United States v. Roxworthy: what does it mean to taxpayers?

• Author: Pugh, Cary D.

In 2002, then-IRS Chief Counsel B. John Williams delivered a speech to the Texas Law Institute in which he made several references to the "Alamo" in the course of setting forth the Internal Revenue Service's view of the scope of the attorney-client privilege in tax matters. (1) Since that time, there has been renewed focus on the limits of attorney-client privilege and work-product doctrine for protecting tax advice. With the change in the IRS policy on tax accrual workpapers and increased auditor demands for tax opinions that might underlie companies' positions on tax reserves, there has been greater pressure on claims of privilege. (2) This has been accompanied by speculation that the only viable means of protecting sensitive advice is the work-product doctrine.

Against this backdrop comes the decision by the U.S. Court of Appeals for the Sixth Circuit in United States v. Roxworthy, (3) on August 10, 2006. The opinion is welcome news to taxpayers and practitioners because it reaffirms the validity of a work-product privilege claim for tax advice before an audit commences, but also highlights the limits to this privilege. First, as students of privilege and work-product cases know, these cases are fact intensive and, consequently, are typically decided by trial judges or magistrates, and a appellate decision is rare and therefore noteworthy. Roxworthy is particularly significant to taxpayers and tax advisers because it adopts the analysis in United States v. Adlman (Adlman II) and goes further by holding that the documents at issue were covered by the work-product doctrine, whereas the Second Circuit in Adlman II remanded the case to the district court to make the ultimate determination. (4) The Roxworthy case also serves as both a cautionary tale and a roadmap for taxpayers who would rely on the work-product doctrine to protect tax advice from discovery.

Summary of the Case

At issue in Roxworthy were two memoranda prepared by KPMG LLP for the general counsel of Yum! Brands, Inc., analyzing creation of a captive insurance company and related stock transfers. The IRS issued an information document request in the course of its audit of Yum's 1997, 1998 and 1999 tax years, in response to which Yum asserted privilege for seven documents including the two memoranda it believed were protected under the work-product doctrine. The IRS then issued a summons to Patrick Roxworthy, Yum's Vice-President, Tax, for the documents on the privilege log. After entering into a limitation of waiver agreement, Yum produced five of the seven documents.

When the two KPMG memoranda were not produced, the IRS brought a summons enforcement action in district court. The case was assigned to a magistrate judge who concluded that the summons should be enforced on the ground that the documents were created to assist Yum in connection with preparation of its tax return in case the IRS asserted penalties on audit. Yum objected to the magistrate's findings and provided the court with additional affidavits to support its position that the documents were prepared in anticipation of litigation. The district court nevertheless adopted the magistrate's report and recommendation. Yum appealed.

In...