LLCs Waived Attorney-Client Privilege for Opinion Letters

By James A. Beavers, J.D., LL.M., CPA, CGMA

Practice & Procedures

The Tax Court held that in a son-of-boss tax shelter case, two LLCs waived attorney-client privilege for opinion letters from their attorneys by asserting defenses that turned on the LLCs' beliefs or state of mind.


The IRS adjusted the partnership items of and assessed accuracy-related penalties against AD Investment 2000 Fund LLC and AD Global 2000 Fund LLC. The IRS claimed that the two LLCs, which were taxed as partnerships, were son-of-boss tax shelters. The LLCs challenged the IRS's determinations in Tax Court.

In the proceedings, the IRS sought to compel the LLCs to produce six opinion letters from a law firm. The letters expressed the law firm's opinion as to whether, on the basis of representations made to the law firm by the LLCs, it was more likely than not that the anticipated tax benefits from the transactions in question would be upheld for federal income tax purposes. The LLCs argued that attorney-client privilege protected all the opinion letters and, therefore, the LLCs did not have to disclose them. The IRS contended that, while attorney-client privilege applied to the opinion letters, under the common law doctrine of implied waiver, the LLCs had waived attorney-client privilege for the letters. According to the IRS, the LLCs had placed the opinion letters into controversy by relying on affirmative defenses to the penalties that turned on the LLCs' beliefs or state of mind.

Sec. 6662 Belief Requirement

Under Sec. 6662(b)(2), the accuracy-related penalty will not apply to an underpayment if there is or was substantial authority for the tax treatment of any items resulting in an underpayment of tax, and the taxpayers (in this case the LLC and its members) reasonably believed that their tax treatment of such items was more likely than not the proper tax treatment. Regs. Sec. 1.6662-4(g)(1)(i)(B) provides that the belief requirement is satisfied if "[t]he taxpayer reasonably believed at the time the return was filed that the tax treatment of that item was more likely than not the proper treatment." This requirement is satisfied if:

  1. The taxpayer analyzes the pertinent facts and authorities . . . , and in reliance upon that analysis, reasonably concludes in good faith that there is a greater than 50-percent likelihood that the tax treatment of the item will be upheld if challenged by the Internal Revenue Service; or
  2. The taxpayer reasonably relies in good faith on the opinion of a professional tax advisor, if the opinion is based on the tax advisor's analysis of the pertinent facts and authorities . . . , and unambiguously states that the tax advisor concludes that there is a greater than 50-percent likelihood that the tax treatment of the item will be upheld if challenged by the Internal Revenue Service. [Regs. Sec. 1.6662-4(g)(4)(i)]
The LLCs' Position

In their pleadings in the Tax Court, the LLCs claimed they satisfied the belief requirement by the first method. They did not assert an advice-of-counsel defense, and their petitions did not even allude to any advice from their attorney. Thus, the LLCs argued that they had not put the information in the opinions into controversy. The LLCs also maintained that under the Second Circuit case In re County of Erie , 546 F.3d 222 (2d Cir. 2008), a generalized "good faith" defense, which does not specifically rely on the advice of counsel, is not a waiver of the attorney-client privilege, and that to impliedly waive the attorney-client privilege, a party must rely on privileged advice from counsel to make the claim or defense. The venue for appeal of the case was the Second Circuit, so the LLCs argued that this precedent should apply.

The IRS's Argument

The IRS conceded that the LLCs had raised only the first method of showing that they satisfied the belief requirement in their pleadings. Nevertheless, the IRS argued that the LLCs had placed the opinion letters into controversy by relying on a reasonable-cause, good-faith defense, which put the LLCs' beliefs in issue. The LLCs received the opinion letters before taking the questioned positions and presumably before making their alleged self-determination of authorities. Thus, the IRS posited, the opinion letters were relevant because, if they contradicted the LLCs' claimed self-determination, they might show that this self-determination was not reasonable, and, if consistent with this self-­determination, they might show that the LLCs made no self-determination and instead relied on the opinion letters.

The Tax Court's Decision

The Tax Court held that the LLCs waived the attorney-client privilege for the opinion letters. Although the LLCs did not claim to rely on the opinion letters to satisfy the belief requirement, the court found that by putting their legal knowledge and understanding into issue to establish a good-faith and state-of-mind defense, the LLCs forfeited the attorney-client privilege for communications relevant to the content and formation of their legal knowledge, understanding, and beliefs.

The court first looked to whether the precedent of In re County of Erie should control. The court explained it will only follow an appellate court precedent if the decision establishing the precedent is "squarely in point." The Tax Court found that the facts of Erie were materially distinguishable from those of the LLCs because, in that case, the taxpayers, unlike the LLCs, did not claim a good-faith or state-of-mind defense. Therefore, the Tax Court concluded it was not obligated to follow the Second Circuit's holding in Erie .

The Tax Court instead followed the precedent from a Second Circuit criminal case, Bilzerian , 926 F.2d 1285 (2d Cir. 1991). In Bilzerian , the defendant was accused of financial crimes. The trial court ruled that if the defendant testified regarding his good-faith efforts to comply with the relevant securities laws, he would waive attorney-client privilege. The defendant did not testify at trial, and, on appeal, he contended that his testimony would not have disclosed even the existence of privileged communications and he would not have asserted he had relied on counsel. Thus, he had not waived the privilege. The Second Circuit rejected his argument, holding that even if his testimony did not refer to protected communications, he would have implicitly waived the privilege if he asserted a claim that in fairness required that the prosecution be allowed to examine otherwise protected communications. The court concluded that, although the defendant did not have to testify about his state of mind, if he did so by asserting good faith, the jury would be entitled to know the basis of his understanding that his actions were legal.

The Tax Court found that the LLCs' situation was analogous to the defendant's in Bilzerian , and that if the LLCs claimed they acted reasonably and in good faith, fairness required that it allow the IRS to inquire into the bases of the LLCs' knowledge, understanding, and beliefs, including the opinion letters, if the LLCs had considered them. The court found that the LLCs had received the opinion letters in time for the LLCs to consider them before filing the tax returns in question and that the LLCs did not claim that they had not considered them. Therefore, because the LLCs raised a good-faith and state-of-mind defense, the IRS was entitled to examine the opinion letters.


As this case makes clear, an opinion letter, which a taxpayer generally uses as a shield, can sometimes end up being a sword in the IRS's hands. Simply put, if a taxpayer raises a defense that can be effectively disproven only through the discovery of attorney-client communications, the taxpayer impliedly waives attorney-client privilege.

In general, Sec. 6664 makes it very difficult for taxpayers to rely on tax shelter opinion letters for protection from penalties. Per Sec. 6664(d)(4)(B)(iii), certain opinions cannot be relied on to establish that the taxpayer had a reasonable belief the anticipated tax benefits would be upheld. Such forbidden opinions include ones in which the adviser receives a contingent fee and ones that are based on unreasonable factual or legal assumptions or unreasonable taxpayer representations. Presumably, the LLCs in this case felt that the court would find that they could not rely on the opinion letters, so they claimed attorney-client privilege to try to prevent the court from considering them at all.

AD Investment 2000 Fund LLC , 142 T.C. No. 13 (2014)

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