Taxpayers must reveal tax shelter opinion letters despite attorney-client privilege

BY ALISTAIR M. NEVIUS, J.D.

By attempting to establish good-faith and state-of-mind defenses, taxpayers put their legal knowledge and understanding into contention, and therefore they waived attorney-client privilege, the Tax Court held on Wednesday (Ad Investment 2000 Fund LLC, 142 T.C. No. 13 (2014)). As a result, the court will order the taxpayers to produce letters that expressed their attorneys’ opinions as to whether anticipated tax benefits of a son-of-boss tax shelter would be upheld.

The IRS adjusted partnership items of two partnerships that had invested in a son-of-boss tax shelter, and the Service determined that accuracy-related penalties should apply to any resulting tax underpayments. The petitioners responded that they should not be subject to the penalties because “the Partnership and its partners reasonably believed that their tax treatment of such items was more likely than not the proper [tax] treatment,” that “[a]ny underpayment of tax was due to reasonable cause,” and that the partnership and partners “acted in good faith.”

The six tax shelter opinion letters at issue were written by a law firm, giving the law firm’s opinion on whether the transactions would be upheld for federal income tax purposes. The IRS sought to compel production of the letters. The IRS agreed that these would normally fall under the attorney-client privilege but argued that the taxpayers had waived that privilege, under the common law doctrine of implied waiver. Under that doctrine, attorney-client privilege is waived when the client places privileged matters “in controversy,” and the IRS argued that by relying on affirmative defenses that relied on the partnerships’ beliefs or state of mind, the taxpayers had put the opinions in controversy. 

The Tax Court agreed that, “When a person puts into issue his subjective intent in deciding how to comply with the law, he may forfeit the privilege afforded attorney-client communications.” By averring that the partnerships “reasonably believed” that their tax treatment was more likely than not correct, that the underpayment was due to “reasonable cause,” and that they acted “in good faith,” the taxpayers put the partnerships’ knowledge, understanding, and beliefs into contention, the court held.

Therefore, if the taxpayers persist in these affirmative defenses, the court said, it would be unfair to deprive the IRS of the knowledge of the contents of the opinion letters that gave the taxpayers that alleged knowledge, understanding, and beliefs. The court granted the IRS motion, requesting the court to compel production of the opinion letters.

Alistair M. Nevius ( anevius@aicpa.org ) is the JofA’s editor-in-chief, tax.

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