ABA Urges Supreme Court to Adopt Uniform Rule on IRS Discovery of Tax Accrual Work Papers

The American Bar Association has asked the US Supreme Court to adopt a uniform federal rule protecting from IRS discovery attorney tax accrual work papers used to inform the audit firm engaging the company’s SEC-filed financial statements. Citing the advent of Sarbanes-Oxley and the adoption of FIN 48, the ABA amicus brief argued that companies are increasingly relying on counsel to evaluate proposed activities and practices before they make business decisions.

The ABA brief was filed in a case where the Supreme Court has been asked to review an en banc First Circuit Court of Appeals ruling that the attorney work product doctrine does not shield from an IRS summons tax accrual work papers prepared by a company’s lawyers to support the calculation of tax reserves for audited financial statements filed with the SEC. Textron Inc. v. United States, Dkt. No. 09-750. In a 3-2 opinion, the full appeals court held that the purpose of the tax audit work papers was not to prepare for litigation, but rather to make book entries, prepare financial statements and obtain a clean audit.

The ABA argued that the assessment of litigation prospects has become commonplace for audits and, in particular, tax liability. Under FIN 48, companies must determine whether it is more likely than not that a tax position will be sustained upon examination by or litigation with the IRS. This determination also entails an assessment of the company’s position in possible litigation.

FASB Standard No. 5 sets out standards for financial accounting and reporting of all material loss contingencies related to income taxes. FASB Interpretation No. 48 provides guidance on GAAP accounting for income taxes. Taken together, FIN 48 and FAS 5 establish a GAAP requirement that public companies must evaluate the possible impact of tax and non-tax contingencies on their financial statements.

In auditing the financial statements, independent auditors must follow GAAS in order to render an opinion that a company’s financial statements fairly present its financial position, results of operations, and cash flows in conformity to GAAP. Thus, in order to prepare their financial statements in accordance with GAAP, public companies share the analysis in tax accrual work papers with their independent auditors.

In the view of the ABA, these documents have a dual purpose of being prepared in anticipation of litigation and the business purpose of preparing financial statements There is currently a split among the federal circuits on the application of the attorney work product privilege to these dual purpose documents, noted the bar group, creating an uncertainty in the business community. This could place attorneys in the untenable position of deciding to create tax accrual work papers when such are privileged in one circuit but not in another.

Further, an overly restrictive approach to these dual purpose documents may threaten the free flow of confidential information from a company to its counsel, reasoned the ABA, information critical to providing effective counseling and advocacy. Thus, the ABA asks the Court to take the case and clarify that the scope of the work product privilege is not limited to work papers prepared solely for use in litigation, but also encompasses materials that are prepared to serve both a litigation and a business purpose.

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