Two Courts Address Tax Shelter Exception to Tax Practitioner Privilege

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

The Tax Court and the Seventh Circuit recently decided cases dealing with the tax practitioner/client privilege under Sec. 7525. The Tax Court held that the tax shelter exception to the tax practitioner/client privilege did not apply to documents in the form of the minutes of meetings between a partnership and a federally authorized tax practitioner because the tax advice in the documents was not given in connection with the promotion of a tax shelter. In another case, the Seventh Circuit upheld a district court’s order to a corporation to produce certain documents containing communications between a corporation and its accounting firm because the tax shelter exception applied to those documents.

Background of Tax Court Case

Timothy Egan is an accountant who is a partner with PricewaterhouseCoopers (PwC). Egan’s clients at PwC include Arthur Winn and the “Winn organization,” a group of corporations and partnerships controlled by Arthur Winn and his associates. Egan had provided tax compliance and tax planning and advisory services to Winn and the Winn organization entities over a long period. As part of his services to the Winn organization, Egan provided tax advice to the organization regarding transactions of the Countryside Limited Partnership. The IRS considered these transactions to be tax shelters.

During litigation with Countryside over these transactions, the IRS asked the Tax Court to compel Countryside to produce a series of 16 documents, all titled “Estate Planning Meeting Minutes” (the minutes), that constituted a cumulative chronicle of communications, in part confidential, from clients, including Countryside, to their attorneys for legal advice; to Timothy Egan, for tax advice; or from those individuals back to their clients. Countryside argued that it was not required to produce the documents because the IRS had failed to prove that minutes were related to the promotion of a corporation’s participation in any tax shelter, so the Sec. 7525(b) tax shelter exception did not apply.

Background of Seventh Circuit Case

Valero Energy Corp. is a large oil refining company based in Texas. In December 2001, Valero acquired a Canadian oil company. Shortly after that acquisition, Valero, with the help of its accounting firm, Arthur Andersen, undertook a complicated series of transactions that allowed it to realize $105 million in foreigncurrency losses.

These large losses led to an IRS investigation. In the investigation, the IRS issued a summons to Arthur Andersen for documents related to the tax aspects of the transactions. Valero resisted the summons in court, claiming that documents were protected by the tax practitioner/client privilege under Sec. 7525. A district court eventually held that the tax-shelter exception to the privilege applied to some of the documents and ordered Valero to produce those documents. Valero appealed this decision to the Seventh Circuit, arguing that the documents were prepared as part of individualized tax planning services provided by Andersen to Valero, so the tax-shelter exception did not apply.

Sec. 7525

Under Sec. 7525(a), a limited privilege, equivalent to the attorney-client privilege, applies to communications between a taxpayer and a federally authorized tax practitioner regarding tax advice. However, under Sec. 7525(b), there is an exception to the privilege for communications regarding tax shelter transactions. At the time of the events in both cases, Sec 7525(b) stated that the privilege did “not apply to any written communication between a federally authorized tax practitioner and a director, shareholder, officer, or employee, agent, or representative of a corporation in connection with the promotion of the direct or indirect participation of such corporation in any tax shelter (as defined in section 6662(d)(2)(C)(iii)).”

Tax Court’s Decision

In the Countryside case, the Tax Court held that the exception did not apply to the minutes because Egan did not give the advice they contained as part of the promotion of a tax shelter. Noting that other courts addressing the meaning of promotion for purposes of Sec. 7525(b) had come to different and widely diverging definitions of the term, the Tax Court decided that recourse to the legislative history of the statute was justified. The Tax Court found that the legislative history of Sec. 7525 indicated that a routine relationship between a tax practitioner and a client did not amount to promotion of a tax shelter for purposes of Sec. 7525(b).

Based on Egan’s deposition testimony about his work for the Winn organization, the veracity of which the IRS did not challenge, the Tax Court found that Egan’s advice about Countryside was provided as part of Egan’s routine relationship with the organization. In coming to this conclusion, the court stressed the close, longterm nature of Egan’s relationship with the organization and the fact that Egan had given similar advice about other transactions under the same procedures on a regular basis during the relationship.

The Tax Court also pointed out that PwC had no stake in the outcome of the Countryside transactions that Egan gave advice on and that the firm was paid on the same hourly basis for the advice as it was for the tax preparation services provided by Egan to the Winn organization as evidence that the advice was not the promotion of a tax shelter.

Seventh Circuit’s Decision

In a decision released shortly after the Tax Court’s decision in the Countryside case, the Seventh Circuit in Valero upheld the district court’s order, rejecting Valero’s claim that the tax shelter exception to the tax practitioner/client privilege did not apply to the documents in question. Valero had argued that, for purposes of the Sec. 7525(b) exception, promotion meant the “active furtherance of sale of merchandise through advertising or other publicity.” It also argued that a tax shelter was limited under the exception to prepackaged, one-size-fits-all tax shelter products and that an individualized tax savings plan, such as the one that Andersen provided Valero, was not a shelter.

Unlike the Tax Court, the Seventh Circuit did not focus on the relationship between the taxpayer and the tax adviser to make its determination. Instead it focused on the separate meanings of the word “promotion” and the term “tax shelter.” It found that promotion meant the encouragement of participation in a shelter as opposed to merely informing a client about a shelter, assessing a shelter in a neutral fashion, or evaluating weak spots in a shelter a client previously used. It found (referring to the language of Sec. 6662(d)(2)(c)(ii)) that the term tax shelter meant “any plan or arrangement whose significant purpose is to avoid or evade federal taxes” and that therefore a tax shelter could include an individualized or one-size-fits-all plan.

The court explained that this definition of the exception was consistent with the broad summons power granted to the IRS under Sec. 7602(a). According to the court, accepting the narrow definition proposed by Valero would restrict the IRS’s summons power, which the court would not do without clear direction from Congress. The court also addressed the House report language that the Tax Court relied on in Countryside. While it agreed with the Tax Court that a House report could be a good record of congressional intent, it also found that in this case the report did not support Valero’s position because nothing in it indicated that tax shelters were limited to actively marketed tax shelters or prepackaged products.


Although the Tax Court and the Seventh Circuit took quite different approaches to determining whether documents were subject to the tax shelter exception and seemed to reach different conclusions, they might well have come to the same general holdings if the cases had been switched. In Countryside, the Tax Court indicated that while Egan advised on the results of transactions for the Winn organization at its request, he did not encourage the organization’s participation in the transactions, and he and his employer, PwC, did not stand to gain if the transactions were completed. Therefore, although the transactions at issue were tax shelters under the Seventh Circuit’s definition in Valero, if the Seventh Circuit had issued the decision in Countryside, it may well have decided that Egan was not promoting the shelters and that Countryside was not subject to the exception for this reason.

In Valero, the Seventh Circuit indicated that the transaction at issue was not an ordinary one for Valero. Instead the transactions at issue were the result of a relatively unusual event—the acquisition of a large foreign company—and were designed specifically to take advantage of a temporary condition in the foreign currency exchange markets. In addition, the Seventh Circuit indicated that in the documents the district court held were subject to the exception, Andersen did actively encourage Valero to undertake the transactions. Given its stance in Countryside, it is likely that the Tax Court would have found that the advice given in the documents was not advice given in the routine relationship between Valero and Arthur Andersen and that therefore it would have held that the documents were subject to the tax shelter exception.

Countryside Limited Partnership, 132 T.C. No. 17 (2009); Valero Energy Corp., No. 08-3473 (7th Cir. 6/17/09)

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