Third Time's Not a Charm: En Banc First Circuit Permits IRS to Obtain Roadmap to "Soft Spots" On Textron's Returns

For the last several years, Textron, Inc. has been seeking to keep its tax accrual workpapers away from the prying eyes of the IRS. That struggle took a turn for the worse on August 13, 2009, when a divided U.S. Court of Appeals for the First Circuit sitting en banc ruled that Textron’s tax accrual workpapers were not protected by the work product privilege. A vigorous dissent effectively dissects the majority’s opinion and suggests that it is time for the Supreme Court to intervene. Whether or not Textron’s battle may have ended, the war over the disclosure of taxpayers’ tax accrual workpapers will surely endure. Background of the Textron Dispute During an audit of Textron’s 1998-2001 tax cycle, the IRS discovered that Textron had engaged in a series of sale-leaseback transactions that the IRS alleged were substantially similar to the so-called SILO transactions that the IRS had “listed” as abusive tax shelters. In accordance with its audit policy, the IRS requested all of Textron’s tax accrual workpapers. 1 Among the documents that were responsive to the request were a series of spreadsheets that contained Textron’s in-house counsel’s lists of return items thought to involve unclear law, “hazards of litigation percentages,” and tax reserve amounts quantifying the hazards of litigation, as well as backup workpapers, including in-house counsel notes and memoranda documenting the rationale behind the numbers in the spreadsheets. As part of its internal audit process, Textron permitted its auditor, Ernst & Young LLP (E&Y), to examine its workpapers with the express understanding that they were to be kept confidential. Textron asserted that the workpapers were protected from disclosure under the “work product doctrine.” Textron’s resistance to producing the workpapers was met by an IRS administrative summons, which the IRS enforced by bringing suit.