Government Brief in Textron Case Asserts that Work Papers Used to Assess Uncertain Tax Positions in SEC Filings Subject to IRS Discovery

Tax accrual work papers used by a company’s accountants and lawyers in assessing uncertain tax positions for SEC filings are prepared for a business purpose rather than for litigation and can be discovered by the IRS, argued the US Solicitor General in the Textron case before the Supreme Court. The government’s brief urging denial of review cited the testimony of a former Chief Auditor of the PCAOB that accounting standards compel public companies to create tax accrual work papers in substantially the same form whether or not litigation is anticipated.

Moreover, the company itself admitted that its work papers included items that it intended to concede, and therefore never litigate, if the IRS were able to discover them during the audit, and that in each audit cycle, the company typically agrees to hundreds of IRS adjustments without any dispute. Indeed, said the Solicitor General, the company has never claimed that any of the uncertain items listed in the tax accrual work papers related to existing or expected litigation. Tax accrual work papers assess uncertain tax positions and not actual or expected litigation, contended the brief, which distinguishes them from litigation reserve documents

Further, even if the Court were to grant certiorari and hold that the tax accrual work papers were prepared “in anticipation of litigation” within the meaning of Rule 26(b)(3)(A) of the Federal Rules of Civil Procedure, the company would still be required to turn over the work papers if the courts below found that the work-product protection had been waived by disclosure to Ernst &Young for use in the preparation of E&Y’s own work papers.

The brief was filed in a case where the 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 federal securities laws require public companies to file annually with the SEC financial statements that have been audited by a public accounting firm. The companies must obtain from the auditor an unqualified opinion that the financial statements conform with GAAP. To prepare GAAP-compliant financial statements, companies must calculate reserves to account for deferred and contingent tax liabilities, including estimates of the liability facing the company if the IRS were to challenge uncertain positions on the company’s income tax return. Independent auditors must review the financial statements under standards requiring them to obtain evidence supporting the accuracy of the financial statements, including evidence regarding the company’s reserve account for deferred and contingent tax liabilities.

To demonstrate that the amount it has reserved is consistent with GAAP, a company creates tax-accrual work papers which list and analyze uncertain tax positions and estimate the likelihood that the position will not withstand scrutiny and calculate the additional tax liability that would result from a successful challenge by the IRS. Independent auditors require access to those work papers in order to provide the clean opinion that the client needs to meet SEC filing requirements. In performing the audit, the independent auditor generates its own tax accrual work papers. The auditor’s work papers must contain an item-by-item analysis of the company’s tax accrual analysis and the auditor’s judgment on the correctness of the client’s tax position

According to the brief, Textron’s tax accrual work papers were created annually by accountants and attorneys in its Tax Department, and then reviewed by its independent auditor, Ernst & Young. Because the tax-accrual work papers were created in the ordinary course of business for a SEC regulatory rather than a litigation purpose, said the government, the company could not prevail under any formulation of the work-product doctrine.

The fact that tax accrual work papers could in some instances describe potential litigation does not mean that they are generated because of litigation, said the government. They are created
because statutory and audit requirements mandate that they be created.

Moreover, the brief contended that providing the IRS access to a company’s tax accrual work papers would not have a chilling effect on the creation of those documents. A public company
seeking an attestation that its financial statements comply with GAAP must permit its independent auditor to verify that those financial statements adequately reserve against tax contingencies. The auditor, in turn, is required by auditing standards now incorporated
into federal law to review sufficient documentation to understand the basis for the amount reserved and to verify that the reserve is adequate.

There is no reason to suppose that the possibility of compelled disclosure to the IRS will induce companies to breach their obligation to prepare tax accrual work papers that are both accurate and sufficiently detailed to enable auditors to verify the adequacy of company reserves.

The government also asserted that the company and its amici ignore the critical fact that tax assessment does not begin on a level playing field. On the contrary, the taxpayer has all the information relevant to its actual tax liability, and it may self report its liability in a manner that minimizes its tax obligations. The IRS must then determine whether the taxpayer’s self-assessment is accurate or whether some of the many items contained in a potentially voluminous tax return should be adjusted.

The corporate taxpayer, by contrast, already knows which issues may merit adjustment and records that analysis in its tax accrual work papers. By requesting those work papers under some circumstances where the corporation has already demonstrated a willingness to engage in listed tax shelter transactions the IRS seeks to perform its obligation to verify the self-assessment despite the information disadvantage inherent in the self-reporting tax system.