Privileged tax advice may not be 'privileged' much longer.

• Author: Prysock, Mark
• Position: Washington Insights

Many finance professionals have noted with some concern that federal agencies and public accounting firms are generating wave after wave of new disclosure policies. The Securities and Exchange Commission (SEC), the Department of Justice (DOJ), the Public Company Accounting Oversight Board (PCAOB), the Environmental Protection Agency (EPA) and the public accounting firms have expanded or recently begun to require disclosures of otherwise protected information.

The Sarbanes-Oxley Act's mandate to improve the quality of corporate disclosures and to strengthen auditors' independence has caused financial auditors to require companies to disclose privileged information, particularly as it relates to tax positions. Independent auditors are now routinely demanding that public companies disclose the privileged and confidential tax advice that helped to inform the companies' judgment about the adequacy of reserves for contingent tax liabilities. The audit firms are making it clear that the penalty for not disclosing this confidential tax advice will be a qualified financial statement.

The dilemma, of course, is that companies that disclose tax advice to auditors will waive the right to protect that tax advice against compelled disclosure to the Internal Revenue Service (IRS). Quite simply, disclosing privileged information to one person causes the privilege to be waived to all, except when such disclosures are judicially compelled. Since disclosures to outside auditors will not be regarded as "judicially compelled," the courts will likely hold that such disclosures are voluntary, and any protecting "privileges" are waived.

Actually, the consequences may be worse still. Taxpayers may be required to waive the privileges for the tax advice that is disclosed to the auditors, and also for all other tax advice on the same subject. The new reality is that companies must choose between certified financial statements and confidential and privileged tax advice. This choice is not really a choice; companies cannot allow qualified financial statements, and must therefore disclose privileged tax advice to their auditors. As a result, the IRS is likely entitled to access that tax advice.

Similarly, companies that cooperate with SEC inquiries and investigations by voluntarily disclosing confidential tax advice to the SEC likewise waive the ability to protect that advice against compelled disclosure to the IRS. The SEC has expressed its willingness to help companies...