Protecting Abusive Tax Avoidance

Abstract:     
In August 2007, a federal court in Rhode Island quashed an IRS summons seeking tax accrual workpapers pertaining to a taxpayer's investment in abusive tax shelters. The court held in United States v. Textron that the documents at issue were protected under the work-product doctrine, which immunizes from discovery documents prepared "in anticipation of litigation" so long as the prospect of litigation was "objectively reasonable" and the documents would not have been prepared "in substantially the same manner" irrespective of the anticipated litigation. The government has appealed the decision.

This Article argues that tax accrual workpapers never deserve work-product protection, because they are prepared for regulatory rather than for litigation purposes. It also argues that in preparing tax accrual workpapers, it is not objectively reasonable for a taxpayer to anticipate litigation, because the nexus between the two events is so attenuated and fraught with contingencies that one leads to the other only a fraction of the time. Indeed, applying work product in the tax context presents unique challenges for taxpayers, tax advisors, tax authorities, and courts, so much so that this Article suggests reforms to the work-product doctrine for non-litigation, regulatory proceedings.

If affirmed, Textron threatens effective tax enforcement. It expands the work-product doctrine beyond its historical role of protecting the adversarial process, and it swallows the attorney-client privilege, effectively cloaking from discovery not just all legal advice but all advice pertaining to potential litigation, no matter how attenuated. In addition, the decision protects precisely the kind of abusive tax avoidance that Congress and the Treasury Department have fought to root out and punish. In the end, the decision destroys the IRS summons power, prevents the IRS from performing its regulatory function of verifying a taxpayer's self-assessed liability, undermines recent anti-shelter efforts, and protects abusive tax avoidance.

Keywords: Taxation, Tax Policy, Tax Practice, Tax Shelters, Professional Responsibility

Accepted Paper Series