US v Sanmina: Attorney Client Privilege and Work Product Protections

US v Sanmina involves a long running discovery dispute. At issue is whether a taxpayer’s disclosing two memoranda created by in house tax counsel led to the waiver of various privilege claims. The Ninth Circuit held that Sanmina did not expressly waive work-product protection merely by providing the memos to outside counsel but it impliedly waived the privilege when it subsequently used the counsel report to support a worthless stock deduction that IRS was reviewing in audit. The important opinion highlights waiver in the context of both attorney client privilege and work-product protection. 

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Facts and Procedural Background

I have previously discussed the discovery dispute here and here. On its 2009 tax return, Sanmina had claimed about a half billion in a worthless stock deduction in one of its subsidiaries. The purportedly worthless subsidiary had two related party receivables with an approximate $113 million book value. Notwithstanding the healthy book value, Sanmina claimed that the FMV of the receivables was zero.

IRS examined Sanmina’s tax return and sent an information document request for documents that supported the deduction. Sanmina gave to IRS a valuation report from DLA Piper (DLA Report), its outside counsel. That report (not surprisingly) supported the taxpayer’s view that the receivables had no fair market value.

Included in the DLA Report was a footnote that referenced but did not describe internal memos that Sanmina’s in house tax counsel had prepared, one in 2006 and the other in 2009.

IRS asked for those two in house memos; Sanmina resisted, leading the IRS to summons them and bring an enforcement action when Sanmina did not comply.

In 2015, the district court held that both in house memos were protected by attorney client and work product privilege and that the “mere mention” of the memos in the DLA Report did not amount to the party’s waiving the privilege.

The government appealed, and in 2017 the 9th Circuit remanded the case “for the district court to review the 2006 and 2009 memos in camera to determine whether the documents requested by the government are privileged to any degree” and “retain[ed] jurisdiction over this appeal.” 

After some more procedural wrangling the 9th Circuit modified its remand, leaving the district court to decide (1) whether the memoranda are privileged in the first instance and (2) whether such privilege was waived. 

On remand the district court reviewed the documents in camera and in a more detailed discussion explained that the memoranda are protected by the attorney-client privilege and attorney work-product doctrine but also found that the privileges were “waived when Sanmina disclosed the memoranda to DLA Piper to obtain an opinion on value, then turned over the valuation report to the IRS.” 

Sanmina appealed that finding, and while both parties for purposes of the appeal agreed that the documents were covered by the attorney client privilege and work product protection they disagreed as to whether Sanmina’s disclosing either the in house memos to DLA Piper or the DLA Report to the IRS resulted in a waiver of either the attorney client privilege or work product doctrine.

Ninth Circuit Agrees With Lower Court on Existence of Privilege But Not on Work Product Waiver

With that by way of background, we can address the main takeaways from the most recent opinion. A starting point to the opinion is the 9th Circuit’s reminder that, because the parties agreed that the memos were subject to both attorney client privilege and work product protection, to order disclosure the court had to find that there was waiver of both privileges. 

The Court Finds that There Was a Waiver of the Attorney Client Privilege When Sanmina Gave the Memos to DLA Piper

This is a key part of the opinion. In reaching its conclusion that there was a waiver, the opinion notes that there are several ways to waive the attorney client privilege, including by express and implied waiver. An express waiver occurs when a party voluntarily discloses documents to third parties. 

Even in the absence of an express waiver, a court can find an implied waiver when a party puts the lawyer’s performance at issue during the course of litigation. As the opinion notes, implied waiver rests on a fairness principle, which

is often expressed in terms of preventing a party from using the privilege as both a shield and a sword. . . . In practical terms, this means that parties in litigation may not abuse the privilege by asserting claims the opposing party cannot adequately dispute unless it has access to the privileged materials. 

Closely related to implied waiver is subject matter waiver, where “voluntary disclosure of the content of a privileged attorney communication constitutes waiver of the privilege as to all other such communications on the same subject.” 

The district court had found that Sanmina’s providing the two in-house memos to DLA Piper amounted to an express waiver, based on its finding that Sanmina had sought non legal advice from DLA as to the valuation of the stock rather than legal advice.  

Whether a party engaging tax counsel is seeking legal advice or non legal advice comes up in a variety of contexts. Even assuming one can cleanly draw a line where tax advice crosses to legal advice, an engagement such as the one with DLA Piper often spans multiple purposes, especially when the tax position is intertwined with valuation issues. The 9th Circuit addressed the subtleties of that inquiry, and noted that courts both within and outside the circuit have approached a “dual-purpose” inquiry differently, with some courts looking to see if the primary purpose of the relationship was for legal advice and others having “transported the ‘because of’ test from the work-product context, and looked to “the totality of the circumstances” to determine “the extent to which the communication solicits or provides legal advice or functions to facilitate the solicitation or provision of legal advice.” 

After acknowledging that there was no decided path in the Ninth Circuit to resolve the issue, the opinion was able to sidestep it, essentially concluding that it could find no clear error with the lower court’s finding that Sanmina’s engagement with DLA had a non legal purpose:

Despite some evidence that Sanmina may have had a “dual purpose” for sharing the Attorney Memos to DLA Piper, the district court’s finding that Sanmina’s purpose was to obtain a non-legal valuation analysis from DLA Piper, rather than legal advice, was not clearly erroneous because it was not “illogical, implausible, or without support in the record.” 

Waiver for Attorney Client Privilege Differs From Waiver of Work Product Protection

After deciding that there was an express waiver for attorney-client privilege purposes, the opinion disagrees with the lower court’s approach that had essentially analyzed waiver with respect to attorney-client privilege and work product in the same way. As the opinion notes, because there was no dispute that the in house memos were both attorney-client communications and protected attorney work product, to order disclosure the court had to find that Sanmina waived both privileges. 

