United States v. Textron, Inc.

Textron, Inc. (defendant) was a large, publicly traded company with over a hundred subsidiaries. Textron and its subsidiaries filed consolidated tax returns. As a public company, Textron had to comply with federal securities laws that required it to publicly disclose audited financial statements. As is typical with large corporate groups, many of the items on Textron’s consolidated tax returns reflected debatable judgment calls. That is, different tax professionals could reasonably reach different conclusions as to the propriety of particular items of gain and loss reported by Textron. Hypothetically, if the Internal Revenue Service (IRS) (plaintiff) were to successfully challenge some of Textron’s reported tax items through litigation, Textron would owe additional taxes. Federal securities law and general accounting principles required Textron to calculate the aggregate risk of such additional taxation and report it as a contingent liability—typically called a tax reserve—on its audited financial statements. As is standard for large public companies, the identification and quantification of debatable tax items and the discounts for probabilities of IRS success in legal challenges were detailed in internal, tax-audit work papers. Ernst & Young, Textron’s auditors, following standard industry practice, would not approve Textron’s calculated tax reserve without the justifications contained in the work papers. The IRS audited Textron’s tax returns. During one of the years under audit, a Textron subsidiary engaged in transactions that federal regulations identified as particularly susceptible to tax abuse, triggering heightened IRS scrutiny. As part of this scrutiny, the IRS issued Textron a summons for its tax-audit work papers, which Textron refused. The IRS then filed an enforcement action pursuant to its summons in district court. The district court ruled in favor of Textron, holding that the work papers were privileged under the work-product doctrine. A panel on the First Circuit Court of Appeals affirmed. The IRS filed a petition for an en banc rehearing, which the court of appeals granted.