Accountant Workpaper Privilege Upheld by First Circuit

On January 21, 2009, the First Circuit upheld a district court’s decision that the work-product privilege applies to certain accountant workpapers (Textron Inc., No. 07-2631 (1st Cir. 1/21/09), aff’g in part, vacating in part, and remanding 507 F. Supp. 2d 138 (D.R.I. 2007)).

Editor’s note: The First Circuit later vacated the decision in the Textron decision discussed here, reheard the case en banc, and reversed the district court. See Textron Inc., No. 07-2631 (1st Cir. 8/13/09).

Textron is a publicly traded conglomerate with approximately 190 subsidiaries. Like other large corporations, Textron’s federal tax returns are audited periodically. Textron and its subsidiaries annually prepare tax accrual workpapers.

Textron’s tax accrual workpapers were prepared by attorneys and CPAs working for Textron. Textron’s subsidiary companies prepared their workpapers with some input from private law firms and outside accounting firms. According to Textron officials, Textron’s ultimate purpose in preparing the tax accrual workpapers was to ensure that Textron was “adequately reserved with respect to any potential disputes or litigation that would happen in the future.”

During an audit of Textron’s 1998–2001 tax years, the IRS issued more than 500 information document requests to Textron. Textron refused to comply with any requests that sought tax accrual workpapers, asserting that the workpapers were protected by attorney-client, tax practitioner–client, and work-product privileges.

The district court, after considering whether the privileges applied and whether Textron had waived the privileges, held that work-product privilege applied and had not been waived (the others had been waived), so Textron did not have to give its tax accrual workpapers to the IRS.

The work-product privilege (or work-product doctrine) is related to the attorney-client privilege and applies to materials prepared or gathered by an attorney in anticipation of litigation (Fed. R. Civ. Pro. 26(b)(3)). Under this privilege, a party seeking an attorney’s work product covered by the privilege is entitled to it only on a showing of a substantial need for it.

The IRS had argued that because Textron was required by financial reporting rules to create the requested documents, the privilege could not apply. But the First Circuit stated that “the presence of a business purpose does not defeat work-product protection” (Textron, slip op. at 12).

The court also held that the resolution of audit disputes with the IRS meets the definition of litigation. The court found that the “driving force” behind the preparation of the documents was the need to reserve money in anticipation of disputes with the IRS (i.e., litigation). Therefore, the work-product privilege applied to the workpapers.

The district court had held that Textron had not waived the work-product privilege by showing the workpapers to its auditor. The First Circuit remanded the case to the district court for reassessment of the question of whether the privilege had been waived.

For more on the district court’s decision, see Tax Trends, “District Court Holds That Tax Accrual Workpapers Are Privileged Documents,” 38 The Tax Adviser 756 (December 2007).