That allowed the panel to discuss how express waiver differs in the context of attorney work-product, with the circumstances warranting an express waiver in the work product context more narrow. The key is that unlike in attorney client privilege waiver analysis, in work product cases it is not sufficient to disclose to a third party; that third party must also be an adversary. The Sanmina opinion explored the distinction: 

[T]he overwhelming majority of our sister circuits have espoused or acknowledged the general principle that the voluntary disclosure of work product waives the protection only when such disclosure is made to an adversary or is otherwise inconsistent with the purpose of work-product doctrine—to protect the adversarial process. 

In framing the issue the court looks to United States v. Deloitte LLP, 610 F.3d 129, 140 (D.C. Cir. 2010): 

Addressing whether Deloitte was a “potential adversary” to Dow, the D.C. Circuit framed the relevant question as “not whether Deloitte could be Dow’s adversary in any conceivable future litigation, but whether Deloitte could be Dow’s adversary in the sort of litigation the [work-product documents] address.” Id. at 140. In concluding “that the answer must be no,” the court noted that, in preparing the work product, “Dow anticipated a dispute with the IRS, not a dispute with Deloitte,” and the work product concerned tax implications that “would not likely be relevant in any dispute Dow might have with Deloitte.” Id

While it was easy for the Sanmina opinion to conclude that DLA Piper was not an adversary (after all it engaged DLA to help with its tax reporting), the opinion notes that courts have expanded the inquiry to see if the work product could be considered disclosed because the actions substantially increased the chances that an adversary would obtain the documents.

The opinion helpfully situates this latter inquiry as part of a “conduit” analysis. In other words, a party cannot avoid a finding that there was an express waiver of the attorney work product doctrine if it was reasonable to expect that the third party would not keep the documents confidential and disclosure to the third party increased the odds that an adversary would get access to the documents. Leaning on the DC Circuit, the court frames the conduit inquiry as follows:

As to the “conduit to an adversary” analysis, the D.C. Circuit noted that its prior applications of the “maintenance of secrecy” standard have generally involved “two discrete inquiries in assessing whether disclosure constitutes waiver.” The first inquiry is “whether the disclosing party has engaged in self-interested selective disclosure by revealing its work product to some adversaries but not to others.If so, “[s]uch conduct militates in favor of waiver” based on fairness concerns. The second inquiry is “whether the disclosing party had a reasonable basis for believing that the recipient would keep the disclosed material confidential.” 

The government argued that DLA should be viewed as a conduit because the DLA Report “was intended for disclosure to interested tax authorities” and any “expectation of confidentiality was therefore absent.”  

In the Ninth Circuit’s view the government take on the conduit analysis was lacking because it failed to focus on the underlying in house counsel documents: 

The relevant inquiry, however, is not whether Sanmina expected confidentiality over the DLA Piper Report. It is whether Sanmina “had a reasonable basis for believing that [DLA Piper] would keep the [Attorney Memos] confidential” In the process of producing its valuation analysis. Deloitte, 610 F.3d at 141. That Sanmina shared the Attorney Memos with DLA Piper to obtain a valuation report for the IRS does not necessarily mean that Sanmina knew or should have known that the resulting DLA Piper Report would disclose or make reference to its attorney work product. If anything, Sanmina’s enlistment of DLA Piper’s assistance in anticipation of litigation with the IRS indicates a “common litigation interest” between Sanmina and DLA Piper insofar as the Attorney Memos are concerned. 

What About the Disclosure of the DLA Report to the IRS?

The above discussion focuses on Sanmina’s possible waiver arising from its providing the in house memos to DLA Piper. A separate issue is whether Sanmina’s turning over the DLA Report to the IRS itself constituted a waiver of the work product protection. This issue turns on whether the DLA Report, which identifies and cites to the existence of the memos in a footnote but does not describe their contents, is enough to conclude that there is waiver of work product protection over the identified documents. 

The opinion notes that the position that disclosure requires some elaboration on the content of documents is both intuitive and supported by case law. Yet that was not enough for the court to conclude that there was no waiver. To fully analyze the issue, the opinion draws on the differences between express and implied waivers:

As we have recognized in the attorney-client privilege context, there is a difference between express and implied waivers. This framework is also applicable in the context of work-product protection, where an express waiver generally occurs by disclosure to an adversary, while an implied waiver occurs by disclosure or conduct that is inconsistent with the maintenance of secrecy against an adversary. 

Drilling down deeper into the issue, the court sets out the relevant task for the court: 

Thus, the focal point of our waiver inquiry is whether, under the totality of the circumstances, Sanmina acted in such a way that is inconsistent with the maintenance of secrecy against its adversary in regard to the Attorney Memos. More broadly, we must ask whether and to what extent fairness mandates the disclosure of the Attorney Memos in this case.

The key consideration is the relationship between the party seeking to maintain the confidentiality and the overall adversary process. On this last point the opinion highlights that Sanmina could have chosen to substantiate its worthless stock deductions with documents or evidence that did not reference the attorney memos, but it chose to reveal their existence when it gave the IRS the DLA Report:

Assuming that Sanmina reasonably expected confidentiality over the Attorney Memos when sharing them with DLA Piper, this expectation became far less reasonable once Sanmina decided to disclose to the IRS a valuation report that explicitly cited the memoranda as a basis for its conclusions. In doing so, Sanmina increased the possibility that the IRS, its adversary in this matter, might obtain its protected work product, and thereby engaged in conduct inconsistent with the purposes of the privilege.

After finding that the actions amounted to waiver, the court then refined its analysis even further, noting that the next step is to focus on the scope of the waiver “which must be ‘closely tailored . . . to the needs of the opposing party’ and limited to what is necessary to rectify any unfair advantage gained by Sanmina from its conduct.” 

