Following up on last week's post, En Banc First Circuit Reverses Panel, Gives IRS Access to Textron's Work Papers: in today's Wall Street Journal, Ruling in Tax-Auditing Case Puts Corporations on Edge, by Amir Efrati:

A little-publicized ruling in a recent case involving the IRS is causing lawyers for big companies some sleepless nights.

Last week, in a widely anticipated ruling, a federal appeals court in Boston said the IRS could gain access to documents created by a defense-contracting firm to determine whether the company's calculation of its tax liabilities would pass muster during a possible IRS audit. The decision in U.S. v. Textron Inc. reversed a January ruling by a smaller panel of judges on the same court.

To some lawyers who represent corporations, the decision signaled an attack by the courts on the "work-product doctrine," the legal rule that shields an individual or business from having to turn over documents created "in anticipation" of litigation. In its ruling, the First Circuit Court of Appeals said the documents at Textron weren't protected under the doctrine because they weren't prepared specifically "for use" in litigation. …

Some tax experts say the concern is misplaced. Corporate lawyers are "trying to expand the work-product doctrine far beyond its original intent," says Dennis Ventry, a law professor at the University of California, Davis, whose analysis of the Textron case was cited by the court in its opinion. "The IRS operates with significant information deficiencies," he says, "and some companies bury things into a large tax return and try to obscure what they're doing."

The debate is playing out as the IRS in recent years has sought to hunt down illegal tax shelters. As part of that push, the agency increasingly is asking to review documents that show companies' analysis of how much they should set aside in reserves for additional tax payments, should the IRS identify questionable tax accounting. In most instances, the documents, known as tax-accrual papers, include the company lawyers' determination of the likelihood that it will win or lose future tax disputes with the IRS.

Steve Johnson, a law professor at the University of Nevada, Las Vegas, said many companies "were engaged in transactions that pushed the envelope in the tax sense. The game was, 'Could we structure this in a way that the IRS wouldn't be able to figure out what was going on?'"

But corporate lawyers say that because tax law isn't always clear, it isn't fair for the IRS to use a company's evaluations about its own tax decisions against it.

See also WSJ Law Blog, More on the Textron Decision, In-House Lawyers’ Latest Worry.