Jump to Navigation | Jump to Content
American Bar Association

Litigation News

Work-Product Protection Denied to Tax Accrual Workpapers

By Robert C. Rodriguez, Litigation News Associate Editor – October 26, 2009

The attorney work-product doctrine does not shield “tax accrual work papers” from an IRS summons even though the documents were prepared by in-house counsel and contain legal insight and analysis, according to a recent ruling of the First Circuit Court of Appeals, sitting en banc.

In United States v. Textron [PDF], the company’s in-house lawyers had prepared the documents to support calculations of tax reserves for the audited corporate financial statements and arguably included legal insights and analysis. The papers were being sought by the IRS in connection with its examination of the company’s tax liability.

Background of Dispute
Textron is a major aerospace and defense conglomerate, with more than 100 subsidiaries, whose tax returns are regularly audited by the IRS. As a publicly traded company, Textron is required by federal securities law to prepare independently audited financial statements. These statements include an estimated amount of potential tax liabilities to be placed in “tax reserves” should the IRS prevail in tax disputes with the company.

While companies vary on the amount of detail provided in financial statement supporting documents, or “tax accrual work papers,” the First Circuit opinion notes that, in this case, Textron’s tax accrual work papers included notes of specific tax entries that could be challenged by the IRS, percentage estimates of the IRS’s likely success in disputing those tax positions, and commentary notes and emails by in-house tax lawyers detailing how the percentages were derived. It was also undisputed that knowing a company’s tax return “soft spots” is highly beneficial to the IRS.

During a 2003 audit of Textron’s tax liability for years 1998–2001, the IRS issued an administrative summons for Textron’s tax accrual work papers. The company refused, arguing that the IRS had no legitimate purpose for seeking the documents, and that they were protected by the attorney-client and attorney work-product privileges.

District Court Ruling Upholding Attorney Work Product
The First Circuit opinion vacated an earlier decision [PDF] in this case by the U.S. District Court for the District of Rhode Island, which had denied the IRS petition to enforce its summons. Although the district court held that the IRS had a legitimate purpose in seeking the documents and that any attorney-client privilege was waived because Textron shared the information with third-party accountants on a regular basis, it also found that the documents were protected by the attorney work-product doctrine set forth in FRCP Rule 26 (b)(3). Textron had not waived that privilege, the district court had ruled.

In rendering its decision, the district court applied the attorney work-product standard set forth by the First Circuit in Maine v. U.S. Department of Interior.

In Maine, the First Circuit held that documents are protected by the attorney work-product doctrine when they are prepared “because of” the prospect of litigation. The doctrine does not apply to “documents that are prepared in the ordinary course of business or that would have been created in essentially similar form irrespective of the litigation.”

Finding Textron’s work papers protected, the district court was persuaded that the company’s legal team envisioned a later legal dispute with the IRS, and prepared the documents “because of” potential litigation.

In January, a panel of three judges in the First Circuit initially affirmed the district court decision, but that panel decision was reversed, in a 3–2 split, by the First Circuit sitting en banc.

First Circuit Reversal
In reversing the district court’s ruling, the First Circuit acknowledged the split in authority amongst the circuits on the applicable test to be used to decide whether tax accrual work papers are protected by the attorney work-product doctrine.

The First and Second Circuits employ the “because of” test discussed in Maine, while the Fifth Circuit uses a narrower “primary purpose” test in determining whether tax accrual work papers are protected by the attorney work-product doctrine. Under that test, documents are protected by the attorney work-product doctrine only when the “primary purpose” for preparing the documents was to assist in litigation.

While purporting to reaffirm the lower court’s use of the “because of” test set forth in Maine, and continuing that test as the First Circuit standard, the appellate court nonetheless found that Textron’s documents were not protected by the attorney work-product doctrine. The First Circuit reasoned that the documents were not prepared in the course of litigating a case, but rather were prepared to comply with federal securities laws.