That led the court to distinguish between differing parts of the in house counsel memos: 

Based on Sanmina’s overall conduct, Sanmina has implicitly waived protection over any factual or non-opinion work product in the Attorney Memos that serve as foundational material for the DLA Piper Report. However, the IRS provides no reason why the scope of this implied waiver should encompass the opinion work product contained in the Attorney Memos. Besides its general argument the Attorney Memos are needed to understand the DLA Piper Report, the IRS does not explain why the “mental impressions, conclusions, opinions or legal theories” of Sanmina’s in-house attorneys are specifically at issue or critical to its assessment of the deduction’s legal validity. Hickman v. Taylor, 329 U.S. 495, 508 (1947). 

As such, the court held that the IRS was not entitled to parts of the in house memos that contained the internal lawyers’ discussion of the legal issue, as that “may potentially undermine the adversary process by allowing the IRS the opportunity to litigate ‘on wits borrowed from the adversary’ in a future legal dispute with Sanmina. Hickman, 329 U.S. at 516 (Jackson, J., concurring). 

Conclusion

The opinion closes by ordering disclosure of the factual portion of the lawyers’ memos, all to be accomplished by a remand that will require the district court to determine which portions of the memos involve factual work product.  Sanmina will still be able to keep from the IRS its lawyers’ mental impressions, opinions, and legal theories.  As Jack Townsend has discussed in a recent blog post, the opinion highlights the difference between factual and opinion work product, and it remains difficult to force disclosure of true legal analysis. The devil, however, is in the details, and the district court will have to carefully distinguish between fact and legal analysis. Perhaps that too will lead to more litigation—all of course as predicate to a possible challenge to the merits of the deduction. 

District Court Finds that Sanmina Waived Privilege Claims For Memos That Tax Counsel Prepared

Earlier this year in Ninth Circuit Defers on Important Privilege Waiver Case I summarized US v Sanmina Corp, a Ninth Circuit opinion that remanded a case to the district court to consider whether by disclosing the existence of purportedly protected documents the taxpayer waived various privilege claims it asserted with respect to memos that its in house tax counsel prepared. Earlier this month a federal district court in California issued an order holding that the taxpayer waived its privilege claims. The issue is important, especially for corporate taxpayers with layers of advisors touching different parts of a transaction or position taken on a tax return.

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As background, and as I repeat from my January post, the case arose out of Sanmina’s 2009 tax return, when it claimed about a half billion dollars in a worthless stock deduction in one of its subsidiaries. The purportedly worthless sub had two related party receivables with an approximate $113 million book value. Notwithstanding the healthy book value, Sanmina claimed that the FMV of the receivables was zilch.

IRS examined Sanmina’s tax return and sent an information document request for documents that supported the deduction. Sanmina gave to IRS a valuation report from DLA Piper, its outside counsel. That report (not surprisingly) supported the taxpayer’s view that the receivables had no fair market value. Included in the report was a footnote that referenced internal memos that Sanmina’s tax counsel had prepared, one in 06 and the other in 09.

IRS asked for those two memos; Sanmina resisted, leading to IRS to summons them and bring an enforcement action when Sanmina did not comply. In 2015, the district court held that both memos were protected by attorney client and work product privilege and that the “mere mention” of the memos in the DLA Piper valuation report did not amount to the party’s waiving the privilege.

The Ninth Circuit reversed and remanded the matter back to the district court, and specifically asked that the district court judge examine the documents in camera so it could provide a “more informed analysis” of the waiver claims.

[As  an interesting aside, the case has been festering for almost four years; the magistrate judge who originally wrote the order that the government appealed, Paul Grewal, has moved on to Facebook where he is Deputy General Counsel.]

After some additional back and forth with the Ninth Circuit about the scope of the remand, the district court has now issued its opinion. In brief fashion, the district court agreed with the taxpayer that the documents were subject to both attorney client privilege and work product protection, but it found that the privileges were waived in light of the DLA Piper valuation report for two main reasons:

  • When Sanmina gave the memos to DLA Piper it did so not with the hope of getting legal advice but for the purpose of getting a valuation for the stock of one of its subs; and
  • In any event when it gave the DLA Piper report to IRS it waived privilege for any of the materials that Piper used to reach its valuation, as the report explicitly stated that it based its conclusions (at least in part) on the two memoranda that were at issue.

Sanmina had attempted to minimize the DLA Paper’s report reliance on the memos, pointing to a Ninth Circuit case Tennenbaum v Deloitte and Touche that suggested that disclosing the existence of the memos was not tantamount to disclosing the contents themselves. The opinion’s framing of DLA Piper as relying on the memos (aided by the in camera review the Ninth Circuit suggested) led the court to reject that argument:

[In Tennebaum], our court of appeals held that a promise to waive privilege is not, in itself, a waiver, rather, it is disclosure that triggers waiver. Id. at 341. The court noted that waiver is rooted in notions of “fundamental fairness” and that its principal purpose is “to protect against the unfairness that would result from a privilege holder selectively disclosing privileged communications to an adversary, revealing those that support the cause while claiming shelter of the privilege to avoid disclosing those that are less favorable.” Id. at 340.

Here, Sanmina wishes to do just that. Sanmina relies on DLA Piper’s determination supporting a $503 million stock deduction, but it avoids disclosing the very foundational analysis that informed its conclusion. DLA Piper acknowledged that it based its conclusions on the memoranda in question. Thus, it would be fundamentally unfair for Sanmina to disclose the valuation report while withholding its foundation.

Conclusion

While the taxpayer may appeal this order, it serves as a cautionary tale for taxpayers who rely on both in house tax counsel and outside advisors. Valuation issues often are at the heart of many disputes with the IRS (and other parties) but when a client leans on outside advice for valuation and those advisors disclose their use of documents prepared in house it creates a road map for a waiver argument for the documents that would otherwise be protected from disclosure.

