Firm Seeks Withdrawal of Uncertain Tax Positions Schedule

Dear Sir or Madam:

We are writing to comment on the proposal to require certain taxpayers to disclose on their tax returns their uncertain tax positions. This proposal was outlined in Announcements 2010-9 and 2010-17, and followed up with the release of draft Schedule UTP (Form 1120) ("Schedule UTP") along with Announcement 2010-30.

We ask that the IRS withdraw Schedule UTP for the following reasons. The stated legal premise on which Schedule UTP was issued is that the IRS may get tax accrual workpapers using its summons power under § 7602. That statement is overly broad and does not take into account the fact that such workpapers may well include information protected by the work product doctrine. Second, the extent to which work product protection applies to tax accrual workpapers is uncertain nationally. For example, work product protection may be found to apply to the descriptions of uncertain tax positions -- this would entirely undercut the legal premise of Schedule UTP. Undue disruption and inconvenience can be avoided by waiting until the law is settled. Next, the Service's authority for currently issuing Schedule UTP is questionable. Finally, the issuance of Schedule UTP is wholly out of proportion to the problems the Service raises as its justification.

1. THE ASSERTED LEGAL PREMISE ON WHICH SCHEDULE UTP WAS ISSUED IS NOT A GENERALLY CORRECT STATEMENT OF THE LAW

Announcements 2002-63 and 2010-9 state essentially that the Supreme Court confirmed the Service's right to obtain tax accrual workpapers in United States v. Arthur Young & Co., 465 U.S. 805 (1984). The implication of the Announcements is that the Service can obtain all workpapers, including portions of workpapers that are protected by work product doctrine. This is not the case.

It's clear that the work product doctrine applies to IRS summonses. Upjohn Co. v. U.S., 449 U.S. 383 (1980). The Announcements are wrong to assert categorically that the IRS can get information regarding uncertain tax positions (descriptions, risk assessments, and tax reserve amounts). Arthur Young did not address whether workpapers protected under the work product doctrine can be obtained by the Service. In that case the Supreme Court simply refused to accept a new judicially created accountant work-product immunity¹ for an independent auditor's tax accrual workpapers summoned under § 7602.² The Supreme Court did not abrogate traditional work-product protection -- this was simply not at issue.³

2. THE LEGAL PREMISE ON WHICH SCHEDULE UTP WAS ISSUED IS POTENTIALLY IN A STATE OF FLUX

Application of work product protection to tax accrual workpapers is at the heart of information required by Schedule UTP.⁴ Yet this issue is presently unsettled -- courts may decide that some or all of the information requested by Schedule UTP is covered by such protection. A Court (other than in the Fifth Circuit) outside the First Circuit may adopt the reasoning of the dissent in United States v. Textron, Inc. and Subsidiaries, 577, F.3d 21 (1^st Cir. 2009), which expressed clear concern that by accessing tax accrual workpapers the work product doctrine was being undercut because "the IRS will be able to immediately identify weak spots" on tax returns.⁵ The descriptions of uncertain tax positions required in Schedule UTP will provide the IRS with this information.⁶

Seven other Circuits⁷ use the "because of" test to make an "in anticipation of litigation" determination in FRCP 26(b)(3).⁸ It's an open question how these Circuits would decide whether the Service can summons tax accrual workpapers.⁹ Outside the First and Fifth Circuits the work product doctrine may apply to quash an IRS summons for tax related documents, even if in the possession of an independent auditor.¹⁰ One or more Appeals Courts in Circuits other than the First and Fifth might agree that tax accrual workpapers are dual-purpose documents and find the "because of" test met, thereby denying the Service access through its summons power. In this case the legal premise underlying Schedule UTP would be entirely undercut in those Circuits.

The upshot is that the legal foundation for issuance of Schedule UTP -- i.e., the IRS's claim that it can get tax accrual workpapers using its summons power in § 7602 -- is subject to uncertainty. This is not a foundation on which the Service should rest the far reaching requirements imposed by Schedule UTP.

3. THE SERVICE'S AUTHORITY FOR CURRENTLY ISSUING SCHEDULE UTP IS QUESTIONABLE

The Service can of course, under its Code-based administrative or interpretive rulemaking authority, promulgate regulations embodying the Service's litigation position.¹¹ This is true even if that position is contrary to the law in one or more Circuits. But the issuance of Schedule UTP is markedly different. FRCP 26(b)(3) is a statute applicable to all federal controversies -- i.e., applicable not just to controversies under the Internal Revenue Code. It provides that

Until the Supreme Court weighs in, each Circuit can decide to interpret the "in anticipation of litigation" standard in FRCP 26(b)(3) so as to remove or retain work product protection for tax accrual workpapers. If the Supreme Court in future grants certiorari in a case involving application of work product doctrine to tax accrual workpapers -- e.g., because of a split among Circuits applying the "because of" test -- it will surely be relevant that in no other federal controversy is one party required to disclose what it perceives to be weak spots in its case.

