The first is the burden of proof shift. The second is the extension of taxpayer confidentiality to communications on tax matters between taxpayers and certified public accountants and enrolled agents (similar to the attorney-client privilege).

Burden of Proof
The "burden of proof" provision generally shifts that burden in civil tax litigation to the IRS with regard to any factual issue where the taxpayer presents credible evidence to support his or her position. The taxpayer must also comply with substantiation requirements of the Internal Revenue Code and regulations and maintain all required records.

In addition, taxpayers other than individuals or estates generally must have a net worth of less than $7 million in order to avail themselves of the rule. Finally and most importantly, the taxpayer must exhaust all administrative remedies and cooperate with reasonable IRS requests for information, documents, and witnesses (see General Explanation of Tax Legislation Enacted in 1998, i.e. the "Blue Book", p. 56 et seq.)

Taken as a whole, the onus still remains on the taxpayer to prove his or her case at the examinations and appeals levels. At best, some imperceptible shift may occur if a case goes to trial. In other words, for most individuals that deal in the trenches of everyday tax practice not much has changed.

Confidentiality Privilege
The much ballyhooed "confidentiality privilege" (IRC section 7525) extends the attorney-client privilege of confidentiality to tax advice that is furnished to a client (or potential client) by CPAs, enrolled agents and enrolled actuaries (referred to as "federally authorized practitioners"). (For a description of the provision, see Blue Book, p. 85 et seq.)

Misunderstandings of this provision are certain to arise and the consequences to affected taxpayers may be devastating depending on the type of information mistakenly thought to be covered by the privilege. Also, the privilege does not extend to information sought in investigations by other regulatory bodies such as the Securities & Exchange Commission, the Federal Reserve Bank and various state tax authorities.

Moreover, the privilege applies only to communications in non-criminal tax proceedings before the IRS or in Federal court. Note also that if a civil proceeding becomes a criminal proceeding at some point, the confidentiality privilege disappears retroactively. Consequently, unsuspecting practitioners may become privy to information that clients believe to be confidential only to have that privilege waived--sometimes with dire consequences for the client.

Recall the case for which Leona Helmsley went to jail for tax fraud. After an indictment was filed, the Hemsley's hired new accountants to review their returns. The new CPA firm discovered overlooked deductions and items on the original returns that could be treated differently and would result in a refund. However, the government prevailed in the litigation on the basis that fraudulent transactions were contained within the original returns.

Helmsley paid a particularly high price for telling a cleaning lady--whose testimony at trial was key--that "only the little people pay income taxes." Suppose instead, in a similar situation, a taxpayer made that comment to a CPA or EA from who she had sought other tax advice pertaining to legitimate issues on her return, while not revealing information pertaining to questionable or fraudulent transactions. In pursuing the crime fraud issue, the confidentiality privilege is negated and the practitioner probably must disclose the taxpayer's comment.

The Effect on Tax Practitioners
The most likely battles, though, will be over the tax preparer exception to the privilege. Congress clearly stated that the privilege of confidentiality is extended to federally authorized practitioners in the same manner that it has applied to attorneys in federal tax matters. It does not modify the attorney privilege of confidentiality; it merely extends it to other practitioners. There is a long history of court decisions that deny confidentiality of information disclosed to an attorney for purposes of preparing tax returns. That is one reason why attorneys that specialize in tax controversy matters do not also prepare income tax returns.

In today's world, the vast majority of complex income tax returns for individuals and businesses are prepared by or under the supervision of CPAs or enrolled agents. As a result, in most cases, it will be difficult for their clients to assert that the confidentiality privilege is applicable. Where the taxpayer makes such an assertion, the IRS will almost surely challenge that argument. It will contend that whatever tax advice given, and whenever it was given, falls under the category of "tax return preparation" and does not qualify as tax advice for purposes of the confidentiality privilege.

A leading case in the area of privilege (actually, the lack of it) involving tax preparation is United States v. Lawless, 709 F.2d 487 (7th Cir.1983), where the court ruled that "information transmitted for the purpose of preparation of a tax return, though transmitted to an attorney, is not privileged information."

The court continued, "when information will be transmitted to a third party (in this case on a tax return), such information is not confidential." Significantly, the court stated that, "If the client transmitted the information so that it might be used on the tax return, such a transmission destroys any expectation of confidentiality which otherwise might have existed…(so) disclosure of tax information effectively waives the privilege not only to the transmitted data but also as to the details underlying that information."

A Legal Minefield
There have been instances where some information provided in tax return preparation has been protected under common law principles. However, for the typical tax practitioner to rely on such exceptions is to cross through a legal minefield littered with casualties. When one of the casualties is a client that may initiate legal proceedings against the practitioner, running the gauntlet necessary to ensure that communications are clearly protected is likely not worth the exposure to the practitioner (particularly where a change to criminal status might rear its ugly head). Nor does the uncertainty surrounding confidentiality with a CPA or EA serve to encourage clients to use it.

It is also important to note that most client relationships with a CPA or EA are ongoing and contain the expectation of a work product including the preparation of income tax returns. This is different from the normal tax attorney-client relationship which is "transaction based," whether the service is tax advice, estate planning or tax controversy defense representation. (In fact, some of the more interesting court issues have involved attorneys losing their privilege in situations where they prepared federal estate tax returns. The privilege issue is more likely to arise in these matters since attorneys commonly prepare estate tax returns as contrasted with income tax return preparation).

Because of the nature of the CPA or EA/client relationship, it is difficult to structure a satisfactory "tax advice" relationship that will meet the standard for "privileged communication." Where it may have some application is where practitioners refer clients to others for advice on specific tax matters while retaining the overall client relationship. (This writer provides this type of service to some former partners and staff members.)

Some firms may try to separate the preparation and advice functions. In fact, this writer envisions the largest firms taking just that position. However, for the vast majority of clients and practitioners this approach is just not feasible. Even in large local accounting and tax firms, the courts will probably look skeptically at assertions that advice and preparation are unrelated in serving the client. Consequently, federally authorized tax practitioners should use an abundance of caution before entering into relationships with clients (or prospective clients) involving the confidentiality privilege.