that the tax strategy is dangerous and should not be pursued, that advice is protected by the attorney-client privilege. On the other hand, if the strategy makes sense and is supported by precedent, the opinion will provide protection both for the taxpayer and the preparer.”
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