9th Circuit Defers on Important Privilege Waiver Case

 US v Sanmina Corp considers whether by disclosing the existence of purportedly protected documents the taxpayer has waived various privilege claims it is asserting with respect to memos that its in house tax counsel prepared.

I will briefly describe the issue and the recent 9th Circuit unpublished opinion that remanded the case back to the trial court.

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On its 2009 tax return, Sanmina had claimed about a half billion in a worthless stock deduction in one of its subsidiaries. The purportedly worthless sub had two related party receivables with an approximate $113 million book value. Notwithstanding the healthy book value, Sanmina claimed that the FMV of the receivables was zilch.

IRS examined Sanmina’s tax return and sent an information document request for documents that supported the deduction. Sanmina gave to IRS a valuation report from DLA Piper, its outside counsel. That report (not surprisingly) supported the taxpayer’s view that the receivables had no fair market value. Included in the report was a footnote that referenced internal memos that Sanmina’s tax counsel had prepared, one in 06 and the other in 09.

IRS asked for those two memos; Sanmina resisted, leading to IRS to summons them and bring an enforcement action when Sanmina did not comply. In 2015, the district court held that both memos were protected by attorney client and work product privilege and that the “mere mention” of the memos in the DLA Piper valuation report did not amount to the party’s waiving the privilege.

The government appealed, arguing that the 2006 memo was really not subject to the attorney client privilege because it was not a communication, as the taxpayer had failed to prove that when it was written it actually was circulated to anyone or the result of anyone in Sanmina seeking advice on the issue. It also argued that the 06 memo was not subject to the work product privilege because it was not prepared in anticipation of litigation, in part due to the time that elapsed between the writing of the memo and Sanmina taking the deduction. The government conceded that the 09 (but not the 06) memo was privileged, but argued that the cloak of protection was lost for both memos due to Sanmina having waived any privilege when it served up the DLA Piper valuation report that relied on and mentioned both memos.

The government on appeal based its waiver argument on two different approaches. First, the government argued that on a careful read of the DLA Piper report it was apparent that the report itself was heavily dependent on the two memos, notwithstanding that their existence was only specifically mentioned in a footnote in the report. Second, the government argued that under the Federal Rules of Evidence it was improper for the taxpayer to selectively waive the privilege when there are documents “that concern the same ‘subject matter’ that ought in fairness to be considered together.”

The 9th Circuit’s brief unpublished opinion vacated the earlier district court order and remanded the case back to the district court, with its opinion emphasizing that the district court should have done more in terms of analyzing the memos themselves:

Our resolution of this case would be greatly facilitated by a more informed analysis from the district court. More specifically, we prefer the district court review the documents in camera and reconsider its ruling on the asserted privileges following its review of the pertinent documents.

Conclusion

This dispute has been festering for close to three years. How much disclosure beyond acknowledging existence to trigger a waiver of privilege is an interesting issue, as is the reach of privilege on an internal memo that a taxpayer’s in house counsel wrote years before the taxpayer claimed the deduction in question.

Additional Links:

Video and audio link to oral argument at 9th Circuit 

District Court decision

Miller & Chevalier tax blog coverage of case (including links to briefs)

Court Orders Release of IRS Documents Despite Deliberative Process Privilege

Government agencies enjoy the cloak of the deliberative process privilege to protect from discovery in court or in FOIA proceedings internal deliberations that are part of their decision making process. Anadarko Petroleum v United States, a recent district court magistrate’s order, illustrates that the protection is not absolute, resulting in possible disclosure of a range of IRS documents that perhaps will shed light on how the agency apparently changed its view on a technical loss deferral regulation under Section 267.

I will summarize the issue and case below.

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Anadarko brought a $25 million refund suit; the substantive issue involved its taking a loss that arose from a liquidation of one of its subsidiaries. The precise question concerned whether a deferral of the loss ended in 2007, when Anadarko liquidated its subsidiary in a taxable liquidation. The government argued that the deferral should have continued, consistent with a regulation Treasury promulgated under Section 267 in 2012 and which Treasury claimed at the time was clarifying existing rules.

In the suit, Anadarko served interrogatories and sought a variety of documents that it felt showed that the 267 regulations did not clarify existing rules because IRS had previously taken differing views on the issue. It asked for documents relating to private letter ruling, a Chief Counsel advisory opinion and even an ABA Tax Section presentation at or around the time of finalizing the regs.

The government argued that the deliberative process privilege insulated the documents from discovery. That privilege essentially keeps from FOIA requests or court discovery agency predecisional documents, including the types that Anadarko sought.

While the privilege is a powerful cloak, it is not absolute. Courts are supposed to weigh the government’s strong interest in protecting full access to how it comes to a decision with the need of the party seeking the requested documents.

In concluding that Anadarko’s need trumped the agency’s interest the magistrate focuses on how agency changes on an issue may be relevant in a court’s legal interpretation. It did not matter, in the magistrate’s view, that the request considered documents that did not in and of themselves directly relate to precedential agency determinations.

In concluding that the government had to comply with the discovery, the court also felt that the request was proportional and reasonable, in light of the amount at issue and the costs to the government in complying. Backstopping its proportionality conclusion was its view that the nonprecedential documents had a bearing on the court’s ultimate task of sorting out the merits of the taxpayer and government’s views of  Section 267 and the regs.

Conclusion

Anadarko is an important taxpayer victory. I am not well versed with the substantive issue in this case. I suspect, however, that the court’s willingness to allow discovery has a lot to do with what the magistrate believes is at a minimum a less than complete explanation accompanying the regs. If IRS takes differing views on a technical issue, and yet when promulgating a final regulation Treasury claims that it is merely clarifying what the law had been all along, a court (and taxpayers) are justifiably curious as to how that explanation jives with what came before the final reg.

