DISTRICT COURT FINDS MEMOS PROTECTED BY ATTORNEY CLIENT PRIVILEGE AND WORK PRODUCT DOCTRINE by Krista Hartwell
We recently posted an article regarding the Tax Court’s recent decision in Eaton Corp v. Comm’r, No. 5576-12, where the Tax Court found the taxpayer waived attorney client privilege and work product doctrine protections when it asserted a reasonable cause/good faith penalty defense. More recently, in United States v. Sanmina Corp., No. 5:15-cv-00092 (2015 U.S. Dist. LEXIS 66123), a District Court in California refused to enforce an IRS summons finding the requested documents—two memoranda prepared by the taxpayer’s tax department lawyers—protected by the attorney-client privilege and work product doctrine.
The taxpayer took a worthless stock deduction of $503 million. One of the documents the taxpayer submitted to the IRS to substantiate the deduction was a 102-page valuation report prepared by outside counsel. A footnote in the report referenced the memoranda at issue: “Guarantee and Capital Contribution Agreement Concerning Sanmima International AG” and “Stock and Debt Losses on Swiss-3600,” both of which were prepared by the taxpayer’s tax department lawyers. The IRS issued a summons and the taxpayer refused to comply, claiming the memoranda were protected by attorney client privilege and the work product doctrine.
Section 7602 of the Internal Revenue Code authorizes the IRS to examine records, issue summonses and take testimony for the purposes of ascertaining the correctness of any return, making a return where none has been made, determining the liability of any person for any internal revenue tax, or inquiring into any offense connected with the administration or enforcement of the internal revenue laws. The court stated the four-part Powell rule for enforcing an IRS summons:
“To enforce a summons, the IRS need only make a prima facie showing that (1) an investigation is being conducted for a legitimate purpose; (2) the information sought may be relevant to that purpose; (3) the information sought is not already within the IRS’ possession and (4) the administrative steps required by the Internal Revenue Code have been followed.”
The court noted that taxpayers challenging a summons have a “heavy” burden to negate the good faith purpose of the investigation or show that the enforcement would amount to an abuse of the court’s process, but that the IRS’s power to obtain information by summons is not absolute and is limited by attorney client privilege and work product doctrine. If the IRS claims the privilege was waived, it bears the burden of production on the issue of waiver. If the IRS meets its burden on the waiver issue, the burden shifts back to the taxpayer to prove the privilege was not waived.
The court stated that for privilege purposes, there is no difference between legal advice and tax advice on compliance, so long as the advice goes beyond mere tax preparation and calculations. A document does not lose protection merely because it is created to assist with a business decision. The court reasoned that a tax analysis prepared in anticipation of a possible IRS audit may constitute work product, even if that material also assisted in making a business decision.
Both of the memoranda at issue in Sanmina were prepared by the taxpayer’s in-house tax lawyers and distributed to the taxpayer’s internal tax team and outside accountants. The court discussed the content of the memoranda in determining whether they were protected, but declined to conduct an in camera review of their content. The memorandum entitled “Guarantee and Capital Contribution Agreement Concerning Sanmina International AG” discussed legal analysis supporting the execution of certain agreements among the taxpayer and its subsidiaries, including the tax treatment of the agreements. It included citations to and analysis of IRS letter rulings and Tax Court decisions. The memorandum entitled “Stock and Debt Losses on Swiss-3600,” analyzed the tax effect of the liquidation of Sanmina International AG, containing a short factual discussion and lengthy legal analysis of the liquidation. It included citations to revenue rulings, tax code provisions, tax court decisions and one U.S. Supreme Court decision.
The court concluded that although the IRS made the required four-part Powell showing for enforcement of the summons, the attorney client privilege and work product doctrine protections attached and were not waived. The court found that the attorney client privilege attached because the taxpayer showed “the memoranda constituted tax advice from lawyers to Sanmina—not merely preparation of tax returns or number crunching…Both memos contain legal analysis, were prepared by Sanmina’s tax department lawyers, and were provided confidentially to company personnel who had a need for legal advice.” The court found that the taxpayer did not waive privilege by producing the valuation report that cited the memoranda even though the valuation report relied on the memoranda and the outside counsel preparing the valuation report sometimes provided non-legal services to the taxpayer.
The court applied a “because of” standard in determining that the memoranda were protected by the work product doctrine. Although the memoranda were not prepared during an audit or litigation, the analysis supported the worthless stock deduction, the size of which made it reasonable for the taxpayer to anticipate an IRS challenge to the deduction. The court also concluded that the taxpayer did not waive its work product doctrine protection by disclosing the memoranda to its outside counsel because the valuation report merely referenced the memoranda, rather than summarizing them.
The court held the memoranda were protected by the attorney client privilege and work product doctrine and denied the IRS’s petition to enforce its summons. Although the Tax Court has held that raising the reasonable cause/good faith defense waives attorney-client privilege and work product doctrine, a full analysis of waiver is still required in the context of summons enforcement.
KRISTA HARTWELL – For more information please contact Krista Hartwell at Hartwell@taxlitigator.com or 310.281.3200. Ms. Hartwell is a tax lawyer at Hochman, Salkin, Rettig, Toscher & Perez, P.C. and represents clients throughout the United States and elsewhere involving federal and state, civil and criminal tax controversies and tax litigation. Additional information is available at http://www.taxlitigator.com.