How to Undermine Your Tax Positions: Let’s Talk About Privilege

It is another brisk morning walk to work. Leaves swirl about and black coffee warms your body as the autumn wind blows. Once inside, you take the elevator all the way up before walking down the hall to your office. You just closed the quarterly books, so your morning is busy preparing to report financials. Despite the chaos, you are calm and in control. You then open an email from your general counsel, and all calm is shattered.

Counsel informs you that your company has been sued. It is a sales tax suit, so you initially assume that it is not significant, but you quickly find out how wrong that assumption is. It is a big number and will be both resource-intensive and expensive to resolve. You email your tax department, who assures you that they worked with a reputable accounting firm to make the determinations and tax filings in question. You request and review the memorandum that the accounting firm drafted with their thoughts on the issue—it was gray, but they reached a decision while pointing out the potential risk. You breathe. You email your controller, who confers with your auditor and then informs you that the position in the suit is not “reasonably possible” and “estimable” and, thus, does not need to be disclosed. You breathe. You draft an email instructing your tax and legal teams (copying the accountants) to engage legal counsel to respond to the filing. Again, you breathe…and move on.

Your quarterly and annual filings go well, and even your Q1 goes out without cause for alarm. But in late spring, the bottom drops out. Again, you open an email from counsel related to the sales tax lawsuit. Except that this email includes a discovery request from opposing counsel requiring you to “[s]tate and describe in detail all facts, reasons, and opinions, including, but not limited to, advice you received from tax preparers, tax accountants, consultants, or others…” You stand up, blood rushing to your face, and before you breathe you call your tax attorneys.

You try to remain calm but fail. How can this be? They cannot obtain this! Communications with tax accountants are confidential and protected in discovery…right?! WRONG. You hang up, you sit down and try to collect your thoughts before briefing your CEO. You screwed up. Your team screwed up. And now, it is going to be expensive.

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This pattern of events may seem unlikely, but it happens more often than you would think. Taxpayers continue to hire accounting and consulting firms to help them sort through various issues related to sales tax—things like whether they have triggered nexus and need to register and collect tax prospectively, or whether the products and services they are purchasing and selling are taxable. Or whether the entity they are looking to acquire has actual historical liabilities or exposures for unpaid tax. These are matters that depend upon statutory and regulatory analysis. In other words, they are legal issues.

Of course, most service providers are happy to look into these issues, provide their analysis, and increase their firm’s revenue by billing a client. However, even if we set aside the issue of engaging in the unauthorized practice of law, the impact that this type of involvement by those parties has on potential disputes with taxing authorities should be sufficient to dissuade non-lawyer providers from representing their clients in this manner.

Increasingly, taxpayers are caught up in significant lawsuits related to sales tax collections, such as class actions for over-collecting and qui tam actions (i.e., False Claims Act or whistleblower lawsuits) for under-collecting. What’s more devastating is that taxpayers may have been operating under the false impression that communications with accountants/consultants are confidential and privileged. Unlike attorneys, whose client communications are entitled to evidentiary privilege, accountants or consultants do not enjoy such a privilege.

Taxpayers often presume that the duty of confidentiality under which they provide information to their accountants/consultants protects that information from being disclosed. Which is to say, they mistakenly believe that the protections provided by attorney-client privilege are the equivalent of the duty of confidentiality. Unfortunately, that is not the case. While the duty of confidentiality is an ethical duty of a party not to share client information, it is different than the attorney-client privilege. Unlike the duty of confidentiality, the attorney-client privilege is an ethical privilege which is at the core of the attorney relationship, meaning that communications with attorneys are generally not discoverable by the opposing side when a client chooses to litigate a matter.

This is a critical difference—taxpayer communications with accountants and consultants are discoverable during litigation whereas those with attorneys generally are not.

Consider the impact this has when a taxpayer litigates a qui tam or class action lawsuit. Or when they decide to litigate an improper denial of a refund claim they’re pursuing. Emails, memoranda, spreadsheets, analyses, and other notes or communications that were exchanged with an accountant or consultant, the ones that aim to protect the service provider’s firm from potential professional liability by pointing out all of the areas of risk and using the “it depends” language freely, must now all be handed over to the qui tam or class action plaintiffs, to the state or local jurisdiction, the Department of Justice, or the attorney general’s office. Not an ideal starting point when litigating a contentious issue.

Also note that the breadth of the attorney-client privilege may not be as absolute as once thought. The Supreme Court recently granted review in In re Grand Jury, a Ninth Circuit opinion which held that communications with in-house attorneys for purposes other than legal advice (i.e., for business advice) may be discoverable. The case is set for argument on January 9, 2023. While this appeal does not specifically impact communications with external attorneys that taxpayers have engaged, the nature of the privilege, at least as it pertains to internal legal departments, will be an issue to monitor moving forward.

  • Kyle M. Brehm

    Kyle is a State and Local Tax practitioner, focused on providing value to clients across a variety of industries: healthcare, financial services, construction, manufacturing and retail. He develops the tax departments with which ...

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