When an attorney’s client receives an IRS audit notice, the process can feel overwhelming. It is essential to act strategically to protect attorney-client privilege while meeting all compliance requirements. Failure to do so can result in serious legal and ethical consequences. Below are key considerations for navigating this process effectively.
Key Considerations
Start by supplying only non-privileged documents. These include financial records such as tax returns, financial statements, payroll records, and expense reports. If a document contains both privileged and non-privileged information, redact the privileged portions before submission. Maintaining clarity and precision in document handling is critical.
Never disclose communications that contain legal advice or confidential client information. Emails, memos, and other privileged materials should remain protected. Similarly, documents prepared in anticipation of litigation are safeguarded under the work product doctrine and should not be shared.
Several landmark cases underscore the importance of attorney-client privilege and work product protection. Upjohn Co. v. United States (1981) established that privilege applies to communications between corporate counsel and employees. Hickman v. Taylor (1947) introduced the work product doctrine, shielding materials prepared for litigation. Reisman v. Caplin (1964) clarified that IRS summonses can be challenged on privilege grounds. Additionally, Revenue Ruling 76-315 affirms that tax advice provided by attorneys is privileged.
If the IRS issues a summons, proceed cautiously. Improper disclosure can waive privilege, exposing sensitive information.
Disclosing privileged information can result in loss of privilege, ethical violations, and disciplinary action. Attorneys must remain vigilant to avoid inadvertent breaches.
Be mindful when copying individuals on client emails. Including someone outside the legal team or without a need-to-know role can compromise privilege. Exercise caution in all electronic communications during an audit.
If you discover client tax fraud during representation, do not disclose this information to the IRS without careful legal analysis. Attorney-client privilege generally prohibits disclosure, but ethical obligations under professional conduct rules must also be considered.
IRS audits demand precision and expertise. Engaging accounting professionals can help with document management, privilege segregation, and proactive issue identification. Their guidance ensures compliance while safeguarding sensitive information.
By following these principles and working with experienced advisors, attorneys can navigate IRS audits confidently—preserving privilege, meeting obligations, and protecting client interests.
What Happens When an Attorney Is Audited?
When an attorney is audited by the IRS, the process generally mirrors other business audits but includes several unique considerations tied to the nature of legal practice. The IRS begins with a pre‑audit analysis, reviewing the attorney’s tax returns and financial information for discrepancies. Particular attention is often given to unreported income, questionable deductions, and compliance with reporting rules such as Form 8300 for cash transactions exceeding $10,000.
Once the IRS initiates the audit, it typically schedules an interview to gain an understanding of how the law practice is structured and how its records are maintained. During this meeting, agents commonly inquire about fee arrangements, client cost advances, accounting methods, and the management of both operating and trust accounts. Following the interview, the attorney receives an Information Document Request (IDR), which may call for bank statements for both operating and trust accounts, client ledgers, payroll documents, and any Forms 8300 or 1099 previously filed.
Attorney‑client privilege becomes an important consideration during the process. Although privileged communications relating to legal advice remain protected, the privilege generally does not extend to client identity, fee agreements, or trust account records. If an attorney withholds documents, the IRS may issue a summons, though privilege can still be asserted for communications that qualify for protection. Audit focus areas often include the treatment of advanced client costs and cash payments that may trigger Form 8300 requirements, and the proper recognition of income. Issues such as leaving earned fees in trust accounts past year‑end or failing to report income that has been constructively received can also draw scrutiny.
Takeaways
The outcome of an audit can vary widely. In some cases, the IRS makes no changes, but audits can also result in additional tax liabilities, penalties for negligence, failure to file required forms, or other compliance shortcomings. Beyond tax consequences, attorneys may face ethical risks if audit findings reveal improper handling of client funds or breaches of confidentiality. To mitigate these risks, attorneys are best served by maintaining strong recordkeeping systems, understanding the limits of attorney‑client privilege, and preparing for audits with well‑organized documentation and clear privilege logs. Engaging qualified tax professionals throughout the process can further help ensure compliance and reduce exposure to errors or penalties.
Author: Nisha Bhanushali, CPA | [email protected]
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