What Does Textron Mean for Preserving the Confidentiality of Tax Accrual Workpapers?

In-house tax managers are perennially concerned that the Internal Revenue Service (IRS) will request their tax accrual workpapers during an audit, as a result of the Supreme Court decision that no general privilege applies to tax accrual workpapers. United States v. Arthur Young & Co., 465 U.S. 805 (1984). Nevertheless, the IRS has long recognized that the fear of disclosure of tax accrual workpapers could cause tax managers to be less forthcoming in their dealings with financial auditors and in Security Exchange Commission (SEC) filings. Therefore, the IRS has had a longstanding formal policy of restraint in requesting the workpapers. See Internal Revenue Manual (IRM) 4.10.20.3.1.

Two relatively recent developments have heightened tax managers’ anxiety concerning the possible disclosure of tax accrual workpapers. The first involves the IRS’s war on corporate tax shelters. In recent years, the IRS has leveraged its legal right to obtain tax accrual workpapers into a tax shelter deterrent. In an attempt to make corporate taxpayers pay a price for engaging in questionable tax practices, the IRS in 2002 formally adopted a policy that all tax accrual workpapers will be requested when the taxpayer has invested in more than one listed transaction or if the taxpayer has not disclosed its participation in a listed transaction. See Announcement 2002-63, 2002-2 C.B. 72 (June 17, 2002), incorporated in IRM 4.10.20.3.2. The second, more recent development, is the Financial Accounting Standards Board (FASB)’s adoption of FIN 481, which requires corporations to prepare and maintain detailed documentation of the legal and factual support for their provisions for uncertain tax positions. Disclosure of the FIN 48 compliance portion of tax accrual workpapers could provide IRS auditors with a road map for potential audit issues. The IRS has repeatedly stated that it has not changed its policy of restraint in requesting tax accrual workpapers to take advantage of the increased disclosure requirements of FIN 48. However, it also has repeatedly stated that it is reviewing its policy of restraint. Naturally, the continuing review and reconsideration unnerves practitioners and tax managers alike.

With this background, there has been increasing focus on the scope of the attorney-client privilege and the attorney work-product doctrine as applied to tax accrual workpapers. If one of these privileges applies, IRS auditors cannot obtain the workpapers, regardless of their internal policies regarding tax shelter situations and FIN 48. For this reason, practitioners and tax managers took notice when the court in United States v. Textron Inc., 507 F.Supp.2d 138 (D. R.I. 2007), denied the enforcement of an IRS summons seeking a corporation’s tax accrual workpapers on the basis that the attorney work-product doctrine applied.