When Your CPA Becomes a Witness in a Criminal Tax Investigation
A taxpayer may tell an accountant things he would never tell anyone else.
That can become a serious problem when a tax matter turns criminal.
Many people assume communications with a CPA are protected in the same way as communications with a lawyer. In a criminal tax investigation, that is generally not true.
The accountant may become a government witness and even be summoned before a federal grand jury. The accountant’s files may become evidence. And, in some cases, the accountant may have criminal exposure too.
The Accountant May Become a Government Witness
If IRS Criminal Investigation begins investigating a taxpayer, federal agents may want to know what the taxpayer told the accountant, what records were provided, and what the accountant understood when a return was prepared.
Investigators may seek emails, workpapers, draft returns, QuickBooks files, source documents, and notes reflecting questions the accountant asked or warnings the accountant gave.
Those records can be particularly important because federal tax crimes commonly turn on willfulness—whether the taxpayer intentionally violated a known legal duty.
The government rarely proves a person’s state of mind through a direct admission. Instead, it may attempt to prove willfulness through surrounding evidence: what the taxpayer was told, what records the taxpayer provided, what warnings were received, and whether the taxpayer’s conduct was consistent with those warnings.
An accountant can therefore become an important witness on the issue at the center of a criminal tax case: what did the taxpayer know?
The accountant’s file may answer that question.
Accountant-Client Confidentiality Is Limited
Federal law provides limited protection for certain communications between taxpayers and federally authorized tax practitioners.
But 26 U.S.C. § 7525 contains a major limitation: the statutory privilege applies only in noncriminal tax matters before the IRS and noncriminal federal tax proceedings.
There is no general federal accountant-client privilege that prevents an accountant from becoming a witness in a criminal tax investigation.
That means communications made to an accountant while a matter is still civil may later be available to the government if the matter develops into a criminal investigation.
The taxpayer may have believed the conversation was confidential.
That does not necessarily make it privileged.
“I Relied on My Accountant” Can Cut Both Ways
A taxpayer confronted with a questionable return may respond:
“My accountant prepared it. I relied on my accountant.”
That can be important.
Good-faith reliance on the advice of a tax professional may undermine the government’s attempt to prove willfulness in a criminal tax case. But reliance requires more than simply hiring an accountant or having a CPA prepare the return. The taxpayer generally must have provided the professional with the relevant facts, sought advice concerning the tax treatment at issue, and actually relied on that advice in good faith.
The critical question often becomes:
What did the taxpayer tell the accountant?
If the taxpayer fully disclosed the relevant facts, sought the accountant’s advice, and genuinely relied on that advice, the accountant may provide powerful evidence undermining the government’s proof of willfulness.
If the taxpayer withheld important information, the opposite may be true.
Suppose, for example, a taxpayer claims that the accountant approved the tax treatment of a particular transaction. If the accountant later testifies that the taxpayer failed to disclose material facts concerning the transaction’s structure, economic substance, or the taxpayer’s relationship to the parties involved, the accountant may do more than weaken the reliance argument.
The omission itself may become circumstantial evidence from which the government argues that the taxpayer understood those facts mattered and intentionally withheld them from the professional whose advice he now claims to have relied upon.
Reliance on an accountant can therefore cut in both directions. Full disclosure may help undermine the government’s proof of willfulness. But selective disclosure may help the government prove it.
The Accountant May Have Exposure Too
Not every criminal tax investigation has the taxpayer on one side and an innocent accountant on the other. Sometimes the government investigates both.
Under 26 U.S.C. § 7206(2), an accountant, return preparer, or other person who willfully aids or assists in the preparation or presentation of a materially false or fraudulent return or other tax document may face criminal liability.
Depending on the evidence, prosecutors may also investigate whether the taxpayer and tax professional agreed to commit an offense or impair the lawful functions of the IRS, potentially implicating conspiracy under 18 U.S.C. § 371.
That can fundamentally change the relationship.
