Work Product, Tax Accrual Workpapers & the IRS
Tax documents such as tax accrual work papers or tax memorandums often become case preparation materials when the taxpayer later presents himself in court to contest a deficiency assessed by the Internal Revenue Service (IRS). Case preparation materials are usually afforded protection under the “work product doctrine.” Because the language of Fed. R. Civ. P. 26(b)(3) indicates that “work product” consists of “documents and tangible things that are prepared in anticipation of litigation,” tax documents from which business decisions are made or from which financial statements are developed potentially results in their exclusion from work product despite their ultimate use in litigation.
In U.S. v. Deloitte, 610 F.3d 129 (D.C. Cir. 2010), the D.C. Circuit permitted work product protections to extend to a memorandum that was generated as part of a routine audit process. In Textron v. U.S., 577 F.3d 21, 30 (1st Cir. 2009), however, the First Circuit refused to consider tax accrual workpapers that were to be used to establish and support the tax reserve figures for the audited financial statements as work product.
The different results can be attributed to what each Circuit considered to be “in anticipation of litigation.”
The court in Textron viewed the workpapers in question as documents created in the ordinary course of business for a nonlitigation purpose, specifically for the purpose of preparing financial statements. Specifically, the court described work product as follows:
It is only work done in anticipation of or for trial that is protected. Even if prepared by lawyers and reflecting legal thinking, materials assembled in the ordinary course of business, or pursuant to public requirements unrelated to litigation, or for other nonlitigation purposes are not under the qualified immunity provided by this subdivision. . . [t]he work product protection does not extend to documents that would have been created in essentially similar form irrespective of the litigation.
Textron, 577 F.3d at 30.
The government argued that even if litigation were “remote,” the company would still have to prepare work papers to support its judgment. Id. at 28. Conversely, Textron argued that “without the possibility of litigation, no tax reserves or audit papers would have been necessary.” Id. at 27.
Ultimately, the court “balanced policy concerns instead of applying abstract logic” and found that “the underlying prudential considerations supported the IRSs position” to deny work product protection, stressing that “tax collection was not a game” and that “underpaying taxes threatens the essential public interest in revenue collection.” Id. at 31. The court found that the workpapers did not reflect work done for litigation but was merely work done to prepare financial statements. Id. at 31
Conversely, the DC Circuit in Deloitte applied the majority approach of the “because of” test to determine whether the document was prepared in anticipation of litigation. Id. at 137. The “because of” test asks whether, in light of the nature of the document an factual situation in the particular case, the document can fairly be said to have been prepared or obtained because of the prospect of litigation. Id.
Like Textron, the government in Deloitte asserted that the document was not prepared because of the prospect of litigation, but was prepared as part of a routine audit process. Id. The DC Circuit differentiated between relying on a documents function instead of its content to determine whether it was work product. Id. “A document can contain protected work-product material even though it serves multiple purposes, so long as the protected material was prepared because of the prospect of litigation.” Id. at 138.
Additionally, the DC Circuit, in its interpretation of the holding of United States v. Adlman, 134 F.3d 1194 (2d Cir. 1998), found that “material developed in anticipation of litigation can be incorporated into a document produced during an audit without ceasing to be work product.”
The language from Adlman, relied upon by the DC Circuit, coincides with the taxpayers argument in Textron.
[a] document created because of anticipated litigation, which tends to reveal mental impressions, conclusions, opinion 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 influenced by the likely outcome of the anticipated litigation. Where a document was created because of anticipated litigation, and would not have been prepared in substantially similar form but for the prospect of that litigation, it falls within Rule 26(b)(3).
Adlman, 134 F.3d at 1195.
The Textron court did not want to extend the protections of work product to documents created proactively by a business where litigation, especially with the IRS, was a definite future possibility but not yet a definite future occurrence. The Deloitte court, however, seems to reflect a more flexible approach for the proactive decisions made by these businesses.
If you have any questions regarding the protections afforded by work product, litigation with the IRS, or any other tax provision, please contact Fuerst Ittleman, PL at contact@fidjlaw.com.