Tax returns are among the most revealing documents in any litigant’s possession. They not only disclose his or her sources of income, but also property, debts, gambling habits, political leanings, charitable activities, marital status, and healthcare expenses. And precisely because tax returns are so revealing, litigants fight tooth-and-nail over their production in discovery. At bottom, however, tax returns are simply documents subject to the same rules of civil discovery as any other: Any party may obtain discovery of any “nonprivileged matter that is relevant to any party’s claim or defense and proportional to the needs of the case.” Fed. R. Civ. P. 26(b)(1).
The recent case of Valencia v. Crop Production Services from the U.S. District Court for the Southern District of California provides a succinct example of how this general discovery rule applies to tax returns. No. 18-cv-0678 (S.D. Cal. Nov. 8, 2018). The plaintiff, a sunflower farmer, alleged that he suffered business losses, including lost profits, when the defendant, an agricultural retailer, sold him the wrong product for his crop. The defendant then requested the plaintiffs’ tax returns to discovery the scope of the alleged losses.
Applying California law under its diversity jurisdiction, the court recognized that California has adopted a qualified privilege for tax returns. That privilege is disregarded only when (1) it has been intentionally waived, (2) the gravamen of the lawsuit is inconsistent with the assertion of the privilege, or (3) it is outweighed by countervailing public policy. Id. at *2 (quoting Weingarten v. Super. Ct., 102 Cal. App. 4th 268, 274 (2002). The plaintiff had argued that public policy favored upholding the privilege because information about his business losses was independently available from his business records. The court, however, adopted the defendant’s position that the privilege was lost where the gravamen of the plaintiff’s lawsuit was his claim for lost profits. The court thus ordered the plaintiff to produce his tax returns to the defendant (although it limited their disclosure to the defendant’s counsel and experts and required their destruction at the end of litigation).
For practitioners and litigants, the court’s terse opinion suggests that the production of the plaintiffs’ tax returns was a foregone conclusion as soon as the plaintiff placed his profits at issue. Nonetheless, the court’s significant limitations on the tax returns’ disclosure reflects an appreciation of their sensitivity. Plaintiffs and their counsel therefore would be wise to discuss whether the prospect of recovering lost profits outweighs this potential loss of privacy.
Joseph V. Schaeffer is with Spilman Thomas & Battle, PLLC in Pittsburgh, Pennsylvania.