Daily Tax Update - May 12, 2008

ALABAMA DISTRICT COURT PROTECTS DOCUMENTS FROM AN IRS SUMMONS FOR TAX ACCRUAL WORKPAPERS: In Regions Financial Corp. et. al. v. United States, No. 2:06-CV-00895 (N.D. Ala. May 8, 2008), the District Court granted a taxpayer’s petition to quash an Internal Revenue Service (“IRS”) summons requesting tax accrual workpapers that was served on the taxpayer’s independent auditor. The District Court held that the withheld documents were protected under the work product privilege, and that the taxpayer had not waived the privilege by disclosing the documents to the auditor.

• The conflict in Regions arose when the IRS issued a summons to the taxpayer’s independent auditor requesting the taxpayer’s “tax accrual workpapers.” The taxpayer asked its auditor to withhold documents related to a transaction. These documents contained a law firm’s opinions, evaluations of legal theories, and analysis of possible attacks on the taxpayer’s reporting of the transactions. The withheld documents also included a written opinion given to the taxpayer by the auditor as well as other derivative documents. The IRS argued that the documents were not protected work product because they were prepared so that the taxpayer could accurately report its contingent liabilities and not in anticipation of litigation. The taxpayer argued that it would not have the contingent liabilities if it did not think that the IRS would sue over the tax consequences of the transaction.
• The District Court agreed with the taxpayer. The District Court held that it need not decide whether the withheld documents were protected under the “primary motivating purpose” or the “because of litigation” tests used to determine whether the work product privilege applies, because the documents were protected under either test. The court explained, “The fact that [the taxpayer] undertook the time and expense of consulting outside firms to assess its potential liabilities shows that it believed litigation to be likely, and this court cannot say that [the taxpayer's] subjective belief was objectively unreasonable.” The court relied on United States v. Textron, 507 F.Supp. 2d 138 (D. R.I. 2007), to support the conclusion that the withheld documents were protected under the work product privilege.
• The court found that petitioner had not waived the work product privilege by disclosing the documents to the independent auditor for two reasons. First, there was no conceivable scenario in which the auditor would file a lawsuit against petitioner because of something the auditor learned in the documents. Second, a confidential agreement between the auditor and the taxpayer prevented the auditor from giving the documents to another party. The District Court found that these facts demonstrated that the auditor was not an adversary or a conduit to an adversary.
• For additional information, contact: Arthur L. Bailey – abailey@steptoe.com or J. Walker Johnson – wjohnson@steptoe.com

COMMISSIONER DESCRIBES HIS PHILOSOPHY AT ABA TAX SECTION MEETING: On May 9, IRS Commissioner Douglas Shulman described his philosophical inclinations for his tenure at the IRS. The Commissioner said that his philosophy was twofold: (1) The IRS must understand the economic realities of the environment in which taxpayers operate; and (2) The IRS must do everything that it can to provide clear guidance to taxpayers.

• To understand economic realties, the Commissioner stated that the IRS needs to have “a robust dialog with the taxpayer community.” He went on to say, “That doesn’t mean we will always agree, but constant communication is important.” The Commissioner stated that clear guidance will keep that the IRS from “contributing to potential noncompliance by failing to issue guidance or issuing guidance that is subject to multiple and varied interpretations.
• The Commissioner’s remarks can be accessed via:  http://www.irs.gov/irs/article/0,,id=182820,00.html

INTERNAL REVENUE SERVICE - CIRCULAR 230 DISCLOSURE:
As provided for in Treasury regulations, advice (if any) relating to federal taxes that is contained in this communication (including attachments) is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to another party any plan or arrangement addressed herein.

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