Editor’s Note: This is the first in a series of “Practice Notes,” providing readers with important background or updates on important issues affecting the avoidance or resolution of controversies with tax authorities. Reader comments should be sent to the authors or to firstname.lastname@example.org.
Surprise Quiz: The Internal Revenue Service just issued a notice expressing its intent to challenge a type of transaction that your employer engaged in. You immediately schedule a meeting with your supervisor, preparing notes about the merits of the transaction and how the company should react to the IRS notice. Later you convert your notes into a formal memorandum that you use when reviewing the company’s reserve determination and you give a copy of the memorandum to your outside auditor. The IRS subsequently issues an Information Document Request (IDR) seeking all “notes or memoranda that relate to or describe” the transaction.
- Do you have to produce the notes and memorandum?
- Does the answer differ if you are a lawyer?
Answers: (1) There is a strong argument that you do not need to produce the notes. You may not have to produce the memorandum, but the answer may depend on the circuit court to which the issue would be appealed if it were litigated. (2) The answer should be the same whether or not you are a lawyer.
The notes and memorandum are almost certainly not covered by the attorney-client privilege. Even assuming that you are an attorney, that privilege is often defined to protect only confidential communications between the attorney and the client, and the IRS might not agree that an attorney’s notes are a “communication” that may be covered by that privilege. In any event, even assuming that the notes would be covered by the attorney-client privilege, the privilege was likely waived when you gave the memorandum to the auditor. Further, a waiver of the attorney-client privilege ordinarily extends to all documents of the same “subject matter” and, in this example, would likely include the notes that formed the basis for the memorandum.
Fortunately, that does not end the analysis because the notes and memorandum may be protected “work product.” The work-product doctrine is more inclusive than the attorney-client privilege in that it protects a broader variety of materials than communications between the attorney and the client. There are two different definitions of work product: (1) the common law rule and (2) the definition in the Federal Rules of Civil Procedure. In most cases, a document only needs to satisfy one or the other to be protected.
The common law rule recognizes that a lawyer’s work may be reflected “in interviews, statements, memoranda, correspondence, briefs, mental impressions, personal beliefs, and countless other tangible and intangible ways-aptly though roughly termed . . . as the ‘Work product of the lawyer.’”1 Federal Rule of Civil Procedure 26(b)(3) ordinarily protects “documents and tangible things that are prepared in anticipation of litigation or for trial by or for another party or its representative (including the other party’s attorney, consultant, surety, indemnitor, insurer, or agent).”2
The common law rule and Federal Rule differ in two important ways. First, the Federal Rule only protects tangible things like documents, whereas the common law rule extends to intangible things like a lawyer’s mental impressions.3 Second, the common law rule protects the lawyer’s work product, whereas the Federal Rule may also protect documents or other tangible things prepared by a party or the party’s agent (including accountants and other non-lawyers).
Under either rule, the first step in the work-product analysis is to assess whether the document was created in anticipation of litigation. In this example, your notes appear to satisfy that standard, because they were created in direct response to the IRS notice indicating it intended to challenge this type of transaction.4
There is a question, however, whether the memorandum created to analyze the company’s tax reserve was prepared in anticipation of litigation or for a different purpose. There has been quite a bit of recent controversy about whether a document that is created in anticipation of litigation but that also serves a business purpose (a so-called dual-purpose document) qualifies for work-product protection. Unfortunately, the courts are not in agreement about whether tax accrual workpapers are work product: Some courts have held that reserve analyses are protected because they would not exist absent potential litigation with the IRS, whereas one appellate court has held they are not work product because they are not “prepared for use in litigation.”5 Thus, whether the memorandum is protected may depend upon what appellate court would have venue over the issue if it were litigated.
The second step in the analysis is to determine whether your having given the memorandum to the auditor waives any work product protection to which it otherwise would have been entitled. There seems to be a growing consensus that disclosure of a reserve analysis to an auditor will not waive any work-product protection because an auditor is not your adversary.6 Even in the unlikely event that a court found that you had waived work-product protection by sharing the memorandum with the auditor, it is unlikely that the waiver would extend to notes that were not shared. Waiver of “opinion” work product is generally much narrower than the “subject matter waiver” that may occur when one waives the attorney-client privilege.
In any event, no court has examined the specific facts in the example, and there is certainly a reasonable basis for claiming your memorandum is protected by the work-product doctrine. To support your claim you should consider documenting why you anticipate litigation and the necessity for issuing a litigation hold so that company employees preserve pertinent documents.
Finally, the text of the Federal Rule answers the second question posed above: While “work product” was originally defined by the Supreme Court to protect “lawyer work,” the Federal Rule extends that protection to documents prepared by a “party” (i.e., you) in anticipation of litigation or for trial.9 This does not mean the involvement of a lawyer is unimportant, since such involvement may be a factor in determining whether a particular document was created in anticipation of litigation and not in the ordinary course of business.
Thomas A. Cullinan is a member of the Tax Practice Group of Sutherland Asbill & Brennan LLP. He focuses on tax controversies against the Internal Revenue Service (IRS) and has represented a large number of corporations, partnerships, and high net-worth individuals in all phases of tax controversy. He received his B.A. degree from the State University of New York (Geneseo), his M.S. degree from the State University of New York (Albany), and his J.D. degree from Vanderbilt University. He may be contacted at email@example.com.
