The Tax Lawyer
Note: The following is an excerpt from the introduction to the article as published in The Tax Lawyer. Author citations have been omitted for brevity. Tax Section members may read the article in its entirety in Adobe Acrobat format.


The Tax Practitioner–Client Privilege: Valero’s Shortcomings and a Better Approach

John O. Sawyko

I. Introduction

In 2002, Valero Energy Corporation (Valero) conducted a series of com­plicated financial transactions through which it realized significant tax-de­ductible losses. When the Service subsequently summoned all documents related to the planning of the transactions, Valero attempted to shield many of the documents from discovery using the tax practitioner–client privilege created by section 7525 of the Code. The Service responded by arguing that even if the documents were privileged, they were discoverable under section 7525(b)’s exception to the privilege for written communications that pro­mote a tax shelter.

The notable aspect of this case is the Seventh Circuit’s interpretation of the tax shelter promotion exception, as Valero was one of the first cases to directly address this provision of the Code. Valero argued that the exception should be read very narrowly and only apply to the active sale of prepackaged tax shelter products, while the Service supported a much broader interpreta­tion. In the end, the court ruled against Valero and held that the tax shelter exception applies to “any plan or arrangement whose significant purpose is to avoid or evade federal taxes.” The court further explained that under this interpretation, the word “promotion” “limits the exception to written com­munications encouraging participation in a tax shelter.”

Part II of this Note examines the structure and development of the tax practitioner–client privilege and the tax shelter promotion exception. Part III explains the Valero decision and the reasoning of the court. Part IV argues that the court erred by adopting a broad interpretation because it allows the exception to effectively swallow the privilege, rendering nearly all privileged communications between tax practitioners and their clients discoverable. Finally, Part V proposes a narrower, alternative reading of the tax shelter pro­motion provision that can be more consistently applied to common tax shel­ter fact patterns.

Published by
Section of Taxation,
American Bar Association
in Collaboration with the
Georgetown University Law Center

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