The conflicting circuit court decisions in United States v. Textron and United States v. Deloitte & Touche USA, LLP leave the privilege status of FIN 48 workpapers significantly unclear. Schedule UTP further complicates taxpayers’ preserving the privilege of tax planning materials by requiring certain corporations to disclose individual uncertain tax positions (“UTPs”) as part of their tax returns starting in the 2010 tax year. Some commentators predict that in reaction, corporations may try to reduce the number of their UTPs by obtaining pre-filing agreements (“PFA”) or private letter rulings (“PLR”) from the IRS. Indeed, according to the IRS’ s published statistics, the total number of PFAs the IRS received increased by approximate ly 70% to 39 in 2011, from 23 in 2010. This is by far the largest year-to-year in crease of PFAs since 2001, suggesting that some corporations may be seeking more certainty prior to filing their returns. On the other hand, the total number of PLRs issued dropped by approximately 25% to 2,900 in 2011, from 3,864 in 2010, suggesting that taxpayers in general are not seeking more certainty upfront. The costs associated with filing a PFA and PLR—a bout $50,000, and $10,000, respectively, a PFA taking more than 250 days on average to be negotiated – and, most importantly, the risk of having disclosed a potential weakness and then obtaining an adverse determination could deter many taxpayers from seeking a PFA or PLR. In the end, before the Supreme Court resolves the privilege issue arising from tax accrual workpapers and Schedules UTP, corporations will probably react by adopting certain approaches that would reduce the quality of their UTP disclosures.
One possible conclusion from the Deloitte court’s reasoning, that material developed in anticipation of litigation can be incorporated into a document produced during an audit without ceasing to be work product, is that distancing the FIN 48 workpapers prepared to support the financial statements from the legal tax opinions and analyses created for assessing the legal risks of tax positions, and then distancing the UTP from the FIN 48 workpapers, can increase the likelihood of the legal opinions being privileged attorney work product. Thus, before the company enters into tax positions that pose significant litigation risks, its tax attorney s could draft legal opinions that evaluate the tax risks and the likelihood of litigation a nd settlement. Such opinions by themselves are likely privileged work product under United States v. Adlman . For purposes of preparing its financial statements at a late r stage, the company could incorporate such legal opinions by reference, instead of preparing legal opinions specifically for FIN 48 purposes. The goal of the “incorporation by reference” approach would be to clearly distinguish the purposes of the legal opinions—to assess the risk of litigation—from the purpose of the FIN 48 workpapers. Certainly, this approach would not apply to all contents of FIN 48 workpapers, but it could potentially strengthen the privilege claims on the legal opinions and litigation risk assessments of certain tax positions.
Further, distancing materials used to file a Schedule UTP from the FIN 48 workpapers also may increase the likelihood of preserving privilege over the legal opinions. To that effect, the company may use an accountant, who has access to only summaries of the FIN 48 workpapers to prepare the Schedule UTP. The summaries would include a quick fact description, reserve amount, and the settlement probability,