Work Product Privilege: the Future of Tax Accrual Work Paper Discovery in the Eleventh Circuit After Textron

• Citation: Vol. 27 No. 3
• Publication year: 2010

Georgia State University Law Review

Volume 27 j 7

Issue 3 Spring 2011

3-1-2011

Work Product Privilege: The Future of Tax Accrual Work Paper Discovery in the Eleventh Circuit After Textron

Tracy Hamilton

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Recommended Citation

Hamilton, Tracy (2010) "Work Product Privilege: The Future of Tax Accrual Work Paper Discovery in the Eleventh Circuit After Textron," Georgia State University Law Review: Vol. 27: Iss. 3, Article 7. Available at: http://digitalarchive.gsu.edu/gsulr/vol27/iss3/7

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WORK PRODUCT PRIVILEGE: THE FUTURE OF TAX ACCRUAL WORK PAPER DISCOVERY IN THE ELEVENTH CIRCUIT AFTER TEXTRON

Tracy Hamilton*

Introduction

The struggle between the Internal Revenue Service (IRS) and business taxpayers regarding the discovery of tax accrual work papers is not a new battle.¹ The IRS, seeking a road map of the corporation's vulnerable tax positions, argues that tax accrual work papers are prepared for ordinary business purposes and are not subject to the protection of the work product privilege as established in Hickman v. Taylor and codified in Federal Rule of Civil Procedure 26(b)(3). Corporate taxpayers, desperate to keep the IRS from discovering work papers containing the probability of success analysis of vulnerable tax positions (not to mention potential tolerance for settlement), argue that tax accrual work papers are prepared in anticipation of potential litigation with the IRS, contain

* J.D. Candidate, 2011, Georgia State University College of Law.

1. Tax accrual work papers typically consist of a listing of vulnerable tax positions and the company's assessment of likelihood of success on each position if the IRS challenges it. See discussion infra Part I.A. See generally United States v. Arthur Young & Co., 465 U.S. 805 (1984) (IRS challenge of a judgment holding that tax work papers are privileged); United States v. Adlman, 134 F.3d 1194 (2d Cir. 1998) (appeal of enforcement of IRS summons seeking taxpayer's internal memo regarding tax consequences of proposed business transaction); United States v. El Paso Co., 682 F.2d 530 (5th Cir. 1982) (appeal of enforcement of IRS summons seeking taxpayer's tax accrual work papers); I.R.S. Announcement 2002-63 (July 8, 2002) (IRS expands internal policy on seeking tax accrual work papers).

2. See Hickman v. Taylor, 329 U.S. 495, 510-11 (1947) ("[I]t is essential that a lawyer work with a certain degree of privacy, free from unnecessary intrusion by opposing parties and their counsel. Proper preparation of a client's case demands that he . . . prepare his legal theories and plan his strategy without undue and needless interference."); United States v. Textron Inc., 507 F. Supp. 2d 138, 150 (D.R.I. 2007) ("The IRS asserts that the workpapers were prepared in the ordinary course of business and in order to satisfy the requirements of the securities laws that financial statements filed by publicly traded companies comply with GAAP . . . ."); Fed. R. Civ. P. 26(b)(3) ("[A] party may not discover documents and tangible things that are prepared in anticipation of litigation or for trial . . . .").

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mental impressions and strategy related to the potential litigation, and are subject to protection under the work product privilege doctrine.

The Supreme Court has not addressed whether tax accrual work papers, created both for financial reporting purposes and to aid in potential disputes with the IRS, fall under the protection of the work product privilege as material created "in anticipation of litigation."⁴ Circuit courts, faced with the question of whether tax accrual work papers were created in anticipation of litigation, have developed two distinct tests for analyzing the material: the "primary motivating purpose" test and the "because of litigation test.⁵ A third test was added on August 13, 2009, when the First Circuit, in United States v. Textron Inc., overturned the district court's application of the because of litigation test and established a new, narrow "for use" test.⁶

The Eleventh Circuit has not addressed whether tax accrual work papers are protected by the work product privilege, nor has it formally adopted a test for determining whether material meets the in anticipation of litigation requirement for work product protection.

3. See Textron, 507 F. Supp. 2d at 150 ("Textron asserts that its tax accrual workpapers were prepared because it anticipated the possibility of litigation with the IRS regarding various items on its return and it points to the hazards of litigation percentages as evidence that the possibility of such litigation was the reason for preparing the workpapers.").

