District court holds that tax accrual workpapers are privileged documents.

• Author: Beavers, James

A district court in the First Circuit held that a corporation did not have to turn over tax accrual workpapers to the IRS because the work-product privilege applied to the workpapers. The court also found that the attorney-client and tax-practitioner privileges could have applied to the workpapers, but the corporation had waived these privileges by sharing the workpapers with its independent auditors.

Background

Textron, Inc. (Textron) is a publicly traded conglomerate with approximately 190 subsidiaries. Like other large corporations, Textron's federal tax returns are audited periodically. During the audits, the Service examines the returns for the tax years that are part of the audit cycle. In seven of its past eight audit cycles before the cycle at issue (which covered the years 1998-2001),Textron appealed disputed matters to the IRS Appeals Board; three of these disputes resulted in litigation.

On an annual basis, Textron and its subsidiaries prepare tax accrual workpapers. The subsidiaries' workpapers were used in the preparation of Textron's workpapers. The workpapers consisted of:

(1) A spreadsheet containing:

(a) Lists of items on Textron's tax returns, which, in the opinion of Textron's counsel, involved issues on which the tax laws were unclear and therefore might be challenged by the IRS;

(b) Estimates by Textron's counsel expressing, in percentage terms, their judgments regarding Textron's chances of prevailing in any litigation over those issues (hazards of litigation percentages); and

(c) The dollar amounts reserved to reflect the possibility that Textron might not prevail in such litigation (tax reserve amounts).

(2) Backup workpapers consisting of the previous year's spreadsheet and earlier drafts of the spreadsheet together with notes and memoranda written by Textron's in-house tax attorneys reflecting their opinions as to which items should be included on the spreadsheet and the hazard of litigation percentage that should apply to each item.

The tax accrual workpapers for Textron were prepared by attorneys and CPAs working for Textron. Textron's subsidiary companies prepared their workpapers with some input from private law firms and outside accounting firms. According to Textron officials, Textron's ultimate purpose in preparing the tax accrual workpapers was to ensure that Textron was "adequately reserved with respect to any potential disputes or litigation that would happen in the future."

IRS Document Requests

In conducting its audit of Textron for the 1998-2001 audit cycle, the IRS followed its standard procedure for gathering relevant information by issuing information document requests (IDRs) to Textron. During the audit cycle, the Service issued more than 500 IDRs, and Textron complied with all of them, except for the ones seeking the tax accrual workpapers of Textron and one of its subsidiaries, Textron Financial Corporation (TFC).The IRS was interested in these workpapers because it believed they contained information on certain sales and leasing transactions by TFC that the IRS believed were tax shelter transactions. Under its general policy of restraint...