November 09, 2020

Kovel Agreement in Cannabis Industry

If an IRS agent shows up at your door, it means you are in trouble. The IRS does not show up unexpectedly unless there is a criminal investigation. When they do show up, their main goal is to get an admission of guilt. The IRS wants to catch you off guard and make you hyperventilate.

What do you do in this case? Call your CPA? Wrong!!!

When it comes to criminal cases, there is no such thing as an accountant-client privilege. There is 26 USC § 7525(a), but it protects only civil tax advice cases. If you call your CPA and say: "Hey, the IRS was at my door, and I think I have a problem. I may have admitted some income items on the return." Just this small admission will get you in trouble. The CPA will be obliged to repeat your words to the IRS.

There is a way around this problem, and it is called Kovel Agreement. By signing a Kovel letter, you shelter your communication with your CPA by involving an attorney. The attorney hires the CPA and treats him/her as they would an employee. This way, the attorney-client privilege is extended to the CPA. The CPA can now help you without being afraid that he will have to testify.

Please Note: This mechanism cannot be used to cloak prior communications. If you met with the accountant before retaining the attorney, your communication would not be protected by the attorney-client privilege. And vice versa, you can not use the Kovel agreement for communications about future criminal acts.

The IRS does not look favorably upon these arrangements. But so far, it can work as long as the agreement is properly written.

Sincerely,

Daria Nagal, Cannabis CPA