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PROFESSIONAL LIABILITY SPOTLIGHT

Kovel agreement basics for

you and your client

By Karen Nakamura, CPA

onsider this scenario. You’re introduced to a result? A wider scope of communications and
Did you C potential client. While you are speaking documents receive protection from disclosure to
know? with the prospect, the individual mentions that third parties.
Kovel agreements he has certain financial accounts held in foreign
take their name financial institutions and that he recently heard RELEVANT PRIVILEGES EXPLAINED
from a 1961 about the Report of Foreign Bank and Financial Attorney-client privilege is a legal concept that
appellate court Accounts filing requirements. He’s concerned protects confidential communications between
decision, Kovel, that he may have an outstanding filing obliga- attorneys and clients that are made for the
296 F.2d 918 (2d tion and has received an IRS notice about the purpose of obtaining or giving legal advice. The
Cir. 1961). IRS’s streamlined filing compliance procedures privilege, which is owned by the client, allows
(SFCP). Because he’s never worked with a tax a client to refuse to disclose and prevent others
adviser and is unsure what the SFCP entails, he from disclosing confidential communications
would like your help. What’s your next thought? (see Black’s Law Dictionary (11th ed. 2019)). It
It should be, “Stop. Our conversation is not is intended to encourage full and candid com-
privileged. You should engage counsel.” munications between attorneys and their clients
Occasionally, clients may need more than a CPA without the fear that such communications
can offer. For example, taxpayers required to comply will be disclosed to a third party. The privilege
with complex IRS programs, such as the SFCP, or does not apply to communications made in the
who want to protect themselves from disclosure of commission or furtherance of criminal activities,
communications and documentation addressing such as fraud or tax evasion.
certain tax positions, may be better served by en- The attorney work product privilege permits
gaging counsel to provide legal advice at the outset. attorneys to withhold from production “docu-
Similarly, taxpayers facing potential litigation due ments and other tangible things” that contain the
to significant underreported income or other fraud attorney’s impressions and insights and that were
indicators may need legal representation. Never- prepared by counsel “in anticipation of litigation
theless, while counsel is qualified to provide legal or for trial” (Fed. R. Civ. P. 26(b)(3)). It also can
advice and/or litigation services, they may not have extend to materials prepared by other parties, such
enough of an understanding of complex accounting as CPAs, engaged by counsel on a client’s behalf.
or tax rules to successfully service the client. Enter
the Kovel agreement. SEC. 7525 MAY NOT PROVIDE SUFFICIENT
PROTECTION
WHY USE KOVEL AGREEMENTS? While tax practitioner-client privilege under
A Kovel agreement is an arrangement whereby a Internal Revenue Code Sec. 7525 is similar to
client engages counsel to provide legal services, attorney-client privilege in providing protections
and counsel, in turn, engages specialists, such as for communications between a taxpayer and a
CPAs, to support its services to the client. The tax practitioner, this privilege has significant
CPA interprets technical accounting, financial, shortcomings. For example, it applies solely to
and tax concepts into more easily understand- tax advice and not to tax compliance or business
able language for the client and counsel. When advice. It is also limited to noncriminal matters
a Kovel agreement is properly drafted and before the IRS or in federal courts in matters
executed, protections that are typically limited to involving the IRS and does not apply to private
the client’s interactions with counsel — namely, civil actions, tax shelters, state and local tax
attorney-client privilege and attorney work advice, or matters before the SEC. In addition,
product privilege — are extended to specialists it only applies to communications between
engaged by counsel on the client’s behalf. The the practitioner and the taxpayer. Finally, the

4 | Journal of Accountancy July 2022