Kovel Letter – Attorney-Client Privilege when Hiring a CPA?

Kovel Letter – Attorney-Client Privilege when Hiring a CPA?

What is ‘Kovel Accountant’ Protection

Many years ago, there was an important tax case in the Second Circuit Court of Appeals involving the extent to which the attorney-client privilege applies in conjunction with the advice received from a non-attorney. The name of the case was Kovel. Unfortunately, the holding in Kovel has been consistently misapplied and mischaracterized by attorneys — and specifically misapplied as to how the ‘protection’ applies to Taxpayers using an accountant to prepare tax returns. The protection that a taxpayer may receive in conjunction with Kovel is very limited. Most importantly, it does not protect accounting advice. As a result, many taxpayers have been misled to believe that if the law firm issues the taxpayer a Kovel letter then all the communications between the taxpayer and the accountant are automatically protected under the attorney-client privilege. Not only is this irresponsible, but it is also dangerous to the taxpayer who may end up inadvertently breaching the attorney-client privilege and confidentiality protections with their attorney, based on incorrect information they received from the law firm that represents them. Let’s walk through the basics of what a Kovel accountant is and isn’t.

U.S. v. Kovel 

In this case, Kovel was a former Internal Revenue Agent who was subsequently employed by a law firm after leaving the IRS. The law firm specialized in tax law. A client of the firm was under investigation for federal income tax violations. When Kovel was subpoenaed, they took the position that since Kovel was employed by the law firm, the communications made by him to the client who was under investigation were protected by the attorney-client privilege.

The Client Holds the Key to the Privilege

When it comes to the attorney-client privilege, it is important to note that it is the client that holds the key to the privilege and not the attorney. In other words, if the client agreed that Kovel could testify for example, then Kovel could not claim the attorney-client privilege because the client would have waived the privilege by consenting or authorizing Kovel to testify. Here, the client did not consent. The judge rejected Kovel’s claim for protection and demanded that Kovel answer the question because the judge’s position was that the privilege does not extend beyond the attorney and since Kovel was not an attorney, the privilege would not apply.

Second Circuit Court of Appeals Ruling

The case was then brought up on appeal on the issue of how the attorney-client privilege would apply in this type of situation, in which there are communications between a non-attorney and a client of the law firm.

Legal vs Accounting Advice

An important key distinction made in this case involves the difference between obtaining accounting advice and legal advice. In other words, if a client is speaking with a non-lawyer employed by a firm for accounting advice, then generally there is no privilege for those communications — and the court refers to the case of Olender v United States. If instead, the advice is coming from a non-lawyer employed by the firm in order to aid the attorney in providing legal advice, then there might be an extension of the attorney-client privilege in certain situations. The question then becomes what type of advice is protected and how far the privilege extends.

Law Firm Personnel

As a side note, the case is not referring to communications made to staff member such as secretaries, receptionists, clerks, etc. — which is covered by the privilege.

As provided by the Court:

• • • On the other hand, in contrast to the Tudor times when the privilege was first recognized, see 8 Wigmore, Evidence, § 2290, the complexities of modern existence prevent attorneys from effectively handling clients’ affairs without the help of others; few lawyers could now practice without the assistance of secretaries, file clerks, telephone operators, messengers, clerks not yet admitted to the bar, and aides of other sorts.

    • “The assistance of these agents being indispensable to his work and the communications of the client being often necessarily committed to them by the attorney or by the client himself, the privilege must include all the persons who act as the attorney’s agents.” 

Kovel Holding

• • • “Hence the presence of an accountant, whether hired by the lawyer or by the client, while the client is relating a complicated tax story to the lawyer, ought not destroy the privilege, any more than would that of the linguist in the second or third variations of the foreign language theme discussed above; the presence of the accountant is necessary, or at least highly useful, for the effective consultation between the client and the lawyer which the privilege is designed to permit.

    • By the same token, if the lawyer has directed the client, either in the specific case or generally, to tell his story in the first instance to an accountant engaged by the lawyer, who is then to interpret it so that the lawyer may better give legal advice, communications by the client reasonably related to that purpose ought fall within the privilege; there can be no more virtue in requiring the lawyer to sit by while the client pursues these possibly tedious preliminary conversations with the accountant than in insisting on the lawyer’s physical presence while the client dictates a statement to the lawyer’s secretary or is interviewed by a clerk not yet admitted to practice.

    • What is vital to the privilege is that the communication be made in confidence for the purpose of obtaining legal advice from the lawyer. If what is sought is not legal advice but only accounting service, as in Olender v. United States, 210 F.2d 795, 805-806 (9 Cir. 1954), see Reisman v. Caplin, 61-2 U.S.T.C. ¶ 9673 (1961), or if the advice sought is the accountant’s rather than the lawyer’s, no privilege exists.”

Interpreting Kovel

A very important takeaway from the Kovel case is that the accountant was hired by the attorney to assist the attorney in providing legal advice – not to provide accounting advice or services. In other words, if a lawyer has to provide legal advice on a matter involving a complicated tax case, and the lawyer relies on an accountant to assist with providing that legal advice — then merely having the client speak to the accountant about the case — so that the accountant can assist the attorney with providing legal advice — does not necessarily destroy the privilege. The reason why the distinction between tax and legal is so important, is that if an attorney hires an accountant to prepare tax returns, the accountant’s services are not covered under Kovel. Likewise, if an attorney hires an accountant to assist the Taxpayer with tax return preparation and the client ends up speaking directly with the accountant on legal-related matters, then the privilege for those communications may be lost (since they were made to the accountant and not the attorney) — or at least not covered under Kovel.

Is Kovel used by Tax Attorneys?

Generally, tax attorneys are well versed in tax matters and do not require an accountant to assist to provide tax legal advice in tax matters. Thus, Kovel is primarily used by non-tax attorneys who do not have a background in tax law. If your tax law attorney is trying to sell you on accounting services with a third party under Kovel, you should be sure to have them explain to you why the law firm in your tax matter must hire a ‘Kovel Accountant’ just so they can provide you with legal advice about tax law (which you are already paying them to provide you with).

Is Tax Return Preparation Protection by Attorneys?

The issue of tax law firms preparing tax returns is a common issue in offshore disclosure matters.

For example: If a law firm hires an accountant in an offshore disclosure matter to prepare tax returns, that tax preparation is not covered under the attorney-client privilege.

But what if the law firm prepares the tax return?

In general, tax returns are not covered under the attorney-client privilege. The question then becomes if an attorney prepares or leads the tax return preparation and the client provides legal information to the attorney, is that information protected under the attorney-client privilege?  The general thought is that the legal information provided to the attorney would still be protected under the attorney-client privilege — different circuits utilize different tests to determine if the communication is protected. 

*Earlier this year a case was grant certiorari by the Supreme Court on the specific issue of ‘dual-status communications’ but was later dismissed as ‘improvidently granted‘ (meaning the Supreme Court then determined certiorari should not have been granted in the first place).

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