IRS wins important tax workpapers disclosure case

In an upset for business taxpayers, the IRS has won an important case involving the disclosure of tax accrual workpapers. The U.S. Court of Appeals for the First Circuit has overturned a decision protecting tax accrual workpapers under the work product doctrine.

Background

One of the taxpayer�s subsidiaries allegedly participated in nine sale-in, lease-out (SILO) tax shelter transactions. The IRS issued an administrative summons to the taxpayer requesting disclosure of the taxpayer's tax accrual workpapers.

Challenging the IRS's petition to enforce the summons in federal district court, the taxpayer claimed that the workpapers were protected by the attorney-client, tax practitioner, or work product doctrine privileges. The IRS countered that the taxpayer had waived any applicable privilege by disclosing the workpapers to an independent auditor.

District and panel decisions

Although it found that the company had waived the attorney-client and tax practitioner privileges by disclosing the workpapers to the auditor, the district court found that the documents were protected by the work product privilege. The court held that the documents were prepared "because of" the prospect of litigation.

A panel of three judges for the First Circuit in January of this year upheld the district court, holding that tax accrual workpapers were protected under the work product doctrine as "dual-purpose" documents, both prepared in anticipation of litigation and for a business reason.

En banc decision

However, in March, the First Circuit agreed to rehear the case en banc (that is, before the full court). In reaching its decision, full First Circuit court noted that the work product privilege aims at protecting work done for litigation and not in preparing financial statements. The court found that the taxpayer's workpapers were prepared to support financial filings and gain auditor approval. That was enough to lift the privilege and let the IRS see the paperwork.

What the IRS will do next, and what other courts will decide if the IRS presses forward with summonses on a regular basis to obtain insights on a businesses tax strategy, remain important issues to be sorted out over the coming year. Public companies and small businesses alike will be affected. Stay tuned.

(Textron, CA-1, August 13, 2009)