Work Paper Protection
In rendering its en banc decision, the First Circuit contrasted tax accrual work papers with “the materials that lawyers typically prepare for purposes of litigating cases.” The majority opinion reasoned that the subject matter of a document conceivably being related to the possibility of litigation should not trigger protection, but instead protection is provided when the documents are prepared for litigation. Because tax accrual work papers are required by statute for financial reporting purposes, rather than prepared for litigation, they were not protected by the work-product doctrine, the opinion concludes.

Dennis J. Ventry Jr., Davis, California, member of the ABA Section of Taxation and UC Davis Law School professor, agrees with the First Circuit’s majority position and does not think these tax accrual work papers should receive work-product protection.

“You have to look at why the documents were prepared,” Ventry says. In Textron’s case, “it was to comply with federal securities law. The papers exist exclusively because of disclosure requirements regardless of any prospect for future litigation,” he notes.

Textron’s dispute with the IRS arose several years after the tax accrual work papers were prepared, Ventry adds.

However, a strongly worded dissent takes issue with the majority opinion’s purporting to follow the “because of test” announced in Maine. The dissent asserts that the majority is adopting a new “prepared for” standard to determine when a document is created in anticipation of litigation. Such a standard is a “narrower variant” of the Fifth Circuit test, the dissent criticizes.

“Nearly every major business decision by a public company has a legal dimension that will require [risk of potential litigation] analysis,” the dissent notes. “Corporate attorneys preparing such analysis should now be aware that their work product is not protected in this circuit,” the dissent warns.

“In straining to craft a rule favorable to the IRS as a matter of tax law, the majority has thrown the law of work-product protection into disarray,” the dissent says.

What Is Protected?
While unable to arrive at a concrete definition of what will be protected, the First Circuit opinion notes that, “any experienced litigator would describe the tax accrual work papers as tax documents and not as case preparation materials.”

“Every lawyer who tries cases knows the touch and feel of materials prepared for a current or possible (i.e., ‘in anticipation of’) lawsuit,” the court says. “No one with experience of law suits would talk about tax accrual work papers in those terms,” the opinion notes.

“The privilege [is] aimed centrally at protecting the litigation process . . . specifically, work done by counsel to help him or her in litigating a case. It is not a privilege designed to help the lawyer prepare corporate documents or other materials prepared in the ordinary course of business. Where the rationale for a rule stops, so ordinarily does the rule,” the majority reasons.

The First Circuit has taken a very qualitative approach, basically saying “I know it when I see it,” observes Gregory P. Joseph, New York, former chair of the Section of Litigation and member of the Section’s Federal Practice Task Force.

The majority opinion has "thrown the law of work-product protection into disarray," argues the dissent. “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,” the dissent says.

However, neither Joseph nor Ventry think that the Supreme Court is likely to review this issue soon. To the extent there is a split among the circuits, it was present well before the Textron case, Ventry says.

On the topic of attorney-client privilege, the Supreme Court heard oral argument on October 5, 2009, in Mohawk Industries, Inc. v. Carpenter [PDF] (08-678), Joseph notes. In that case, the Court is expected to review whether a party has an immediate appeal under the collateral order doctrine court’s order, finding waiver of the attorney-client privilege and compelling production of privileged materials.

Keywords: United States v. Textron, First Circuit, work-product doctrine, tax accrual workpapers

Related Resources
  • » United States v. Textron Inc., No. 07-2631, 577 F.3d 21 (1st Cir. 2009).
  • » United States v Textron, Inc., 507 F. Supp. 2d 138, 150 (2007).
  • » For the Second Circuit’s application of the “because of” test, see United States v. Adlman,134 F.3d 1194, 1202–1203 (2nd Cir. 1998).
  • » For a discussion of the “primary purpose test,” see United States v. El Paso, 682 F.2d 530, 543 (5th Cir. 1984).


Be the first to comment.


We welcome your comments. Please use the form below to post.

Copyright © 2017, American Bar Association. All rights reserved. This information or any portion thereof may not be copied or disseminated in any form or by any means or downloaded or stored in an electronic database or retrieval system without the express written consent of the American Bar Association. The views expressed in this article are those of the author(s) and do not necessarily reflect the positions or policies of the American Bar Association, the Section of Litigation, this committee, or the employer(s) of the author(s).

Back to Top