Update on Schaeffler Privilege and Work Product Dispute With IRS

Last December we discussed the Schaeffler Group’s multi-million dollar dispute with the IRS and in particular the Second Circuit’s opinion concerning attorney-client privilege and work product protection. See PT guest poster Ben Bolas’s Schaeffler v. United States: Second Circuit Rejects District Court’s Limitations on Attorney-Client Privilege and Work Product Doctrine in the Context of Tax Advice.

As Ben discussed, the Second Circuit reversed the district court and pushed back on opinions that had limited privilege in the face of parties having a common interest beyond a legal interest. The Second Circuit held that Schaeffler did not waive the attorney-client privilege and work product protections when Schaeffler shared opinions and communications with financial institutions pursuant to a common interest agreement even though the parties had a shared commercial interest. In resolving the summons dispute with respect to some of the documents at issue, the Second Circuit remanded the case to determine whether other documents were protected by the attorney client privilege or work product doctrine.

Law 360 a couple of weeks ago reported that the parties had settled the underlying tax dispute. See Schaeffler, IRS End $25M Dispute Over Stake Sale Loss, (not a free link) where it stated that the parties had “come to an accord ‘with respect to all issues’ in the U.S. Tax Court case.

With that resolution I was somewhat surprised when I came across last week the district court issuing an opinion and order that resolved an ongoing dispute regarding the IRS summons despite the merits settlement. In this brief post, I will discuss the nature of the dispute and offer a reason why the parties were still fighting about the summons even though the underlying case settled.

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Here is how the District Court framed the dispute:

On appeal, the United States Court of Appeals for the Second Circuit vacated this Court’s judgment and remanded the case for “further proceedings.” The IRS recently withdrew the summons and now moves to dismiss the petition for lack for subject matter jurisdiction on the ground that it is moot. Schaeffler has cross-moved for entry of a judgment quashing the summons.

The District Court opinion detailed further the parties’ actions following the Second Circuit opinion:

Schaeffler appealed the Court’s decision to the Second Circuit.See Notice of Appeal, filed June 6, 2014 (Docket # 55). The Circuit vacated this Court’s judgment and “remand[ed] for such further proceedings as may be necessary to determine, in a manner consistent with this opinion, whether any remaining documents are protected by the attorney-client privilege or work-product doctrine.” Schaeffler v. United States, 806 F.3d 34, 45 [116 AFTR 2d 2015-6708] (2d Cir. 2015). The Second Circuit’s mandate issued on January 28, 2016. Mandate, filed Jan. 28, 2016 (Docket # 64).

This Court then ordered “[t]he parties … to consult to determine whether there should be any further proceedings in this matter.” Order, filed Jan. 29, 2016 (Docket # 65). On February 5, 2016, the parties submitted a joint letter “agree[ing] that there is no need for further proceedings ….” Letter from Todd Welty and Rebecca S. Tinio, filed Feb. 5, 2016 (Docket # 66). The parties represented that they were “working to draft stipulated dismissal documents.” Id.

One week later, however, on February 12, 2016, the IRS withdrew the summons that was the subject of the petition to quash. Ramirez Decl. ¶ 5. In a letter, the IRS informed Ernst & Young that “[n]o further attempt will be made by the Internal Revenue Service to seek production of records from Ernst & Young under this summons.” Letter from Hugo Ramirez to Melissa Galetto, dated Feb. 12, 2016, appended as Exhibit 1 to Ramirez Decl. The instant motions to dismiss and for entry of judgment followed.

The rest of the opinion essentially discusses the mootness doctrine, which stems from Article III of the constitution. That doctrine requires that courts have an actual controversy before it. Last week’s district court opinion notes that there are many cases that have held that the withdrawal of an IRS summons moots a petition to quash that summons. In finding that no exception to the mootness doctrine applied, the opinion granted the IRS’s motion to dismiss and denied Schaeffler’s motion for entry of judgment quashing the summons.

What was going on with the dispute? It was not entirely clear to me but I discussed the opinion with Jack Townsend, who authors the Federal Tax Crimes blog and who is the successor author with me on the Saltzman and Book criminal tax penalties chapter in IRS Practice and Procedure. Jack suggests that in opposing the government’s motion to withdraw and in cross-moving for an entry of a judgment quashing the summons Schaeffler “might want the issue to be final between Schaeffler and the Government via some type of preclusion (res judicata or collateral estoppel) if the issue arises in the future as may be likely in subsequent audit proceedings or litigation.” While this is merely an inference it makes sense to me.

While for Schaeffler the resolution of the summons dispute means that there is no court order quashing the summons on privilege grounds (and some opening for future disputes between the parties), the Second Circuit opinion remains a powerful weapon for parties seeking the attorney client privilege and work product as well as the ability to raise the common legal interest doctrine generally.

 

 

 

 

Tax Court Order Sets Out Quick Peek Process in Discovery Dispute

A couple of weeks ago the Tax Court issued an order in the ongoing dispute between IRS and Guidant relating to over billions in adjustments for the years 2001-07 involving transfer pricing and the transfer of intangibles to foreign corporations (as well an accuracy-related penalty). We have on occasion in the blog discussed the high stakes and intense battles surrounding privilege disputes (see for example DOJ and Davis Polk Take off the Gloves in Recent Discovery Dispute Involving GE’s $660 Million Tax Refund Suit).

