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.