Waiver Of Privilege: Disturbing Trends

Several recent cases have given the government the upper hand in the battle over protection of privileged communications. Arguing that taxpayers cannot use the attorney-client and tax practitioner privileges and work product protection as both a "sword" and a "shield," courts have increasingly required taxpayers to disclose tax advice prepared by their accountants and lawyers.

The attorney-client and tax practitioner privileges are waived when the privileged material is shared with any third person. That waiver then applies to "all other communication relating to that same subject matter." Fort James Corp. v. Solo Cup Co., 412 F.3d 1340, 1349 (Fed Cir. 2005). Work product protection is waived when confidential material is shared with an adversary or a conduit to an adversary. The scope of waiver of work product immunity is more nuanced, depending on the type of work product. The waiver of work product, however, also extends to all non-opinion work product concerning the same subject matter. In re EchoStar Comms. Corp., 448 F.3d 1294, 1302 (Fed. Cir. 2006). Several recent opinions illustrate the application of these waiver rules and the potential ramifications of relying on privileged tax advice as a defense to proposed Internal Revenue Service (IRS) penalties.

In Salem Financial, Inc. v. United States, No. 10-192T (Fed. Cl. Jan. 18, 2012) (opinion and order on motion to compel discovery), as part of its defense to IRS penalties, the taxpayer contended that it had reasonable cause for claiming foreign income tax credits associated with a financial transaction known as STARS (Structured Trust Advantaged Repackaged Securities). Specifically, the taxpayer relied upon "extensive KPMG and Sidley tax opinions, PwC's conclusion that reliance on these opinions was reasonable, and [the taxpayer's] own internal review and approval of the proposed transaction." The taxpayer therefore "put the advisor's advice at issue."

The government, predictably, first sought to obtain the taxpayer's tax reserve workpapers. The taxpayer attempted to distinguish between PwC's "technical analysis of STARS" and the information and analysis that resulted in the taxpayer's tax reserve position. The taxpayer specifically noted that it considered factors other than PwC's technical analysis as part of determining its tax reserve position. The court, however, held that PwC's technical evaluation of the strengths and weaknesses of the transaction "influenced" the taxpayer's analysis of its litigation and settlement positions. By relying on PwC's advice...