Our laws protect certain communications. This includes communications with doctors, religious advisors, spouses, and even attorneys.
When it comes to Federal tax matters, communications with tax attorneys are usually at the forefront. The IRS often seeks information about these communications to help it figure out how the taxpayer structured their affairs. The attorney-client privilege is usually upheld by the courts. However, there are instances when the privilege has not been upheld. The crime-fraud exception is one such example.
The crime-fraud exception to the attorney-client privilege allows for the disclosure of otherwise privileged attorney-client communications if they were made in furtherance of a criminal or fraudulent act. This means that if the IRS can show probable cause that an individual communicated with their tax attorney with the intention of committing a crime or fraud, the attorney-client privilege will not protect those communications from being disclosed.
In order to invoke the crime-fraud exception, the IRS must show probable cause that a crime or fraud has been attempted or committed, and that the communications were made in furtherance of that crime or fraud. The IRS must also show that the communications were made with the intent to further the crime or fraud, and not simply related to it.
There are a few key factors that the courts consider when determining whether the crime-fraud exception applies in a particular case. These include the timing of the communications, the involvement of family members or close associates, and the involvement of illegal or fraudulent activities.
Overall, the attorney-client privilege is an important legal principle that protects communications and documents made for the purpose of seeking or receiving legal advice in federal tax matters. However, the privilege is not absolute and can be overcome in certain circumstances, such as when the IRS can show probable cause that a crime or fraud was committed and that the communications were made in furtherance of that crime or fraud.
The recent case of United States v. Lax, No. 1:18-cv-04061(ILG)(PK) (E.D.N.Y. 2022) provides an opportunity to consider the crime-fraud exception to the attorney-client privilege.
Facts & Procedural History
This case involves a company that was unable to pay its debts, including its back taxes owed to the IRS.
The owner of the company decided to form a new company and to sell the assets of the old company to the new company. This was accomplished by transferring assets in a New York state court proceeding called an “assignment for the benefit of creditors” or “ABC.” The ABC is a pre-bankruptcy liquidation process provided under New York law.
The ABC worked like this: the corporation’s shareholder renamed the existing corporation. It then transferred the corporation’s assets to an attorney under state law with the intent that the attorney sells the assets to pay creditors. The assets were sold to a new corporation owned by the old corporation’s wife. The state court authorized the sale.
This case involves a dispute over communications by and with the attorney and law firm that assisted with the ABC. The Federal government brought suit claiming that the taxpayers engaged in fraudulent activities to evade the payment of taxes owed by the estate. The Federal government is seeking an order in this case that the attorney-client privilege does not apply as the crime-fraud exception applies.
The Attorney-Client Privilege
The attorney-client privilege is a legal principle that protects communications between a client and their attorney from being disclosed without the client’s consent.
This privilege is important because it allows individuals to candidly discuss their legal matters with their tax attorneys without fear of their discussions being used against them. In the context of federal tax matters, the attorney-client privilege can be particularly important because individuals may need to discuss sensitive financial information with their tax attorneys in order to properly address their tax issues.
One key aspect of the attorney-client privilege in federal tax matters is that it only applies to communications made for the purpose of seeking or receiving legal advice. This means that if an individual is discussing their tax situation with their attorney in order to get advice on how to handle the matter, those communications are protected by the privilege. However, if the individual is discussing their tax situation with their attorney for some other purpose (such as to get help with preparing or filling out their tax forms in general), those communications may not be protected.
In addition to communications, the attorney-client privilege also protects certain documents that are created for the purpose of seeking or receiving legal advice. This includes documents such as legal opinions, briefs, and other written materials that are prepared by an attorney for the purpose of providing legal advice to their client.
The attorney-client privilege is to be asserted by the attorney on behalf of his client, or it is waived.
The Crime-Fraud Exception
One important exception to the attorney-client privilege in federal tax matters is the crime-fraud exception.
This exception allows for the disclosure of otherwise privileged attorney-client communications if they were made in furtherance of a criminal or fraudulent act. This includes civil fraud that does not rise to the level of criminal fraud.
The crime-fraud exception allows for the disclosure of otherwise privileged attorney-client communications if they were made in furtherance of a criminal or fraudulent act.
To invoke this exception, the moving party must show probable cause that the defendant communicated with their attorney with the intention of committing a crime or fraud. The party seeking the exception must first demonstrate that there is probable cause to believe a crime or fraud has been attempted or committed, and then show that the communications were made with the intent to further the crime or fraud.
The exception applies even if the attorney was unaware of the criminal or fraudulent nature of the communication and the crime does not need to have been completed for the exception to apply. Facially legitimate conduct may be considered as being in furtherance of fraud under certain circumstances.
The Party’s Arguments
The Federal government argued that the taxpayers committed a crime or fraud through the 2010 assignment for the benefit of creditors (ABC) transaction involving their corporation. It cited the communications with family members about shielding the company’s assets from the IRS before the ABC was initiated and that the assets were immediately sold to a company owned by the wife of the owner of the corporation.
The taxpayers argued that the 2010 ABC was a typical ABC allowed by state law and that the documents being sought by the plaintiff are protected by the attorney-client privilege.
The Federal government countered that the taxpayers did not identify a “benign purpose” for the ABC given the evidence and the documents being sought are not protected by the attorney-client privilege as the crime-fraud exception applies.
The court agreed with the Federal government. It granted the Motion to Declare Waiver of Attorney-Client Privilege and that the Crime-Fraud Exception Applies. The court held that the taxpayers waived attorney-client privilege.
The crime-fraud exception can void the attorney-client privilege. If the facts show that the communications were made with the intent to further a criminal act, and not merely related to a crime, the exception can apply. This is even true if the attorney did not know that the advice was to be used in a crime.
Despite the existence of the attorney-client privilege and the crime-fraud exception, the IRS still has a number of tools at its disposal to obtain information that is relevant to a tax investigation. For example, the IRS can issue a summons to an individual or entity requiring them to produce documents or appear for an examination. If the individual or entity fails to comply with the summons, the IRS can seek enforcement through the courts.