Kovel Arrangements: Keeping Your Accountant Inside the Privilege

Tax cases run on numbers, and numbers are an accountant's job. In a case with criminal exposure, that creates a problem. The people best equipped to analyze your records may not be covered by any privilege, and anything you tell them may end up in front of a grand jury.

The solution lawyers use has a name taken from a 1961 appellate decision: the Kovel arrangement. This guide explains the problem, what the court held, and the limits. It is general information about published law. How privilege applies to your communications is a question for your lawyer.

The problem: the tax practitioner privilege stops at criminal matters

Congress created a confidentiality privilege for tax practitioners in IRC 7525. It extends to communications with a federally authorized tax practitioner, such as a CPA or enrolled agent, "the same common law protections of confidentiality which apply to a communication between a taxpayer and an attorney," to the extent the communication would be privileged if it were with an attorney.

Then the limitation. Under section 7525(a)(2), the privilege "may only be asserted in" a "noncriminal tax matter before the Internal Revenue Service" and a "noncriminal tax proceeding in Federal court brought by or against the United States." Subsection (b) adds that it does not apply to certain written communications promoting tax shelters.

So in an IRS-CI investigation or a grand jury proceeding, the statutory practitioner privilege is unavailable by its terms. What remains is the attorney-client privilege.

The case: United States v. Kovel

In United States v. Kovel, 296 F.2d 918 (2d Cir. 1961), the defendant was a former IRS agent with accounting skills who had worked since 1943 for a law firm that specialized in tax law. A grand jury investigating one of the firm's clients subpoenaed him. He refused to answer certain questions about communications with the client, claiming attorney-client privilege. The trial judge said the privilege did not extend to a non-lawyer, held him in contempt, and sentenced him to a year in prison.

The Second Circuit, in an opinion by Judge Friendly, vacated the judgment and remanded.

What the court held

The court started with the tension in privilege law: privileges are construed narrowly because they keep evidence from courts, but lawyers cannot practice without help from others. It said nothing in the privilege's policy suggests lawyers can create a privilege just by putting accountants on the payroll. But it also refused to confine the privilege to clerical staff.

The court's key analogy was translation. A lawyer working with a client who speaks a foreign language may use an interpreter without destroying the privilege. "Accounting concepts are a foreign language to some lawyers in almost all cases, and to almost all lawyers in some cases." So the presence of an accountant, "whether hired by the lawyer or by the client," while the client explains a complicated tax story to the lawyer, should not destroy the privilege. And if the lawyer directs the client to tell the story first to an accountant engaged by the lawyer, who then interprets it so the lawyer can give legal advice, the client's communications reasonably related to that purpose should be privileged too.

Then the court drew the lines that still matter:

• "What is vital to the privilege is that the communication be made in confidence for the purpose of obtaining legal advice from the lawyer."
• "If what is sought is not legal advice but only accounting service ... or if the advice sought is the accountant's rather than the lawyer's, no privilege exists."
• Communications a client makes first to the client's own accountant are not privileged, "even though he later consults his lawyer on the same matter." The court acknowledged that line may seem arbitrary, calling it the "inevitable consequence" of reconciling the absence of an accountant privilege with the operation of the attorney-client privilege.

What this means in practice

Kovel gives lawyers a framework. It does not create a privilege for accountants. A few consequences follow directly from the opinion's reasoning.

The purpose has to be legal advice. The accountant's work must be for the purpose of helping the lawyer give legal advice. Ordinary return preparation is accounting service.

History is not rewritten. Communications you had with your own accountant before a lawyer was involved were not privileged under Kovel's reasoning. Your return preparer may be a fact witness about what you said and provided. The IRS fraud manual, IRM 25.1.2.4, tells examiners in fraud cases to document who prepared the information used to complete the return. The IRS indicators of fraud in IRM 25.1.2.3 include failure to make full disclosure of relevant facts to an accountant or return preparer.

Confidentiality has to be real. The opinion stressed that the communication must be made in confidence. Kovel itself noted another court's case where information was given for the precise purpose of passing it to an IRS agent, and suggested the necessary confidentiality was lacking there.

It gets litigated. Kovel was decided on a record that did not show how the client came to be communicating with the accountant, and the court remanded so the facts could be developed. The party claiming privilege may have to show the facts that support it.

Why accountants are easy to reach

The government has several ways to get information from an accountant who is not inside a privilege. In civil matters, IRC 7602(a) authorizes the IRS to summon not only the taxpayer but "any person having possession, custody, or care of books of account containing entries relating to the business of the person liable for tax," and "any other person the Secretary may deem proper," to produce records and give testimony under oath. In criminal matters, a grand jury can subpoena witnesses and documents, as Kovel itself shows: the accountant there was subpoenaed to testify before a grand jury about a client.

The Code adds, in IRC 7602(c)(3)(C), that the advance notice rules for IRS contacts with third parties do not apply "with respect to any pending criminal investigation." An accountant can be contacted without any notice to the client, and the client may not learn about it until much later.

How the CI manual sees the roles

The IRS criminal investigation manual describes the roles of the people in the room differently. IRM 9.4.5.3.4.6 says "the attorney has a duty to furnish legal advice to the client relating to any matter discussed," and that this is the attorney's principal function at an interview. IRM 9.4.5.3.4.5 describes the accountant's duty as assisting the client "in all bookkeeping and accounting matters."

That distinction tracks Kovel's line between legal advice and accounting service.

Where this comes up

Kovel arrangements show up in exactly the situations covered elsewhere on this site:

• Eggshell audits, where a civil examination may turn criminal and the accounting work needs to be done without creating evidence. See the eggshell audit.
• Voluntary disclosures, where amended returns, delinquent returns, and the Form 14457 narrative require significant accounting work before anything is filed. See the Voluntary Disclosure Practice.
• CI investigations and grand jury matters, where the government may seek testimony from anyone who worked on the books. See your rights in an IRS criminal interview.

The takeaway

If there is any chance your tax problem has criminal exposure, the order matters. Talk to a lawyer first. Let the lawyer decide whether and how to bring in an accountant, so the accounting work supports legal advice inside the privilege. Telling your story first to your regular preparer can create a witness instead of an advisor.

Kovel also explained why the line matters in practice: "the distinction has to be made if the privilege is neither to be unduly expanded nor to become a trap." Setting up the arrangement correctly at the start is how lawyers try to keep it from becoming one.

General information only, not legal advice. Reading this page does not create an attorney-client relationship. Laws and IRS procedures change; the sources cited were reviewed on the date shown above.