4.3 Common Law Duties, Privilege, and Confidentiality
Key Takeaways
- A CPA's engagement is a contract that carries a duty of care; the same facts can support a client's breach-of-contract claim and a negligence claim, while third-party ordinary-negligence liability depends on whether the jurisdiction requires privity or near-privity or instead reaches reasonably foreseeable users.
- Under the Ultramares and Credit Alliance near-privity approach, a CPA's ordinary-negligence liability to third parties is limited to the client and a known relying party linked to the CPA; fraud and gross negligence typically reach third parties even without privity.
- IRC §7525 extends common-law attorney-client confidentiality to tax-advice communications with a federally authorized tax practitioner, but only in noncriminal tax matters before the IRS and noncriminal tax proceedings in federal court brought by or against the United States.
- Section 7525 does not apply to criminal tax matters, to written communications promoting participation in a tax shelter as defined in §6662(d)(2)(C)(ii), or to communications that are not tax advice; a Tax Court deficiency case is a noncriminal federal-court proceeding in which §7525 can apply.
- Confidentiality under the AICPA Code, SSTSs, and IRC §7216 is a duty not to volunteer client return information; privilege is an evidentiary right to refuse production. IRC §6701 separately penalizes aiding or abetting an understatement of another person's tax.
4.3 Common Law Duties, Privilege, and Confidentiality
Blueprint I.D has two official topics, and REG tests both. I.D.1 is the tax return preparer's common law duties and liabilities to clients and third parties. I.D.2 is privileged communications, confidentiality, and privacy in tax practice. Assign each fact pattern to the right box: a missed filing deadline is usually contract or negligence; an IRS summons for emails is privilege; a CPA who mails a client list to a lender is confidentiality.
Contract, duty of care, and the two civil theories
The engagement letter is a contract. The CPA promises a defined service — prepare Form 1040, file by the due date, advise on an election — for a fee. Failure to perform that promise is breach of contract. Damages are what the client lost because the promise was not kept (penalties and interest from a missed filing the CPA agreed to make, the cost to redo the work).
Independent of the contract, the CPA owes the client a duty of care: the competence of a reasonably prudent CPA performing similar tax work. Negligence requires duty, breach, causation, and damages. Taking an undisclosed position with no reasonable basis, missing a known election, or ignoring documents the client supplied can be a breach of that duty even if the engagement letter is silent on the point.
The same facts often support both theories. The distinction REG wants:
- Breach of contract is about the agreed performance. Third parties generally cannot sue on the contract unless they are intended third-party beneficiaries.
- Negligence is about the standard of care. The client can sue. Whether a third party (a lender, a buyer, an investor) can sue for ordinary negligence depends on the jurisdiction's privity rule.
Privity, near-privity, and reasonably foreseeable users
REG typically splits third-party ordinary-negligence liability into two camps. Do not invent a restatement section number.
Privity / near-privity. Ultramares Corp. v. Touche, 255 N.Y. 170 (1931), refused to hold accountants liable in ordinary negligence to an undetermined class of relying lenders. Credit Alliance Corp. v. Arthur Andersen & Co., 65 N.Y.2d 536 (1985), restated a near-privity test: the CPA was aware the work would be used for a particular purpose, a known party was intended to rely, and conduct linking the CPA to that party showed the CPA understood that reliance. Under this approach, a bank the CPA never knew about cannot recover for ordinary negligence on a tax return or compilation prepared only for the client.
Reasonably foreseeable users. Other jurisdictions extend ordinary-negligence liability to a broader class of third parties who the CPA could reasonably foresee would use the work. That is the more open-ended camp. REG will tell you the jurisdiction's rule or describe the facts (named lender vs. unknown future buyer). Apply the stated rule. Do not announce that every state follows Ultramares.
Fraud, constructive fraud, and gross negligence typically reach third parties even without privity. A CPA who certifies a known false return, or who recklessly ignores obvious red flags, is not protected by the absence of an engagement letter with the lender.
Aiding and abetting — IRC §6701
§6701 is a statutory overlay, not a common-law cause of action. It penalizes any person who aids, assists in, procures, or advises with respect to the preparation or presentation of a portion of a return, affidavit, claim, or other document, who knows (or has reason to believe) it will be used in a material tax matter, and who knows that the portion would result in an understatement of the tax liability of another person. The penalty is $1,000, or $10,000 if the document relates to the tax of a corporation, with only one §6701 penalty per person per taxpayer per period. Mechanical typing is not aid or assistance. The taxpayer need not have known. §6701(f)(2) coordinates with §6694: the IRS does not assess both on the same person with respect to the same document.
Privilege: attorney-client, §7525, and work product
Attorney-client privilege is common law. Confidential communications between a client and a lawyer for the purpose of obtaining legal advice are privileged, subject to the crime-fraud exception. The privilege can be asserted in civil and criminal matters. Return preparation, standing alone, is generally not legal advice, even when the preparer is a lawyer.
