A Kovel agreement extends the attorney-client privilege to communications between a taxpayer and an accountant when a lawyer hires the accountant to assist in providing legal advice to the client. This means that communications and work product from the accountant are protected from disclosure in certain legal proceedings, including those involving tax issues.
Simply put, a Kovel agreement is an arrangement whereby a client engages counsel to provide legal services, and counsel, in turn, engages specialists, such as certified public accountants (CPAs), to support its services to the client.
The accountant, often a CPA, plays a crucial role in a Kovel agreement. They interpret complex technical accounting, financial, and tax concepts into easily understandable language for clients and counsel.
When a Kovel agreement is executed, protections typically limited to the client's interactions with counsel, namely attorney-client privilege and attorney work product privilege, are extended to specialists, such as CPAs, engaged by counsel on the client's behalf.
With a Kovel agreement in place, a wider scope of communications and documents receives robust protection from disclosure to third parties, ensuring a sense of security for the involved parties.
Attorney-Client Privilege
The attorney-client privilege is a crucial legal concept that protects confidential communications between attorneys and clients made for the purpose of obtaining or providing legal advice. Its significance is paramount, as it allows a client to refuse to disclose confidential communications and prevent others from disclosing them as well.
The privilege does not apply to communications made in the commission or furtherance of criminal activities, such as fraud or tax evasion. For instance, if a client seeks legal advice on how to evade taxes, such communications would not be protected by the attorney-client privilege.
The attorney work privilege, often confused with the attorney-client privilege, is a separate concept. It permits attorneys to withhold from production documents and other tangible things that contain the attorney's insights and that were prepared by counsel in anticipation of litigation or for trial.
It can also extend to materials prepared by other parties, such as certified public accountants (CPAs) engaged by counsel on behalf of a client.
This privilege is distinct from the attorney-client privilege, which protects confidential communications between attorneys and clients made for the purpose of obtaining or providing legal advice.
Is the Protection Sufficient?
While the accountant-client privilege under Internal Revenue Code Sec. 7525 is similar to the attorney-client privilege in providing protections for communications between a taxpayer and an accountant, this privilege has weaknesses.
For example, it applies solely to tax advice and not to tax compliance or business advice. It is also limited to non-criminal matters before the IRS or in federal courts involving the IRS, and does not apply to:
- Private civil actions,
- Tax shelters,
- State and local tax advice, or
- Matters before the SEC.
Additionally, it only applies to communications between the accountant and the taxpayer. Also, the privilege is not available upon the commencement of a criminal investigation or prosecution. Therefore, no one should place significant reliance on this privilege.
Kovel Agreements Quick Facts
- The Internal Revenue Service (IRS) has broad statutory authority to investigate and audit taxpayers.
- The IRS often attempts to fulfill this authority by seeking communications made between taxpayers and accountants.
- Communications between taxpayers and their accountants are not protected unless a Kovel agreement is in place.
- By extending attorney-client privilege to communications with accountants, a Kovel agreement provides significant relief to taxpayers facing IRS scrutiny, reassuring them of the protection their communications receive and enhancing their sense of security.
- A "Kovel accountant" is an accountant or CPA whom an attorney uniquely hires to provide legal advice to a client in tax matters.
- Named after a landmark ruling in U.S. v. Kovel (1961), a "Kovel agreement" introduced a pathway to shield certain taxpayer-accountant communications. This agreement allows the attorney to hire an accountant to assist in providing legal advice to the client.
- The Kovel privilege generally applies when the attorney hires the accountant to assist in providing legal advice, not just for general accounting or tax preparation services.
- A Kovel agreement should state that it is counsel's responsibility to direct the CPA's services, and the CPA takes instruction from counsel for all aspects of the engagement.
- A Kovel agreement should identify the party responsible for the payment of the CPA's fees, which is typically the client.
What Does Section 7525 Say?
26 U.S. Code 7525 - Confidentiality privileges relating to taxpayer communications says -
(a) Uniform application to taxpayer communications with federally authorized practitioners.
(1) General rule
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.
(2) Limitations
Paragraph (1) may only be asserted in
(A) any noncriminal tax matter before the Internal Revenue Service; and
(B) any noncriminal tax proceeding in Federal court brought by or against the United States.
(3) Definitions
For purposes of this subsection-
(A) Federally authorized tax practitioner
The term "federally authorized tax practitioner" means any individual who is authorized under Federal law to practice before the Internal Revenue Service if such practice is subject to Federal regulation under section 330 of title 31, United States Code.
(B) Tax advice
The term "tax advice" means advice given by an individual with respect to a matter which is within the scope of the individual's authority to practice described in subparagraph (A).
(b) Section not to apply to communications regarding tax shelters
The privilege under subsection (a) shall not apply to any written communication which is-
(1) between a federally authorized tax practitioner and-
(A) any person,
(B) any director, officer, employee, agent, or representative of the person, or
(C) any other person holding a capital or profits interest in the person, and
(2) in connection with the promotion of the direct or indirect participation of the person in any tax shelter (as defined in section 6662(d)(2)(C)(ii))."
What are the Requirements?
To ensure that communications with a Kovel accountant are protected, specific stipulations must be met, such as the following:
- The accountant must be formally hired by the attorney, not directly by the taxpayer.
- The accountant's work must directly relate to the attorney's provision of legal advice rather than independent accounting functions.
- The engagement agreement should clearly identify the attorney, not the taxpayer, as the client.
- All communications involving the accountant, attorney, and taxpayer must be made confidently and for the purpose of obtaining legal advice.
What Should You Consider?
While Kovel agreements are not always necessary in civil tax cases, they can be important when a taxpayer is under criminal investigation or when sensitive information could expose them to legal liability. Without a Kovel arrangement, communications with an accountant could be subject to disclosure during audits, depositions, or court proceedings.
Suppose an accountant uncovers a potential tax irregularity while representing a client. In that case, the absence of a Kovel agreement may require them to disclose this information if subpoenaed. Thus, taxpayers navigating IRS scrutiny must take deliberate steps to protect their communications and safeguard their legal rights.
A Kovel agreement offers a tool to extend the protections of attorney-client privilege to an accountant's work when it supports legal advice. If you are facing tax issues or believe criminal charges may arise, contact our federal criminal defense attorneys to determine whether obtaining a Kovel accountant is the right move for you.
A taxpayer should ensure that a Kovel agreement has been entered into before making any potentially harmful communications to an accountant or certified public accountant (CPA). For more information, contact the Hedding Law Firm, located in Los Angeles, California.
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