If investigators begin scrutinizing the accountant’s own conduct, the accountant’s interests may no longer align with the taxpayer’s. The accountant may retain separate counsel, invoke constitutional protections, cooperate with investigators, or provide testimony concerning the taxpayer.
The professional who once prepared the taxpayer’s returns may therefore become a witness, a subject, a target, or potentially a defendant.
For both taxpayers and tax professionals, the point to involve federal criminal counsel is not necessarily when someone has already been charged. If a government inquiry begins raising questions about intentional misconduct, false returns, concealment, or other potential criminal exposure, waiting can substantially limit the available options.
Attorney-Client Privilege Is Different
Attorney-client privilege is different from accountant-client confidentiality.
Confidential communications between a client and an attorney for the purpose of obtaining legal advice may be protected from disclosure. That protection allows a taxpayer to speak candidly with counsel about past conduct—even potentially criminal conduct—in order to obtain legal advice.
But the privilege is not unlimited.
Under the crime-fraud exception, the privilege generally does not protect communications made for the purpose of furthering contemplated or ongoing criminal or fraudulent conduct.
There is therefore an important difference between telling an attorney:
“This is what happened. Tell me what my legal exposure is.”
and asking the attorney to help carry out or conceal unlawful conduct, which an attorney may not do.
The privilege is designed to protect candid communications made for legitimate legal advice, not communications intended to facilitate a crime or fraud.
Privilege is also distinct from reliance on counsel. If a taxpayer later contends that he took a particular tax position because an attorney advised that it was lawful, the significance of that advice may depend on whether the taxpayer fully disclosed the material facts and actually relied on the advice in good faith. The assertion of reliance on an attorney may also waive certain attorney-client privileged communications.
A lawyer’s advice based on incomplete or misleading facts may provide little support for any reliance argument.
What About an Accountant Hired by the Lawyer?
There is an important exception to the general rule concerning accountants.
In complex criminal tax matters, an attorney may need an accountant to help interpret financial records and accounting concepts so that the attorney can provide legal advice.
That is commonly referred to as a Kovel arrangement, after United States v. Kovel.
Under Kovel principles, attorney-client privilege may extend in appropriate circumstances to communications involving an accountant who is assisting the attorney in providing legal advice. The theory is essentially that the accountant functions as a translator of complicated financial information for counsel.
But Kovel is not a magic privilege that can be placed over an existing accountant-client relationship.
The accountant must be assisting counsel in rendering legal advice. Ordinary bookkeeping, return preparation, or accounting advice does not become privileged simply because a lawyer has entered the picture. Generally, the lawyer directs the accountant’s work for purposes of the legal representation.
Nor can a taxpayer generally take years of preexisting communications with an accountant and retroactively make them privileged by later retaining criminal tax counsel.
The structure and purpose of the relationship matter.
Why the Distinction Matters
Once a civil tax problem begins showing signs of criminal exposure, the accountant’s role should be examined carefully.
The accountant may be:
a witness explaining what the taxpayer said;
the source of documents the government uses to prove willfulness;
evidence supporting a genuine good-faith reliance defense;
a subject or target with independent criminal exposure; or
an accountant retained through counsel to assist with the provision of legal advice under Kovel principles.
Those roles are very different.
Once criminal exposure becomes possible, the important questions are no longer simply whether the taxpayer has a good accountant.
They become:
What did the taxpayer disclose to the accountant? What advice did the accountant give? And what will the accountant tell investigators?
The answers may support a defense—or become part of the government’s case.
When criminal exposure becomes possible, understanding the accountant’s role is part of marshaling a defense.
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Eddie R. Mendoza is a former federal prosecutor and former Trial Attorney with the U.S. Department of Justice Tax Division. He is the founder of Mendoza Defense PLLC, where he represents clients in white-collar investigations, federal criminal cases, and criminal and civil tax matters. He can be reached at eddie@mendozadefense.com.