IRC §7525 is narrower. With respect to tax advice, the same common-law confidentiality protections that apply to a taxpayer-attorney communication also apply to a communication between a taxpayer and a federally authorized tax practitioner (FATP) — an individual authorized to practice before the IRS under 31 U.S.C. §330, which includes CPAs — to the extent the communication would be privileged if it were with an attorney. Tax advice means advice within the scope of that practice authority.
§7525(a)(2) limitations. The privilege may be asserted only 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.
Two statutory carve-outs complete the map. First, criminal tax matters are outside §7525. A CID investigation, a grand jury, or a tax-crime prosecution is not a noncriminal tax matter. Second, §7525(b) provides that the privilege does not apply to any written communication between an FATP and the taxpayer (or specified related persons) in connection with the promotion of the direct or indirect participation of the person in any tax shelter as defined in §6662(d)(2)(C)(ii).
Tax Court is not a criminal case, but that does not make every Tax Court communication privileged. Tax Court is a federal court. A deficiency case is a noncriminal tax proceeding brought against the United States' determination, so §7525 can apply there to tax-advice communications. It still does not apply to criminal matters, to tax-shelter promotion writings, to state-court or state-board proceedings, or to communications that are not tax advice.
Work product is a different doctrine. Materials prepared in anticipation of litigation receive qualified protection. An attorney's mental impressions are at the core. A CPA's exam file assembled in the ordinary course of return preparation is not work product merely because an audit might someday occur. Work product can survive in settings where §7525 does not, but it is not a general CPA-client secrecy rule.
Confidentiality: when a CPA may disclose
Privilege is an evidentiary right to refuse production. Confidentiality is a duty not to volunteer. Chapter 2 already flagged the AICPA Code, the SSTSs, and IRC §7216 (criminal unauthorized disclosure or use of return information) and §6713 (civil counterpart). Here the REG skill is when disclosure is allowed and when §7525 does not apply.
A CPA may disclose client tax information when:
- the client gives specific consent in the form the engagement and §7216 regulations require;
- a court order or IRS summons lawfully requires production after any applicable privilege has been asserted and, if necessary, adjudicated;
- disclosure is permitted for quality or peer review, or other uses the §7216 regulations allow in connection with preparing the return.
A CPA may not hand a return, a transcript, or a client list to a bank, a buyer, a relative, or a marketer because it would be convenient. Confidentiality continues even when §7525 does not. Losing the privilege argument does not authorize a press release.
When §7525 does not apply, even though confidentiality still does:
- Criminal tax matters, including IRS Criminal Investigation.
- Written communications promoting participation in a tax shelter.
- Proceedings that are not before the IRS and are not federal court (state tax agencies, state boards, private lawsuits between private parties).
- Communications that are not tax advice (bookkeeping, return-mechanics workpapers that merely compile numbers, business consulting).
Worked scenario: CID versus civil exam, CPA-client emails
A CPA has two email folders with Client A. Folder 1 is tax advice: whether a research credit meets §41, with legal analysis and a recommendation. Folder 2 is return-preparation mechanics: a spreadsheet of Form 1099 totals and a request to confirm an address. Two requests arrive in different years.
Civil examination. A revenue agent issues an information document request for all CPA-client emails about the credit. This is a noncriminal tax matter before the IRS. The CPA, as an FATP, may assert §7525 as to Folder 1 tax-advice communications, to the extent they would be privileged if made with an attorney. Folder 2 return-mechanics emails are generally not tax advice and are not privileged. Confidentiality still forbids mailing the file to a third party; it does not forbid a privileged assertion to the IRS, and it does not forbid producing nonprivileged mechanics after the assertion is resolved.
Criminal Investigation. A special agent requests the same emails in a CID inquiry. §7525 does not apply. If an attorney is on the email for legal advice, attorney-client privilege may still apply and must be preserved. CPA-client tax-advice emails with no attorney are not protected by §7525 in a criminal matter. The CPA should not volunteer extra files, should not destroy documents, and should tell the client to retain criminal-tax counsel. Work product may protect materials actually prepared in anticipation of the criminal case; it does not convert the entire return-prep archive into privileged mail.
A revenue agent in a civil examination requests the CPA's emails with the client analyzing whether a research credit is allowable. Separately, an IRS Criminal Investigation special agent later requests the same emails in a criminal tax inquiry. Which statement correctly applies IRC §7525?
A CPA prepares a compilation and tax projections solely for a closely held client. An unknown bank later relies on those papers in making a loan and sues the CPA for ordinary negligence after the business fails. The jurisdiction follows the Ultramares / Credit Alliance near-privity approach. Which statement is most accurate?
A client is in United States Tax Court on a deficiency petition. The CPA, a federally authorized tax practitioner, has confidential emails of tax advice about the disputed item and, separately, a written slide deck the CPA used to promote the client's participation in a tax shelter as defined in IRC §6662(d)(2)(C)(ii). Which statement is correct under IRC §7525?