There have been a series of discovery disputes in the Guidant case, which is not surprising for a case of this size. In the latest dispute, Guidant has been seeking documents from IRS, and IRS has claimed deliberative process privilege for over 4,000 documents. Guidant filed a motion to compel. IRS had sent across privilege logs and Guidant thought the logs were “inadequate and fail to provide the necessary information to support the privilege or at the minimum are deficient in a number of formatting and practical issues or have missing essential information.” The taxpayers argued that “hundreds of entries on respondent’s logs fail to identify the deliberative process involved and fail to identify the decision to which they relate.” The taxpayers suggested that the Court “issue a Protective Order for the benefit of respondent if respondent would release the documents to petitioners during discovery.” IRS felt that the Protective Order “would not adequately protect respondent and suggested “that a sampling of the thousands of documents claimed to be subject to the privilege be examined in camera by the Court.” The taxpayers objected to the sampling because they felt that it “would be inherently biased because respondent would know what the documents contained because they had possession of them but petitioners would not know.”

With that impasse, the order notes that the parties agreed to use a “quick peek” procedure to resolve the dispute, with the requirement that the parties file a status report. I was not familiar with that process, and briefly describe it below.

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A 2015 New York Law Journal article from attorneys Christopher Boehning and Daniel Toal at Paul Weiss discusses their use and defines them as follows:

Under “quick peek” agreements, parties to a litigation may produce documents after little to no privilege review, subject to the understanding that any privileged documents disclosed will be returned to the party who produced them free from the recipient’s assertion of waiver.

Quick peek agreements grew out of 2008 changes to the Federal Rules of Evidence (FRE) that sought to mitigate the risks of inadvertent waivers of privilege. FRE 502(b) provides that if a party takes reasonable steps to prevent disclosure a mistaken production of privileged material does not waive the privilege. The FRE 502(b) change resolved conflicts in common law and were significant. In addition to FRE 502(b), as the 2015 NY Law Journal article states “FRE 502(d) is even more sweeping. Under that provision, parties may ask a court to enter an order specifying that the parties’ production of privileged material does not constitute waiver, even if the parties fail to take reasonable steps to prevent its disclosure.”

From FRE 502(d) (and Advisory Committee Notes accompanying Federal Rule of Civil Procedure 26(b)(2)) is how we get to quick peek. The Paul Weiss authors state that FRE 502(d) has encouraged the use of quick peek agreements, which has the potential to speed discovery because it reduces the amount of privilege review before production.

Observations on the Procedure

As my recent Tax Court experience is in tax clinic cases where discovery was rare, I sought thoughts on the process from Sean Akins, Special Counsel at Covington, co-author of Thomson Reuters’ Litigation of Federal Tax Controversies and former Procedurally Taxing guest poster. While Sean likewise has no direct experience with the process, he does have significant insight, noting that quick peek “is consistent with the Tax Court’s practice of seeking to have the parties communicate and cooperate to the greatest extent possible” and that he “suspects that the Court hopes that the parties will be able to agree that certain documents are truly protected by the deliberative process privilege, some are not, and as to the others there remains a fair dispute.” As Sean observes, even if the parties still may dispute whether privilege attaches, it could lessen the need for further court intervention “because Petitioners will have the opportunity to review the substance of the documents, and it may be that they elect not to challenge the privilege claim if they determine some of the documents lack relevance/materiality.”

Sean also however expressed “a little surprise” at its use in the context of the government claiming deliberative process privilege:

[T]the quick peek method was utilized concerning documents purportedly subject to the deliberative process privilege.  The theory behind that privilege, as I understand it, is that assuring government employees of confidentiality with respect to their decision-making process should permit those individuals to provide more candid advice.  Allowing a quick peek, even if the privilege attaches and remains unwaived, cuts against this, as the decision-making process is revealed.  Somewhat ironically, the IRS resisted the notion that a protective order would adequately protect the IRS should the documents be produced to Petitioners.  But, nothing in the Order that the Court issued would preclude Petitioners or their counsel from disclosing to others the substance of what they learned during the quick peek process.  In the absence of protections against such disclosure, I would have opted for a protective order.

Sean adds that “he would be interested to keep an eye on this and see how it is ultimately resolved, and whether the parties are again before the Court with a more narrow set of documents requiring an in camera review.” We will keep an eye on the Guidant case and also for other orders where the Tax Court uses this approach.

For those interested I include the language from the order setting out the procedure:

  1. Respondent does not waive any privilege it has asserted with respect to deliberative due process or any other privilege it has previously asserted in this case. The privilege is not waived in this litigation and any disclosure is also not a waiver in any other Federal or State proceeding.
  2. Counsel for respondent shall disclose each document for which he claims privilege and counsel for petitioners shall review such document but is not permitted to retain or copy such document unless both counsel agree otherwise or except as provided.
  3. All documents which both counsel agree are properly claimed as privileged shall remain so and respondent shall not be required to produce that document further. All documents which both counsel believe are not properly claimed as privileged shall be immediately produced and given to petitioners.
  4. The parties shall file a status report after they have concluded their quick peek procedure.

Summary Opinions for the second half of May

Here is part two of the items from May we didn’t otherwise cover.  We’ll have the June items shortly, and then July.  Hopefully, I’ll get back on track for weekly summaries in the near future.