Joseph M. DePew, a member of Sutherland’s Tax Practice Group, focuses on tax litigation and controversy, corporate taxation, and income tax with an emphasis on federal and state procedures, dispute resolution, collection, and tax litigation. He received his B.A. degree from the State University of New York (Oswego), his J.D. degree from Ohio Northern University, and his LL.M. degree (Taxation) from the University of Florida. He may be contacted at joe.depew@ sutherland.com.
Kendall C. Jones is a member of Sutherland’s Tax Practice Group. He has more than 32 years of tax controversy experience, including IRS procedural, controversy, and dispute resolution matters, as well as tax litigation. Before entering private practice, Mr. Jones spent 15 years with the IRS, serving as a Large Case Program Manager, National Office Special Trial Attorney, IRS National Tax Shelter Coordinator, a Technical Assistant to the Deputy Chief Counsel, and the Acting District Counsel (Foreign Operations). He received his B.S. degree from the University of Colorado, and his J.D. degree from the University of San Diego. He may be contacted at firstname.lastname@example.org.
1. Hickman v. Taylor, 329 U.S. 495, 511 (1947).
2. Federal Rule of Civil Procedure 26(b)(3).
3. For example, the U.S. Court of Appeals for the District of Columbia Circuit has held that notes taken by an auditor of a meeting with the taxpayer’s lawyers may qualify as work product under the common law definition even though the notes would not satisfy the definition in the Federal Rules, because the notes reflected the mental impressions of the lawyers. United States v. Deloitte LLP, 610 F.3d 129, 139 (D.C. Cir. 2010).
4. See United States v. Adlman, 134 F.3d 1194 (2d Cir. 1998); United States v. Deloitte LLP, 610 F.3d 129 (D.C. Cir. 2010); United States v. Roxworthy, 457 F.3d 590 (6th Cir. 2006).
5. The courts have adopted two competing tests to determine whether a document was created “in anticipation of litigation.” Most courts apply the more liberal “because of” test, which can cover dual-purpose documents, but a minority of courts apply a more restrictive “primarily or exclusively” standard. Compare United States v. Adlman, 134 F.3d 1194, 1202 (2d Cir. 1998) (“The formulation of the work-product rule used by the Wright & Miller treatise, and cited by the Third, Fourth, Seventh, Eighth and D.C. Circuits, is that documents should be deemed prepared ‘in anticipation of litigation,’ and thus within the scope of the Rule, if ‘in light of the nature of the document and the factual situation in the particular case, the document can fairly be said to have been prepared or obtained because of the prospect of litigation.’”) and United States v. Roxworthy, 457 F.3d 590, 593 (6th Cir. 2006) (“Today, we join our sister circuits and adopt the ‘because of’ test as the standard for determining whether documents were prepared ‘in anticipation of litigation.’”) with United States v. El Paso Co., 682 F.2d 530, 542 (5th Cir. 1982) (“In United States v. Davis we phrased the test in the following terms: ‘(L)itigation need not be imminent . . . as long as the primary motivating purpose behind the creation of the document was to aid in possible future litigation.’”) and United States v. Textron Inc., 577 F.3d 21, 30 (1st Cir. 2009) (“The Fifth Circuit, which employs a ‘primary purpose’ test, found [in El Paso] that the work papers’ ‘sole function’ was to back up financial statements. Here, too, the only purpose of Textron’s papers was to prepare financial statements.”).
6. See United States v. Deloitte LLP, 610 F.3d 129, 139-40 (D.C. Cir. 2010) (“To the best of our knowledge, no circuit has addressed whether disclosing work product to an independent auditor constitutes waiver. Among the district courts that have addressed this issue, most have found no waiver . . . . [Here] the government contends that Dow has waived work-product protection for the Dow Documents because Deloitte is (1) a potential adversary and (2) a conduit to other adversaries. We reject both contentions and conclude that Dow has not waived the protection.”).
7. In re Martin Marietta Corp., 856 F.2d 619, 626 (4th Cir. 1988) (“We think that when there is subject matter waiver, it should not extend to opinion work product. . . .”); Cox v. Administrator, United States Steel & Carnegie, 17 F.3d 1386, 1422 (11th Cir. 1994); In re EchoStar Communications Corp., 448 F.3d 1294, 1302 (Fed. Cir. 2006).
8. The IRS has a policy of not requesting tax accrual workpapers except in certain specific circumstances that may provide another avenue to resist production of the memo, at least during an audit. See IRS Chief Counsel Attorney Memorandum, IRS AM 2007-012, 2007 WL 1668817 (Mar. 22, 2007); IRM Section 18.104.22.168(2). In addition, the IRS has announced an expanded policy of restraint in the Schedule UTP context. According to IRS Announcement 2010-76, the IRS will not assert that the work-product doctrine has been waived by providing Schedule UTP documents to an independent auditor. The Announcement also authorizes taxpayers to redact certain information from requested copies of tax reconciliation workpapers relating to the preparation of Schedule UTP.
9. See, e.g., Augenti v. Cappellini, 84 F.R.D. 73, 79 (M.D. Pa. 1979) (“Traditionally, the work product of a lawyer in preparation for trial was not subject to discovery and Rule 26(b)(3) extends that immunity to work products not only of lawyers, but to documents prepared ‘By or for a party.”‘).