Since Information Not Available from Another Source, CPA Ordered to Turn Over Tax Return of Client to Plaintiff in Suit Against Client
A CPA firm may be faced with a subpoena related to a client to produce various documents, including tax returns, when a client is a party to a suit. The validity of the subpoena is a key issue, since generally CPAs are not allowed to voluntarily disclose client information in most cases under state law and tax-related information under the federal law, but the CPA must produce those documents when the law does mandate such production.
In the case of Anyclo International, Inc. V. Cha, US District Court District of New Jersey, Case No. 18-5759[1], the question arose regarding whether a plaintiff in a civil suit could obtain a copy of the defendant’s income tax returns from the defendant’s CPA. Or, in the alternative, would such production be a violation of the defendant’s privacy rights.
In the case before the court, Anyclo alleged that Cha had misappropriated funds sent to the defendant to assist the plaintiff in incorporating a subsidiary in New York. The Court describes the allegations as follows:
In 2016, Anyclo International, Inc., hired Yang-Sup Cha to assist in incorporating a subsidiary of it in the State of New York. (Am. Compl. ¶¶ 16-17, ECF No. 25; Answer to Am. Compl. ¶¶ 16-17, ECF 30.) Plaintiff claims it wired Defendant Stafford Cha seed money and additional funds for operating costs and other expenses. (Am. Compl. ¶¶ 18, 24, 32-34.) According to Plaintiff, "Defendants conspired to make it appear as if Defendant [Yang-Sup] Cha was following Anyclo International' s directives when i[n] fact Defendants created Anyclo USA as a corporation owned by one or more of the Defendants .... " (Am. Compl. ¶ 30.) Plaintiff alleges Defendants improperly misappropriated Plaintiff's funds and improperly withheld "payments received from third-parties for goods manufactured and delivered by" Plaintiff. (Am. Compl. ¶ 83.) As part of that claim, Plaintiff alleges it gave money to Anyclo USA for rental expenses, later learning that Anyclo USA did not rent a space at its reputed address and that the entity to which Anyclo USA was purportedly paying rent, Mojo Moto, LLC, did not own a space there. (Am. Compl. ¶¶ 69, 106-07, 123.) Mojo Moto, LLC, is allegedly owned by Defendant Nam-Hee Kim. (Am. Compl. ¶ 69.)[2]
A CPA was engaged during this process, and the plaintiff sought information from that CPA:
Certified public accountant, Daniel Cho, was obtained to assist in establishing Anyclo USA. (Am. Compl. ¶¶ 20-21; Answer to Am. Compl. ¶¶ 20-21, ECF 30.) On March 27, 2019, Plaintiff served Cho with a subpoena, commanding he produce “[a]ll communications (electronic and otherwise) with Yang-Sup Cha, Nam-Hee Kim and Stafford Cha as it relates to Anyclo USA, Inc. and/or Mojo Moto, LLC” and “[c]opies of all documents prepared for the benefit of Yang-Sup Cha, Nam-Hee Kim, Stafford Cha, Anyclo USA, INC., and/or Mojo Moto, LLC.” (Certification of Gregory J. Cannon, Esq. Ex. A, at 1, Ex. B, ECF No. 32-1.)
The issue in dispute is whether Mr. Cho should be required to provide individual income tax returns for certain defendants in this action.
The Court begins by noting that the Third Circuit Court of Appeals, to which any appeal would be taken, has provided that generally tax returns are not subject to disclosure, but also that there are some exceptions to that general rule. As the Court notes:
In DeMasi, the Third Circuit recognized that public policy favors the non-disclosure of income tax returns because “Congress has guaranteed that federal income tax returns will be treated as confidential communications between a taxpayer and the government,” 669 F.2d at 119 (citing 26 U.S.C.A. § 6103), and because confidentiality removes the pressure taxpayers may otherwise feel to refrain from reporting all of their income or from taking advantage of all of the tax-saving measures to which they are entitled, id. at 120 (citing Fed. Sav. & Loan Ins. Corp. v. Krueger, 55 F.R.D. 512, 514 (N.D. Ill. 1972)). “A party’s income tax returns, even if containing some relevant financial information, are protectable from discovery as confidential documents if the party seeking protection demonstrates good cause to uphold its expectation of confidentiality, as well as the availability of reliable financial information from other sources.” Farmers & Merchants Nat. Bank v. San Clemente Fin. Grp. Sec., Inc., 174 F.R.D. 572, 585 (D.N.J. 1997).[3]
The Court, citing a number of cases, determines that it must apply a two-part test to determine if, despite the individual’s right to privacy, the tax returns are subject to disclosure. To require disclosure of the returns, the Court must find:
The returns are relevant to the litigation at hand and
The party objecting to disclosure does not demonstrate the availability of reliable financial information from other sources.
The party seeking the returns has the burden of demonstrating the relevance, while the party seeking to avoid disclosure has the burden of showing the availability of information from other sources.[4]
The Court finds that the plaintiff had demonstrated the information in the returns would be relevant to the matter being litigated, noting:
First, the Court agrees with Plaintiff that Defendants' tax returns are relevant to determining whether Defendants improperly diverted funds paid by Plaintiff and relevant to determining the truth of Defendants' asserted explanations and the validity of their defenses. As Plaintiff contends, the contemporaneous treatment of monies allegedly paid to support Anyclo USA' s business operations on Defendants' individual tax returns may support or undermine each parties' contentions. While unlikely to provide a clear accounting, Defendants' reported income is likely to show whether Yang-Sup Cha, Nam-Hee Kim, or Stafford Cha reported Plaintiff's wire transfers as personal income, which would support Plaintiff's diversion and embezzlement claims.[5]
The Court also found that the defendants had not shown the existence of alternative sources of the financial information:
Second, it does not appear to the Court that the same information discoverable in Defendants' individual tax returns is discoverable by other means. Defendants submit "Plaintiff's own records can be the source of its prima facie proof of loss," (Mot. to Quash Subpoena 3, ECF 36), and while that may be true, the value in Defendants' tax returns extends beyond proving loss. The crux of Plaintiff's claims are the allegations of diversion and embezzlement. The treatment of the funds paid by Plaintiff is vital to proving those claims. The Court does not perceive-and Defendants do not proffer an alternative method of showing how Defendants treated Plaintiff's monetary transfers.[6]
Unfortunately, CPAs often find themselves drawn into disputes that clients get themselves embroiled in. As this case demonstrates, whether or not the Form 1040 must be turned over to the party offering up a subpoena is not something the CPA will be able to determine on his/her own. When such a situation arises, the CPA should seek counsel and follow counsel’s advice about how to respond to avoid either failing to turn over documents that are required to be turned over, or denying the CPA’s client the ability to timely object to the production of such documents.