  • The Sixth Circuit in Ednacot v. Mesa Medical Group, PLLC affirmed the lower court tossing a physician assistant’s claim that an employer wrongfully withheld employment taxes.  The Court determined this was tantamount to a refund suit, which required the taxpayer to first file an administrative claim for refund with the IRS prior to bringing suit.  There seems to be a lengthy past between the parties in this case.  The petitioner brought up a valid seeming point that she did not know if the withholdings were paid to the IRS, and therefore wasn’t sure if the refund was appropriate, but the Court held that Section 7422 was designed to funnel these issues through the administrative process.
  • Couple interesting privilege cases recently, including the Pacific Management Group decision blogged by Joni Larson for us.  In a case that may have a somewhat chilling effect on making reasonable cause claims, the Tax Court has held that claiming reasonable cause to the substantial valuation misstatement penalty waived attorney client privilege and the work product doctrine for certain communications between the taxpayer and its lawyer and accountant.  See Eaton Corp. and Sub. v. Comm’r.  This holding was the affirming of a motion for reconsideration.  The Court found that although there was an objective determination under Section 6662(e)(3), whether relying on the advice on Section 482 was based on the facts and circumstances, including the advice of the lawyer.  By claiming reasonable cause, the privileges were waived for that issue.
  • Taxpayer was successful arguing against the substantial understatement penalty in Johnston v. Comm’r, but it was because the taxpayer didn’t actually owe the tax.  The IRS had argued that a debt between the taxpayer (an executive of a telcom company) and his company was discharged by his employer when he moved to a related entity.  There was credible evidence that it was not discharged and payment continued.  There was the pesky issue that the loan wasn’t paid until the IRS audited the individual, but the Court found that the audit prompted the company to do something with the loan and it hadn’t been tax avoidance…must have been persuasive testimony.
  • LAFA issued guidance on the effect on the limitations period on assessment for payroll tax when the wrong form is filed. (LAFA 20152101F).  Employers are generally required to file quarterly returns on Form 941 for employment taxes when they are paid in that period.  A different form, Form 944 is used for certain employers with little  employment tax liability, and that is required annually.  The statute generally runs from the date of the deemed filing of employment tax returns, which is April 15 the following year.  See Section 6501(a)&(b).  The LAFA reviews the following three situations:
  1. Employer is required to file Form 944, but instead timely files four quarterly Forms 941.

  2. Employer is required to file Form 944, but timely files Form 941 for the first and second quarters of the year instead, and files nothing for the third or fourth quarters of the year.

  3. Employer is required to file quarterly Forms 941, but timely files annual Form 944 instead.

 

The quick conclusions were:

  1.  Assuming the Forms 941 purport to be returns, are an honest and reasonable attempt to satisfy the filing requirements, are signed under penalty of perjury, and can be used to determine Employer’s annual FICA and income tax withholding tax liability, the Forms 941 meet the Beard formulation and should be treated as valid returns for purposes of starting the period of limitations on assessment.

  2.  An argument can be made that the Forms 941 for the first and second quarters of the tax year constitute valid returns under the Beard formulation since they purport to be returns and are signed under penalty of perjury. However, given that Employer’s FICA and income tax withholding tax liability for the third and fourth quarters will not necessarily be equal to that reported for the first two quarters, the Forms 941 arguably are not sufficient for purposes of the determining Employer’s annual FICA and income tax withholding tax liability and may not be honest and reasonable attempts to satisfy the tax law.

  3.  Assuming the Form 944 purports to be a return, is an honest and reasonable attempt to satisfy the filing requirements, can be used to determine Employer’s annual FICA and income tax withholding tax liability, and is signed under penalty of perjury, Employer’s Form 944 meets the Beard formulation and should be treated as a valid return for purposes of the period of limitations on assessment.

  • A taxpayer in a chapter 11 case, Francisco Rodriquez (not the current Brewers closer who pitched for the Mets before choking out his relative in the clubhouse) was successful in avoiding a lien under 11 USC 506 on property held by the taxpayer that was already underwater with three prior liens.  In re Rodriguez, 115 AFTR2d 2015-1750 (Bktcy D MD 2015).  Section 506 allows liens to be stripped if the property lacks equity, which was what the taxpayer was attempting.  SCOTUS in Dewsnup v. Timm held that  a chapter 7 debtor cannot “strip down” an allowed secured claim (clearly, I was not the debtor, otherwise SCOTUS would have tossed on some Its Raining Men, and granted my right to strip down—I only did it to pay for college, I swear—and yet, still so many student loans).  Various other cases have held that Dewnsup does not extend to other chapters in bankruptcy, and the District Court held that lien stripping was appropriate in chapter 11 under the taxpayer’s circumstances.
  • The Tenth Circuit continues its clear prejudice and hatred towards Canadians (I completely made that up and that link is NSFW) in Mabbett v. Comm’r, where it found the Tax Court properly tossed a petition as being untimely that was filed by a resident of the US, who was a Canadian citizen.  The Court found the Service had properly sent the stat notice to the taxpayer at her last known address (and even if that was not the case, her representative had forwarded her a copy well before the due date of the petition).  The taxpayer also claimed that she was entitled to the 150 day period to file her petition to the court under Section 6213(a) because she was a Canadian citizen.  The Court stated, however, that the statute was clear that the 150 day rule only applies when “the notice is addressed to a person outside the United States.”  The taxpayer had been traveling, and was Canadian, but failed to show she was outside of the United States at the time the notice was sent.
  • In case you haven’t seen, the Service has started a cybercrimes unit to combat stolen ID tax fraud.  In my mind, this is sort of like the IRS and Tron having a lovechild, which I would assume to look like this.  Jack Townsend has real coverage on his Federal Tax Crimes Blog.
  • Jack also has coverage of the new IRS FBAR penalty guidance, which can be found here

 

Summary Opinions for May, part 1

May got away from me, and so has much of June.  I’ll post the Summary Opinions for May in two parts, and handle June in the same manner.  Below are some of the tax procedure items in May that we didn’t otherwise cover:

