Hand over Your Tax Accrual Workpapers: The First Circuit in United States V. Textron Exposes Dual-Purpose Documents to Discovery

IntroductionIn the wake of Enron and other corporate financial scandals, corporate taxpayers have been increasingly subject to government regulation. 1 Recently, the Internal Revenue Service (IRS) has concentrated on tax shelters-corporate transactions designed to avoid tax liabilities. 2 Tax shelters deprive the U.S. Treasury of a large source of revenue and contribute to the federal budget deficit.3 To detect tax shelters, the IRS now frequently requests disclosure of corporate taxpayers' tax-related documents.4 Corporate taxpayers, however, are reluctant to provide this information freely and have tried to shield their tax documents from discovery by using various legal doctrines including the attorney- client privilege, the tax practitioner-client privilege, and, recently, the attorney work-product privilege.5In August 2009, the U.S. Court of Appeals for the First Circuit, sitting en banc, decided United States v. Textron Inc. and the issue of whether a corporate taxpayer's tax accrual workpapers are protected under the limited attorney work-product privilege.6 The en banc court, reversing the decisions of the district court and a First Circuit panel, held that Textron's tax accrual workpapers were not privileged under the work-product doctrine and granted the IRS a monumental win.7 The court based its ruling on its conclusion that tax accrual workpapers are prepared for business purposes, not for litigation.8 It also expressed a desire to support the IRS.9Taxpayers and practitioners have voiced sharp outcry in the wake of the Textron decision.10 One concern is that the IRS now has an unfair advantage in tax return litigation.11 More broadly, any adversary, not just the IRS, may now access an opponent's tax accrual workpapers.12 The Textron decision, however, is unlikely to be short-lived, as the U.S. Supreme Court denied certiorari in May 2010.13 Additionally, the IRS has continued to demand transparency and disclosure and is unlikely to cease requesting tax accrual workpapers.14This Comment begins in Part I with an overview of the First Circuit's en banc decision in Textron.15 Part II then discusses the majority's reasoning and the heavy emphasis the decision placed on IRS's interests in revenue collection.16 Finally, Part III argues that, as a result of the desire to support the IRS, the Textron majority created an overly narrow, tax-centric work-product standard that fits poorly in the broader scope of attorney work-product.17I. Tax Accrual Workpapers and the Work-Product Privilege: What They Are and How the Textron Court Considered Them in TandemA. Tax Reporting Requirements and Tax Accrual WorkpapersFederal securities laws require publicly traded corporations like Textron to obtain audited financial statements annually from independent accounting firms.18 This audit typically requires an accountant to issue a favorable, or "clean," opinion letter, which certifies that the company's financial statements fairly represent the company's financial condition.19 Prior to issuing this opinion letter, accountants usually request to view the company's tax returns so that they can identify transactions that may result in tax liabilities, or "contingencies," if challenged by the IRS.20 The company must quantify these contingencies and set aside enough money in reserve to satisfy them.21Tax accrual workpapers are often used to determine the size of a company's reserves by analyzing the tax impact of completed transactions. 22 Although there is no standard definition for tax accrual workpapers, the IRS defines them asthose audit workpapers, whether prepared by the taxpayer, the taxpayer's accountant, or the independent auditor, that relate to the tax reserve for current, deferred and potential or contingent tax liabilities . . . and to footnotes disclosing those tax reserves on audited financial statements. These workpapers reflect an estimate of a company's tax liabilities and may also be referred to as the tax pool analysis, tax liability contingency analysis, tax cushion analysis, or tax contingency reserve analysis. …