Waiving the Privilege - Tax Accrual Work Papers

Have you shared tax accrual work papers with an independent outside auditor? If so, you've waived your privilege to keep those papers from the Internal Revenue Service.

Many tax practitioners have been following the tumultuous progression of the Textron case, in which the First Circuit decided, en banc, to side with the IRS. Textron fought an IRS summons on four grounds - 1) the summons lacked a legitimate purpose; 2) the tax accrual work papers were protected by attorney-client privilege; 3) the papers were protected by tax practitioner privilege; and 4) the papers were protected by the work product doctrine.

The district court found that though the papers were prepared by attorneys, Textron waived its attorney-client privilege when it presented those documents to its independent auditor. Waiver of attorney client privilege occurs when the client opts to share the information with a third party. When shared with an independent third party, such as an independent auditor, the court views the information as no longer protected by the narrow confines of the attorney-client privilege doctrine. The waiver of attorney client privilege by Textron suffered no further scrutiny, but other aspects of Textron's argument temporarily gained some ground within the First Circuit.

The lower court agreed with Textron that the tax accrual work papers were protected by the work product doctrine, a privilege intended to prevent premature disclosure of legal strategy. Concluding the papers were protected by the work product doctrine, the lower court ruled that Textron did not have to provide the papers to the IRS. The IRS disagreed.

Appeals ensued. The First Circuit's Appellate Panel agreed with the lower court, and then the First Circuit, en banc, vacated both lower court decisions. The en banc appeal focused on the narrow question of whether the documents were protected by the work product doctrine and concluded they were not. The First Circuit reasoned that the papers were written in accord with ordinary business practices, and though they described the hotly litigated issue of SILOs, they were not written "in anticipation of litigation." As such, Textron's documents were not protected by the work product doctrine, and Textron had to provide them to the IRS.

Only two Circuits, the First and the Fifth, have addressed work product protection for tax audit work papers; Textron is the most recent. It reflects a change in the Service's long standing history of restraint on requesting tax accrual work papers. Large scale fraud activity has captured the attention of the courts and resulted in an erosion of legal privileges generally. The courts are requiring documents to be provided to fraud investigation entities and protecting only very narrow types of information from judicial and opponent review.

KEMY is up to date on the changing law and its impact on tax work papers. If you have access to legal tax papers and do not know whether or not they can be provided to the IRS in pursuit of uncovering fraud, call KEMY for a free consult today.