Introduction.

In many cases, a taxpayer with an IRS audit may have exposure to potential criminal charges in addition to potential increased tax liability, penalties and interest. Cases that have potential criminal exposure are often referred to as “eggshell” or “sensitive issue” audits.

Part One of this article describes potential tax crimes and why the tax practitioner-client privilege is inapplicable to criminal cases.

Part Two of this article discusses the duties imposed on taxpayer representatives by IRS Circular 230 can create liability for incriminating discloses by the taxpayer.

Part Three of this article describes signs to help a taxpayer representative recognize when a criminal investigation is ongoing and the article concludes with a description of remedies to protect both the taxpayer and the representative in "eggshell" audits.

PART TWO

Can a Tax Practitioner be Sued for Failure to Taking Steps to Protect the Client?

In general, all professionals owe a duty to provide services at a level expected of a reasonably competent professional of their type. If a client suffers injury as a result for failure to render such services, they may be liable for damages. This is the standard that is imposed on doctors, lawyers, accountants, engineers, etc. Likewise it could apply to tax practitioners. The question then becomes does a reasonably competent tax practitioner have a duty to prevent a client from disclosing potentially damaging information to them? Recent changes to IRS Circular 230 seem to indicate yes. IRS Circular 230 governs who can represent taxpayers before the IRS and governs the activities of such persons. IRS Circular 230 was recently modified with new provisions effective 20 June 2005. Many of these modifications were meant to deal with abuses in opinion letters and tax shelters. However, some changes may also create duties that would allow tax representatives to be sued when a client is injured due to the representative’s failure to take steps to protect the client when criminal exposure is present. Circular 230 provides in Section 10.33 certain “Best Practices for Tax Advisors”. This section provides that:

Tax advisors should provide clients with the highest quality representation concerning Federal tax issues by adhering to best practices in providing advice and in preparing or assisting in the preparation of a submission to the Internal Revenue Service… best practices include the following:

(1) Communicating clearly with the client regarding the terms of the engagement. For example, the advisor should determine the client’s expected purpose for and use of the advice and should have a clear understanding with the client regarding the form and scope of the advice or assistance to be rendered…

(2) Establishing the facts, determining which facts are relevant, evaluating the reasonableness of any assumptions or representations, relating the applicable law (including potentially applicable judicial doctrines) to the relevant facts, and arriving at a conclusion supported by the law and the facts.

(3) Advising the client regarding the import of the conclusions reached, including, for example, whether a taxpayer may avoid accuracy-related penalties under the Internal Revenue Code if a taxpayer acts in reliance on the advice

Circular 230 goes on in Section §10.51 to describe acts of incompetence that can result in discipline. It reads:

Incompetence…for which a practitioner may be censured, suspended or disbarred from practice before the Internal Revenue Service includes, but is not limited to-- (l) Giving a false opinion, knowingly, recklessly, or through gross incompetence, including an opinion which is intentionally or recklessly misleading, or engaging in a pattern of providing incompetent opinions on questions arising under the Federal tax laws… False opinions described in this paragraph (l) include … concealing matters required by law to be revealed,…For purposes of this paragraph (l), reckless conduct is a highly unreasonable omission or misrepresentation involving an extreme departure from the standards of ordinary care that a practitioner should observe under the circumstances. A pattern of conduct is a factor that will be taken into account in determining whether a practitioner acted knowingly, recklessly, or through gross incompetence. Gross incompetence includes conduct that reflects gross indifference…

Circular 230 imposes a duty on practitioners to establish with a client a “clear understanding with the client regarding the form and scope of the advice or assistance to be rendered.” This clear understanding should include that the client should not disclose to the practitioner any information that may tend to incriminate the client. This is because Circular 230 also imposes a duty on the practitioner to “establish the facts” of the situation and relate “the applicable law (including potentially applicable judicial doctrines)” to these facts. Potentially applicable judicial doctrines would include the Constitutional right against self incrimination.

Breach of this duty could be considered common law negligence and lead to liability.

Moreover, Circular 230 in Section 10.51 provides that “concealing matters that are required by law to be revealed” is giving a “false opinion.” Since Section 10.33 imposes a duty to establish a clear understanding of applicable judicial doctrines (as described above), failing to do so would be deemed a “false opinion”. Section 10.51 goes on to say that “incompetence” is defined as giving a “false opinion” either knowingly, recklessly or through gross incompetence. Thus, failure to disclose that if the client provides incriminating information to the tax practitioner, such information can be used against them, appears to meet the definition of “incompetence.”

Based on the analysis of the provisions of Circular 230, it seems quite clear that a tax practitioner has at a minimum, a duty to warn clients that information conveyed to the practitioner can be used against them in criminal proceedings and probably in civil or administrative proceedings as well. But is merely providing a warning sufficient?

The specific examples of Circular 230 are not intended to be a definitive guide to what is “best practices” or “incompetence”. Both Sections 10.33 and 10.51 clearly indicate that the subparagraphs listed are included as examples but are not exhaustive lists. Section 10.33 imposes the duty to provide the “highest quality representation concerning Federal tax issues by adhering to best practices.” Section 10.51 imposes the duty to not provide “incompetent” services. It is hard to see how merely warning that disclosures can have adverse consequences would be the “highest quality services”, especially when simple additional actions can prevent the harm. As described in Part two of this article, there is a simple process that would facilitate the prevention of the harm rather than merely warning against it. If prevention is so easy, wouldn’t be the “best practice” to prevent the harm? If prevention is easy, wouldn’t be “incompetent” not to prevent the harm?

Lets look at this in an analogous context:

You go to the doctor. The doctor knows that many people in your circumstances face an easily preventable yet very serious health problem. The doctor warns you that you could be at risk and that this problem could be serious. Has this doctor performed the “best practices” or has this doctor acted “incompetently”?. Shouldn’t this doctor tell you what can be done to prevent this harm?

Assume the doctor discloses the potential health risk and then tells you that there is a shot that can prevent the problem? Isn’t this better?

Assume the doctor discloses the potential health risk, tells you that the shot is available and offers the shot to you? Isn’t this better yet? Isn’t this “competent” service and the “best practice?”

As described in Part Three of this article there is a simple “shot” that tax practitioners can give their clients that can prevent this serious problem.