It's unclear that the Service's rulemaking authority extends to taking away the protection of FRCP 26(b)(3) from tax accrual workpapers. Subsection 7805(a) provides that

Subsection 6011(a) grants the Treasury legislative authority to issue regulations relating to returns, etc.:

4. THE ISSUANCE OF SCHEDULE UTP IS WHOLLY OUT OF PROPORTION TO THE PROBLEMS THE SERVICE RAISES AS ITS JUSTIFICATION

In crafting the common law forerunner of the work product doctrine in FRCP 26(b)(3) the Supreme Court explained that "[d]iscovery was hardly intended to enable a learned profession to perform its functions either without wits or on wits borrowed from the adversary."¹³ This comment directly applies to the disclosure of uncertain tax positions in Schedule UTP. The concerns about efficient use of IRS audit resources are beside the point. What federal controversy would not be more efficient if one side could learn of uncertainties in the other's position? Efficiency is not a ground for eroding a bedrock principle of our federal judicial process, which has since its inception provided checks (like the work product doctrine) on government powers.

²See, United States v. Textron, Inc. and Subsidiaries, 577 F.3d 21, 42-43 (Torruella, J., dissenting).

³ 465 U.S. at 817 ("Nor do we find persuasive the argument that a work-product immunity for accountants' tax accrual workpapers is a fitting analogue to the attorney work-product doctrine established in Hickman v. Taylor, 329 U.S. 496 (1947).") At trial, Arthur Young only argued that work product protection applied to some of the documents sought by the IRS under § 7602 -- to so-called "Special Report Workpapers." U.S. v. Arthur Young & Co., 496 F.Supp. 1152, 1157 (S.D. NY 1980). The judge agreed that work product protection applied and that the IRS couldn't overcome the protection either by showing that it has a "substantial need" for the materials or by showing that the information cannot be obtained from any other source without undue hardship. 496 F.Supp. at 1158. The IRS did not appeal that portion of the District Court's holding. 677 F.2d at 215.

⁴ The taxpayer is required to identify its uncertain tax positions, provide its reasons for determining that the item is an uncertain tax position, and provide any positions for which the taxpayer has not set up a reserve because it expects to litigate.

⁵ 577 F.3d at 36.

⁶ Schedule UTP's requirement to disclose a taxpayer's reasons for determining an item is an uncertain tax position a fortiori invokes the work product doctrine.

⁷ Namely, the Second, Third, Sixth, Seventh, Eighth, Ninth, and D.C. Circuits.

⁸ The relevant inquiry under the "because" of test is whether a document was prepared or obtained "because of" the prospect of litigation. United States v. Adlman, 134 F.3d 1194, 1198 & 1205 (2nd Cir. 1998) ("[T]he enforceability of the IRS summons for the Memorandum will turn on whether it (or substantially the same document) would have been prepared irrespective of the anticipated litigation and therefore was not prepared because of it.")

⁹ The issuance of Schedule UTP increases the chances that one of these Circuits would be soon faced with the issue because of the possibility of an assertion of work product protection to withhold information from a Schedule UTP.

¹⁰ In Regions Financial Corp. v. U.S., 2008-1 USTC ¶ 50,345 (N.D. Ala. 2008) the District Court refused to allow an IRS § 7602 summons filed on E&Y -- the auditors of Regions Financial -- for certain "core documents": three memos from a law firm and a memo created by E&Y partners not involved in auditing Regions. Citing the trial court decision in Textron, the District Court stated that "[w]ere it not for anticipated litigation, Regions would not have to worry about contingent liabilities and would have no need to elicit opinions regarding the likely results of litigation." The District Court held the contested documents to be protected by the work product privilege, regardless of whether the "primary motivating purposes" or the "because of litigation" test applied (the Court, in the Eleventh Circuit, thought that the "because of" test should apply). The District Court, in footnote 5, commented that relevant Eleventh Circuit precedent "cannot be read to prevent the protection of trial preparation materials simply because they were created by an accountant." See also, United States v. Deloitte & Touche USA LLP, 623 F.Supp.2d 39 (D.D.C. 2009) (Document created by taxpayer's auditors, recording the thoughts of taxpayer's counsel regarding the prospect of litigation, held to be covered by work product protection under the "because of" litigation test.)

¹¹ For example, in 2002 the Treasury issued former Prop. Treas. Reg. § 1.482-7(d)(l) "clarifying" that stock options give rise to a cost that must be shared in a qualified cost sharing arrangement. This regulation was finalized in 2003, and memorialized the IRS's unsuccessful litigation position under former regulations in Xilinx, Inc. v. Commissioner, 125 T.C. 37 (2005), aff'd 598 F.3d 1191 (9^th Cir. 2010).

¹² It would be reasonable to think that application of the work product doctrine would prevent application of penalties for failing to provide requested information.

¹³ 329 U.S. at 516 (Jackson, J., concurring).