US tax lawyers, enrolled agents and CPAs are bound by Circular 230

In delivering legal services, an attorney will often need the assistance of non-lawyers who will become privy to confidential information.  At its most basic level, non-attorney personnel in the lawyer’s firm – paralegals and other assistants, secretaries, etc. – will become privy to the information.  Disclosures of such information to these personnel will not constitute a waiver of any privileges that may otherwise apply.  Often, however, the attorney will find it helpful to engage personnel outside the firm.  For example, often in a tax engagement, an attorney will hire an outside accountant to assist the lawyer in delivering legal services to the client.  The lawyer may want the accountant to meet with the client and obtain information directly from the client, and cloak that information in the attorney-client privilege just as if the lawyer obtained it directly rather than through the accountant.  The traditional method by which that is done, at least in a tax practice, is through an arrangement whereby the lawyer engages the outside personnel – accountant in the present example – to become part of the team delivering legal services to the client.  

This procedure was approved early on in a case called United States v. Kovel, 296 F.2d 918 (2d Cir. 1961).  The case is now shorthand for the concept.  The engagement for such legal related services is now commonly called a Kovel engagement, and the service provider is called a Kovel accountant or whatever is appropriate for the nature of the services.  Here, as in many areas of the law, it is imperative to do it and do it right.

The Kovel arrangement is just a logical subset of the attorney-client privilege.  So, its parameters are set by the attorney-client privilege we have discussed above.  However, the following key points to keep in mind in using the arrangement. 

First, it is better form for the attorney to engage the Kovel expert rather than having the client do so.  Some cases will honor the Kovel claim for client-engaged experts, but establishing the required nexus between the Kovel expert and the attorney can be dicier where the attorney is not involved in the engagement.  The better part of wisdom is to avoid this issue by doing it right in the first place.  Good lawyers will formally engage the accountant, often in a three-way agreement among the lawyer, the accountant and the taxpayer.  A nuance of this consideration is how the Kovel expert’s billing is handled.  Some attorneys have the Kovel expert to bill the law firm, with the law firm then passing the cost to the client.  Others have the Kovel expert bill the client for direct payment by the client, but only after the lawyer reviews and approves the bill first.  Either way should work. 

Second, a valid Kovel expert can involve any type of expert needed for legal representation – not just the accountant as expert on tax matters used in the Kovel case.  For example, media experts used by the attorneys in providing representation can qualify for the privilege.  And, so long as the third party is assisting the attorney in the legal representation, there is no requirement that the third party have a formal engagement agreement or even be independently paid by the client or the lawyer.  The key is that the client asserting the privilege with respect to such services show the logical nexus to the delivery of legal services. 

Third, as in Kovel, the attorney need not be present when the Kovel expert and the client are meeting in furtherance of the expert providing the assistance to the lawyer. 

Fourth, potential problems are encountered in the Kovel engagement of an accountant that has been a long-term accountant for the taxpayer or provides ongoing non-legal services for the taxpayer.  The threshold problem is that it might be difficult to distinguish between what the accountant knows outside the Kovel engagement and what he or she knows only within the Kovel engagement.  Using the historical accountant requires that extra steps be taken to assure that the information related to the Kovel engagement is clearly separate from the information learned in the accountant’s other engagements.  A relatively recent case involved a large corporation that engaged a large accounting firm to render advice on a sensitive reorganization issue.  The officer in the corporation who engaged the accountants was a lawyer who, of course, rendered legal services to the corporation.  By having clear understandings and clear responsibilities, the lawyer could have “Kovelized” the accountants.  He did not do that, however, and the engagement was treated as just a continuation of the historical services which were services rendered by accountants to the corporation.  As I said, the planning was very sensitive and when the IRS audited, it wanted to look at the planning memoranda.  Bottom-line, the Second Circuit held that the taxpayer had not satisfied its burden to establish that the accountants had been engaged in the rendering of legal services through an attorney for the taxpayer.  Like I say, with a little attention to detail, for that type of planning transaction, the accountant could have easily been Kovelized.  The attention to detail would have been to prepare a Kovel agreement clearly delineating that the services would be rendered to the corporate attorney for legal advice to the corporation, to require the accountants to treat the engagement separately (e.g., separate billing and maintenance of separate privileged files within the accounting firm), and have the corporate attorney as the conduit through which all advice flowed. 

Fifth, one of the most nettlesome issues in dealing with the attorney-client privilege in a tax practice, exemplified by Judge Posner’s visceral reaction in Frederick, is to distinguish between providing legal services that qualify for the privilege and providing other types of services which do not qualify for the privilege.  It is always the client’s obligation to establish the privilege.  This means that where an attorney or an expert serves in more than the capacity of just serving as lawyer or as an expert rendering advice to assist in the legal representation, respectively, the client may not be able to establish the privilege.  This issue often arises in a situation of the filing of an amended return.  If an accountant is engaged by the attorney to prepare the amended return that, after review, may be filed by the client, does the filing of the amended return waive the privilege for all communications to the accountant or alternatively, at least as to information that flowed from the client to the accountant /return preparer that is put on the return, was there ever an expectation of confidentiality, a basic requirement for the privilege?  This is just to say that, just as the lawyer who appears in a dual role a la Frederick and Bornstein must be careful what he does, so too must the lawyer pay close attention to the Kovel expert’s services. The lawyer may not want everything the accountant learns to be an open book to the IRS if it inquires.  This particularly should be considered where the lawyer engages an accountant under a Kovel arrangement to prepare amended or delinquent returns in order, for example, to qualify for the voluntary disclosure policy.  The filing of the returns will mean that the Kovel expert’s kimono is opened a bit, at least as to the items on the return, under the traditional attorney-client analysis.  The question is whether the IRS can then force the full Monty.  (OK, I recognize I am mixing my allusions, but you get the point.)  A court willing to slice and dice the relationship a la Bornstein may save the day for the client, but an unwilling court (or apparently unwilling court) such as Frederick may not.  Careful practitioners with clients with large budgets may solve the problem by engaging two separate accountants – one to serve as a pure Kovel accountant to gather the information and analyze it and then, in consultation with the attorney, to deliver to the second accountant, not a Kovel accountant, only the information for inclusion on the return.  The second accountant then prepares the return with knowledge only of that information.  So the theory goes, if the IRS presses, it will only learn from that second accountant only what he knows which is already presented on the return.  Whether or not this will work remains to be seen, but in appropriate cases (high risk) it should be considered. 

Finally, the IRS is noising about taking a more aggressive stance toward accountants in IRS criminal investigations.  It is too early in the cacophony – to date it is just noise – to figure out precisely what the IRS’ attack may be.  Obviously, however, the IRS will want to interview accountants who are not wearing a Kovel assistant sign on their foreheads, just because they often have information relevant to a tax investigation and, at least in their status as accountant or return preparer, they have no privilege that can be asserted in a criminal investigation.  Indeed, that is precisely why one of the first summonses or subpoenas that are issued are to the accountants.  But, once that accountant is summonsed or subpoenaed, the lawyer engaging the accountant (or the accountant) may spring the attorney-client privilege in its Kovel iteration.  The Government will not be pleased because the very nature of any privilege – particularly an absolute one like the attorney client privilege – is to bar the Government from getting the information.  From the reported cases, the Government does not seem to have aggressively tested the validity of the assertion of the privilege in the Kovel context.  I think the warnings now issuing forth are that the Government will pick out some very extreme cases to test the limits of the Kovel privilege.

 http://federaltaxcrimes.blogspot.ch/2013/04/using-kovel-experts-to-protect-attorney.html