4. See United States v. Textron Inc., 577 F.3d 21, 26 (1st Cir. 2009) ("[T]he Supreme Court has not ruled on the issue before us, namely, one in which a document is not in any way prepared 'for' litigation but relates to a subject that might or might not occasion litigation."); id at 43 (Torruella, J., dissenting) ("The time is ripe for the Supreme Court to intervene and set the circuits straight on this issue which is essential to the daily practice of litigators across the country."); Regions Fin. Corp. v. United States, No. 2:06-CV-00895-RDP, 2008 WL 2139008, at *3 (N.D. Ala. May 8, 2008) ("The Supreme Court has not provided a controlling standard, and a split has developed between the various courts of appeal.").

5. See El Paso, 682 F.2d at 542 ("Litigation need not be imminent . . . as long as the primary motivating purpose behind the creation of the document was to aid in possible future litigation." (emphasis added) (quoting United States v. Davis, 636 F.2d 1028, 1040 (5th Cir. 1981))); Adlman, 134 F.3d at 1195 ("We hold that a document created because of anticipated litigation, which tends to reveal mental impressions, conclusions, opinions or theories concerning the litigation, does not lose work-product protection merely because it is intended to assist in the making of a business decision . . . ." (emphasis added)).

6. See Textron, 577 F.3d at 29 (3-2 decision) ("From the outset, the focus of work product protection has been on materials prepared for use in litigation, whether the litigation was underway or merely anticipated." (emphasis added)); id. at 32 (Torruella, J., dissenting) ("The majority purports to follow this [because of litigation] test, but never even cites it. Rather, in its place, the majority imposes a 'prepared for' test, asking if the documents were 'prepared for use in possible litigation.'").

7. See discussion infra Part II.A; Regions, 2008 WL 2139008, at *5 (noting that the Eleventh Circuit had not adopted a test, and it was not necessary to decide which test should be adopted in this case because the material at issue would be protected under either the because of or primary motivating

2011] WORK PRODUCT PRIVILEGE 731

Part I of this Note discusses the various tests adopted for determining whether material is prepared in anticipation of litigation, including the recent creation of a new test by the First Circuit Court's decision in Textron. Part II analyzes the existing primary motivating purpose and because of tests, the history of the Eleventh Circuit's decisions regarding material prepared in anticipation of litigation, and the potential impact on the Eleventh Circuit of the new for use test established by the First Circuit in Textron⁹ Part III proposes that the Eleventh Circuit formally adopt the because of litigation test based on the merits of this test and the weaknesses of the primary motivating purpose and the new for use tests.¹⁰

I. Background

A. The Purpose of Tax Accrual Work Papers

The tax accrual work papers of interest to the IRS¹¹—and litigated in the courts—typically consist of schedules and other material

12

prepared by the corporation's lawyers and tax department. The schedules list the tax positions reported on the corporation's tax

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return that could be vulnerable to attack by the IRS.

Publicly traded corporations are required by law to have their financial statements audited by independent public accountants to ensure compliance with Generally Accepted Accounting Principles

factor test); see also Michelle M. Henkel, Textron: The Debate Continues as to Whether Auditor Transparency Waives the Work Product Privilege, 50 Tax Mgmt. Memorandum 251, 253 n.22 (2009) (listing the circuits adopting one of the two main tests and noting that the Tenth and Eleventh Circuits

have yet to adopt tests).

8. See discussion infra Part I.

9. See discussion infra Part II.

10. See discussion infra Part III.

11. The term "tax accrual work papers" is a general term used to indicate work papers that analyze potential tax liabilities that could arise due to a dispute with a taxing authority. These work papers are also known as "tax pool analysis work papers," "FIN 48 work papers," or "tax reserve work papers." See, e.g., United States v. El Paso Co., 682 F.2d 530, 533 (5th Cir. 1982) ("This appeal is centrally concerned with documents known to the accounting profession under various names—the noncurrent tax account, the tax accrual work papers, and the tax pool analysis.").

12. See United States v. Arthur Young & Co., 465 U.S. 805, 812-13 (1984); United States v. Textron Inc., 577 F.3d 21, 23 (1st Cir. 2009); El Paso, 682 F.2d at 532-34.

13. See Arthur Young, 465 U.S. at 812-13; Textron, 577 F.3d at 23; El Paso, 682 F.2d at 532-34.

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(GAAP).¹⁴ As part of this process, GAAP requires that the corporation have adequate liabilities recorded for uncertain tax...