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CAN CORPORATIONS HIDE TAX ACCRUAL WORKPAPERS BEHIND THEIR LAWYER'S SKIRTS?

August 30, 2007

In a decision that has the potential to open a lucrative new sideline for law firms, a U.S. District Court in Rhode Island yesterday denied the IRS access to tax accrual workpapers under the "work product privilege."

Tax accrual workpapers document the computations and conclusions that corporations use in reporting their taxes on their financial statements. Such workpapers have been considered fair game for the IRS since the 1984 Supreme Court Arthur Young decision. As the workpapers have to document risky tax positions, the IRS likes to see them. Yesterday's district court decision allowed Textron to hide their workpapers from the IRS via the expedient of running them by their lawyers. From the decision:

Each year, Textron's tax accrual workpapers are prepared shortly after the corporation's tax return is filed. The first step in preparing the workpapers is that Textron's accountants circulate to Textron's attorneys a copy of the previous year's tax accrual workpapers together with recommendations regarding their proposed changes and/or additions for the current year. Textron's attorneys, then, review those materials, propose further changes to the spreadsheets and hazard litigation percentages which are returned to the accountants who compile the information and perform the mathematical calculations necessary to compute the tax reserve amounts. The attorneys and accountants, then, meet to give their approval so that the accountants may finalize the workpapers. (emphasis added)

The court said that the lawyers made all the difference:

The IRS's reliance on Arthur Young is misplaced because, although Arthur Young deemed tax accrual workpapers pinpointing the "soft spots" on a corporation's tax return relevant to examination of the corporation's return, it did not hold the attorney-client privilege inapplicable to legal conclusions of counsel contained in the workpapers.

It seems like a stretch to say that accounting workpapers become legal papers just by running them by a lawyer, so I think the chances are good the IRS will get a reversal on appeal. If the decision holds up, though, lawyers will now get a cut of that annual public company audit fee.

Cite: Textron Inc. and Subsidiaries, D.C. - R.I., No. 1:06-cv-00198

UPDATE: More from the TaxProf.

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