- 1 IRS Tax Audits
- 2 Case Study Example: Kendra & Foreign Account & Asset Compliance
- 3 Unreported Foreign Accounts
- 4 Kovel Accountant & Quiet Disclosure
- 5 What is a Kovel Accounant
- 6 Kendra is Audited
- 7 Kendra Received an IDR from the IRS
- 8 Does Kovel Protect These Communications with the CPA?
- 9 Tax Return, Kovel, and Attorney Communications
- 10 Developing a Comprehensive Strategy at the Outset of Representation
- 11 Golding & Golding: About Our International Tax Law Firm
IRS Tax Audits
IRS Tax Audit Attorney or CPA: When a US taxpayer is under audit by the Internal Revenue Service, there is a lot at stake. Oftentimes, the taxpayer could be staring down the barrel of a hefty fine or penalty. In addition, depending on the facts and circumstances, the taxpayer may find themselves right smack dab in the middle of an eggshell audit or reverse eggshell audit — and has to maneuver carefully to avoid self-incrimination, while not making any intentional misrepresentations or omissions. When the taxpayer speaks with their attorney, in general, legal discussions with an Attorney are privileged, whereas the same discussions with a CPA are not privileged. Let’s look at an example of the difference between using an attorney or CPA for legal matters involving complex legal/tax issues to see what’s at stake.
Case Study Example: Kendra & Foreign Account & Asset Compliance
Kendra is a Legal Permanent Resident. She came to the United States about 10-years ago and moved from H1B to Green Card. Initially, Kendra was filing her tax returns herself, but recently she had a significant increase in income and complexity to her returns, and decided to get professional help.
Unreported Foreign Accounts
About 5-years ago, Kendra learned that her foreign bank and investment accounts needed to be disclosed to the IRS — but she never did it. The amount of unreported income was small, but since she is admittedly willful — because she knew of the reporting requirements — she would not qualify for the streamlined program or reasonable cause. Instead, she would have to make a VDP (Voluntary Disclosure Program) submission. Before applying for VDP, she considers the option of avoiding the offshore amnesty programs altogether by submitting her prior tax returns and reporting forms silently (without using amnesty) – this is referred to as a Quiet or Silent Disclosure.
Kovel Accountant & Quiet Disclosure
It is evident that Kendra was willful, and all the attorneys she spoke with tell her the quiet disclosure is not the best option. One firm convinces her she can have this all done with a CPA and Kovel Letter. The firm will refer her out to a CPA who will prepare the tax return and forms — and then submit the package to the IRS. The fee seems lower than other firms, but the attorney assures her it’s a sure thing and not to worry about it. Since the amount of unreported income was not that high, it is just “minor” tax noncompliance and she should be able to avoid any major catastrophes with the IRS. Kendra signs a Kovel letter.
What is a Kovel Accounant
The purpose of a Kovel letter is in the unique and uncommon scenario in which an attorney requires a CPA to explain tax information to them. In a Kovel scenario, the client first speaks to the CPA first so that the CPA understands the facts. Then, the CPA (or accountant) can relay the information back to the attorney so that the attorney understands — and then can determine how to move forward on the case. It is rarely used by tax attorneys — and it does not cover tax preparation. Kendra is hesitant but believes this may be a viable option and takes the attorney’s advice. She finds the CPA easy to talk to and even though the fees were a bit higher she seems happy that the CPA took the time to listen to her full story whereas the attorney did not.
Kendra is Audited
About a year or two later Kendra is audited — not because of her foreign accounts, but because there was a mistake in her tax return regarding certain deductions. The IRS wants to confirm that the expenses are legitimate comically their relatively high for a consultant.
Kendra Received an IDR from the IRS
An IDR is an Information Document Request. The request asks Kendra to provide all the information she has regarding her expenses, along with any unreported income. It turns out that Kendra did not include the interest income she earned from her foreign account in the quiet disclosure. This was because it was in a fixed deposit and not distributed. She is concerned this will lead to a deeper inquiry into her foreign accounts and prior quiet disclosure. In reviewing the IDR, she gets even more concerned because it asks for any information, communications, etc made to her CPA. Since the information they discussed was about her noncompliance, this can be a serious problem for Kendra. Kendra finds incriminating emails she sent the CPA about her willfulness. She only sent these emails because her attorney told her to reach out direct to the CPA.
Does Kovel Protect These Communications with the CPA?
No. these were legal communications that should have been made to the attorney. The information should not have been put in writing and should not have been shared via email –- It turns out Kendra was misled by the attorney. She was made to believe that by signing the Kovel agreement, anything she tells the CPA is protected. The law firm also neglected to tell her that since she was willful, she absolutely does not qualify for reasonable cause.
Tax Return, Kovel, and Attorney Communications
When a taxpayer speaks with their attorney, the communications are confidential. If that information is supplied to a 3rd party, the privilege is generally waived. For example, in this case, had Kendra kept the discussions surrounding willful vs non-willful between herself and the attorney, there would be no privilege or confidentiality issue. Had the attorney’s firm internal team prepared the tax returns, the legal information discussions between the attorney and client would be protected – since that confidential information would have been made direct to the attorney, and not published to a 3rd party in a tax return. Of course, Kendra would not be emailing incriminating evidence to her attorney — she would be discussing the matter with them. This way, the attorney could have represented the client without issue and the legal confidential information would not be discoverable. Here, Kendra suffers two big setbacks:
- She was misrepresented how Kovel Protection works; and
- She spoke to a CPA about the legal issues.
Developing a Comprehensive Strategy at the Outset of Representation
In conclusion, It is important to understand the difference between the attorney client privilege in the very limited accountant client privilege. when a taxpayer has both a legal and tax situation involving the IRS, it is crucial that they understand the different roles representatives play and how to best protect confidentiality without risking the attorney-back in client privilege.
Golding & Golding: About Our International Tax Law Firm
Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure. Contact our firm today for assistance with getting compliant.