In an important ruling upholding the rights of corporate taxpayers, the U.S. Court of Appeals for the First Circuit held this week in United States v. Textron, Inc. that a taxpayer can shield its tax accrual work papers from an Internal Revenue Service subpoena under the work product doctrine. The court also held that the taxpayer does not waive this protection by disclosing these work papers to its outside auditor in connection with the taxpayer's financial statements. The decision has practical significance for corporate taxpayers because disclosure of tax accrual work papers to an outside auditor, as is typically done, deprives the documents of protections under other legal privileges that might otherwise apply.

At issue in Textron were a series of tax accrual work papers assessing the strength of various tax positions taken by the company, including evaluations of the likelihood that the company would prevail on each position against an IRS challenge. These work papers underlay establishment of the company's income tax reserve, a required component of its financial statements under Generally Accepted Accounting Principles (GAAP). Tax accrual work papers are of interest to the IRS because they can serve as a road map for an audit. Accordingly, in Textron, the IRS issued an administrative subpoena for the work papers to aid its investigation of the company's potentially improper tax shelter transactions. When Textron objected, the IRS petitioned to enforce the subpoena in Federal District Court in Rhode Island, which ruled in Textron's favor on work product grounds.

Affirming key aspects of the District Court's decision, the First Circuit held that Textron's tax accrual work papers qualified for protection under the work product doctrine because they were "prepared in anticipation of litigation." In so holding, the court rejected the IRS's argument that Textron prepared the work papers for a business purpose, i.e., to satisfy GAAP. The court concluded that the documents had a "dual purpose" in that they served a business need and were also prepared in anticipation of litigation. It reasoned that the work product protection applied because the business need to develop a reserve in the event of tax disputes with the IRS was "inextricably related" to litigation of those same disputes. The court held that, for work product purposes, the term "litigation" extends to "adversary administrative processes, including proceedings before the IRS Appeals Board."

The First Circuit also rejected the IRS's fallback argument that, even assuming the work papers qualified for work product protection, Textron had waived that protection by sharing the work papers with its outside auditor, Ernst & Young. Noting that a party waives work product protection for documents by disclosing them to its adversaries, the IRS contended that an auditor is a potential adversary of its client if, for example, it issues a qualified opinion on the client's financial statements because it believes the tax reserve is unsupportable. By contrast, the court characterized the relationship between Textron and its auditor as "a cooperative not adversarial relationship" that was marked by the auditor's duty of confidentiality and was unlikely to lead to litigation between the two. The court remanded the action to the District Court to determine factual issues relating to discoverability of the auditor's own tax work papers.

The Textron opinion is at odds with a 1982 Fifth Circuit decision that ordered disclosure of accrual work papers after applying a more restrictive view of the work product doctrine. In addition, under prior Supreme Court precedent, IRS could subpoena Ernst & Young's work papers from the Textron audit, assuming they did not reflect information contained in Textron documents that qualified as work product. That issue is now being addressed on remand.

Textron is an important decision for corporate taxpayers, who have an obvious interest in shielding their tax accrual work papers from the IRS and state tax authorities, which do not share the IRS's policy of restraint in seeking such documents outside the tax shelter area. To maximize the likelihood of work product protection, corporate taxpayers should have an attorney prepare or at least supervise the preparation of tax accrual work papers. Moreover, the work papers should be safeguarded and only disclosed selectively to necessary, nonadversarial parties to head off any argument that their confidentiality has been waived.

To discuss the Textron opinion or issues relating to the preparation or discovery of tax accrual work papers, please contact Edward D. Rogers, at 215.864.8144 or, or Wendi L. Kotzen, at 215.864.8305 or

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