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  • The Middle District of Louisiana, after the Fifth Circuit vacated and remanded the case, reversed its prior decision and, under Woods, held that the Section 6662(e) valuation misstatement penalty could be imposed when the underlying transaction had been determined to lack economic substance. Chemtech Royalty Associates, LP v. US.   This case was the result of some crazy tax planning by Dow Chemicals to goose its basis in a chemical plant.  Here is Jack Townsend’s prior coverage of the case.
  • Sticking with substantial valuation misstatement penalty, the Tax Court in Hughes v. Comm’r upheld the penalty against a KPMG partner who claimed a step up in basis in stock when he transferred the shares to his non-resident spouse.  This was based on some informal tax research, and conversations with some co-workers that were also informal.  The Court essentially felt Mr. Hughes should have known better, and tagged him with a big penalty (probably didn’t help he was transferring the shares to try and ensure his ex-wife couldn’t make a claim for the increase in value).
  • IRS has released Chief Counsel Advice regarding abatement of paid tax liabilities.  In taxpayer friendly advice, CCA 201520010 states the language of Section 6404(a) is “permissive” and does not require the liability to be outstanding.  That Section states the “IRS is authorized to abate the unpaid portions of the assessment of any tax or any liability in respect thereor…”  The reference to “unpaid”, according to the CCA, is not binding on the Service.
  • The Service has released CCA 201519029, which provides advice on when preparer penalties can apply in situations where the prepared didn’t sign the return or didn’t file the return, and when a refund claim was made after the statute had expired.  For the third situation, the Service stated that “understatement of liability” does not include claims barred by the statute.  The full conclusions in the CCA are:

Issue 1: Yes. If the return is not filed, a penalty under I.R.C. § 6694(b) may be assessed if the return preparer signed the return and the return preparer’s conduct was willful or reckless.

Issue 2: Yes. Under the language of I.R.C. § 6694(b)(1), the return preparer penalty may be assessed if the tax return preparer prepares any return or claim for refund with respect to which any part of an understatement of liability is due to willful or reckless conduct. There is no requirement that the Service allow the amounts claimed on an amended return before the I.R.C. § 6695(b) penalty may be assessed.

Issue 3. The penalties under I.R.C. §§ 6694(a), 6694(b) or 6701 should not be assessed merely because the return preparer made and filed a claim for refund after the period of limitations for refunds had expired, because an “understatement of liability” does not include claims that are barred by the period of limitations. In addition, there may be extenuating circumstances that weigh against asserting the penalty. The amended return, for example, may be perfecting an earlier timely informal claim for refund.

  • The Service has announced it will be refunding the registered tax return preparer test fees.  There will be a second refund procedure where you can request your time back…but it will be ignored.
  • Professor Andy Grewal in early May had an excellent blog post on Yale’s administrative law blog, Notice and Comment, which highlights more potential penalties on employers attempting to follow the ACA requirements.
  • Another CCA (CCA 201520005) , where the IRS has held that the deficiency procedures apply to the assessment of the penalty under Section 6676 to erroneous refund claims based on Section 25A(i) American Opportunity Credit, since the penalty can only apply to a refund claim based on the credit if that claimed credit is part of a deficiency.  Carlton Smith previously had a blog post touching on this issue, found here, where he persuasively criticized  this position.  You should check out the entire post, but I’ve recreated a portion below:

A third issue discussed by the PMTA is how the section 6676 penalty is to be assessed.  Frankly, I read the Code as providing that the assessment is done like a section 6672 responsible person trust fund penalty — straight to assessment, without the deficiency procedures applying.  That seems to be what section 6671 provides.  But, the PMTA takes the position that only for underlying issues on which the section 6676 penalty applies where there is no jurisdiction in the Tax Court under the deficiency procedures, such as for excessive refund claims regarding employment taxes or the section 6707A reportable transaction penalty, the section 6676 penalty is done by straight assessment, without prior notice to taxpayers.  However, for section 6676 penalties on what would constitute a “deficiency” — and excessive refundable credit claims are clearly part of a deficiency under section 6211(b)(4)‘s special rules — the PMTA concludes that the section 6676 penalty should be asserted in a notice of deficiency.  The PMTA reasons that Tax Court cases have in the past held that a penalty which is computed as a function of a deficiency (which I would point out includes extra late-filing and late-payment penalties on the tax deficiency) are also treated under the deficiency procedures.  This reasoning is all mixed up.  The Tax Court applies the deficiency procedures to penalties like the late-filing and late-payment penalties of section 6651(a) that are imposed on the tax deficiency only because of special language in section 6665(b) that directs the Tax Court to do so.  There is no similar language in section 6671 directing deficiency procedures to apply to any penalties imposed in the following sections.

  • And another CCA (201517005), this one dealing with the statute of limitations for refunds based on foreign taxes deducted.  Specifically, whether a refund claim more than ten years (yr 13) after the tax year in question (yr 2) was timely when it resulted from an NOL (yr 4) where the taxpayer elected to deduct foreign taxes paid instead of taking foreign tax credit.  The IRS concluded that no, Section 6511(d)(2) applied to the NOL and required the claim to be made three years after the NOL year.  Section 6511(d)(3), which allows for a ten year statute for refunds pertaining to foreign tax credits, was not applicable.
  • Apparently, some states are starting to scale back the amount of tax credits available for movie productions.  Two years ago, The Suspect was filed in my building, staring Mekhi Phifer and no one else you have ever heard of.  I think it was “catered” by a fast food joint, and they may have been using our coffee pots to make coffee.  I can’t imagine Pennsylvania dropped the big bucks to land that film.
  • Emancipation day is throwing off filings again next year.  I always assumed that had something to do with the date of the Emancipation Proclamation, but I was wrong. The Emancipation Proclamation went into effect January 1st, 1863.  On April 16th, 1862, President Lincoln signed the Compensated Emancipation Act, freeing the enslaved living in the District of Columbia.  The linked Rev. Ruling explains what those in Massachusetts who are celebrating Boston Marathon Day (Patriots Day-celebrating the shot heard round the world) should do also.
  • Initially when writing this, I was watching the US women’s national team take it to Colombia, and recalling what a jackass Sepp Blatter has been.  Hoping this article is in reference to the shoe dropping on him next.  Even if he didn’t evade taxes, he should have to pay someone money for suggesting he would boost viewership of the women’s game with hot pants.  Or for not knowing who Alex Morgan is…or for making the women play on turf.