Taxpayers under audit should be aware of significant amendments to the U.S. Tax Court's rules on work product protection and the discoverability of draft expert witness reports and certain communications between counsel and experts.

The U.S. Tax Court recently amended its rules as part of its continuing efforts to further align its rules more closely with the Federal Rules of Civil Procedure (FRCP).  Two of the more significant amendments were changes to Rule 70 to adopt the “substantial need and undue hardship exception” to the work product privilege and to limit the discoverability of draft expert witness reports and certain communications between counsel and expert witnesses.

The work product doctrine shields communications and other materials prepared in anticipation of litigation.  It protects the attorney’s patterns of investigation, determination of relevant facts, preparation of legal theories, planning of strategy and recording of mental impressions.  It also applies to information and materials prepared by a party representative other than an attorney working on behalf of the attorney, or gathered by an agent acting under an attorney’s direction. 

In Hickman v. Taylor, 329 U.S. 495, 509 (1947), the Supreme Court of the United States acknowledged that the work product privilege is not absolute, but found that the party seeking the production of fact-based work product materials could not overcome the privilege due to failure to make “any showing of necessity or any indication or claim that denial of such production would unduly prejudice the preparation of [the party’s] case or cause him any undue hardship.”  This exception was subsequently codified in FRCP 26(b)(3)(A).  With respect to opinion work product—i.e., work product reflecting mental impressions, conclusions, opinions, or legal theories of a party’s attorney or other representative concerning the litigation—discovery is permitted, if at all, only in rare and exceptional circumstances involving more than “substantial need and undue hardship.”

“Substantial Need and Undue Hardship” Exception

The Tax Court did not adopt the undue hardship exception contained in the FRCP when it originally enacted its rules, and early opinions reflected that work product protection was absolute.  However, over the years several Tax Court opinions chipped away at the absolute protection for work product, culminating in the holding in Ratke v. Commissioner, 129 T.C. 45, 52 (2007) that “[t]he privilege resulting from the work product doctrine is qualified; it may be overcome by an appropriate showing.”  Any remaining doubt on the subject was cleared up by the recent amendment, as the Tax Court officially adopted the application of the work product doctrine set forth in FRCP 26(b)(3). 

Tax Court precedent and the ability to contest the Internal Revenue Service’s (IRS) determination in a prepayment forum are generally viewed as the most important factors weighing in favor of litigating a case in the Tax Court.  Some have viewed the absolute protection afforded to all work product materials espoused in early Tax Court cases as a factor weighing in favor of litigating a case in the Tax Court.  To the extent that absolute protection previously existed, it does so no longer.  Thus, in cases where fact-based work product materials contain particularly sensitive information that could dramatically impact the proceedings, the IRS may be able to obtain such information upon the requisite showing of substantial need and undue hardship.  Further, based on the adoption of the same work product rules contained in FRCP 26(c)(3), it appears that even opinion work product may be subject to discovery if a party makes a showing beyond the substantial need/undue hardship test required for fact-based work product. 

Another important, and yet unresolved, issue is which law will apply in the Tax Court if disputes arise regarding the “undue hardship” exception.  Under Section 7453, the Tax Court is governed by the Federal Rules of Evidence, as its proceedings are conducted in accordance with the rules of evidence applicable to trials without a jury before the U.S. District Court for the District of Columbia.  Therefore, the Tax Court applies the case law of the D.C. Circuit.  The Tax Court is not bound by the FRCP, although it does give weight to the FRCP where there is no applicable rule of procedure.  However, under the rule announced in Golsen v. Commissioner, 54 T.C. 742 (1970), it will defer to clear rulings on issues of law made by the U.S. Court of Appeals in the circuit to which an appeal would lie. 

It is unclear whether the Tax Court will decide disputes over work product by looking to the case law of the D.C. Circuit or the circuit to which an appeal would normally lie.  Prior Tax Court opinions discussing the protection afforded to work product have referenced Section 7453 and D.C. Circuit precedent, as well as precedent from the circuit to which the case was appealable, in discussing the protection afforded to opinion work product.  The question of which law to apply is significant in other areas as well, for example, the high-profile disputes in recent years over the applicability of the work product protection to tax accrual workpapers.  In view of this uncertainty, practitioners and taxpayers need to make sure they are familiar with case law under both the D.C. Circuit and the circuit to which an appeal would normally lie. 

No Discovery of Drafts of Expert Reports

Another substantial change was to the discovery of draft expert reports and communications between experts and counsel.  In the Tax Court, an expert witness’s report is treated as his or her direct testimony, and additional direct testimony is limited.  As adopted, the Tax Court’s rules did not contain a limitation on the discovery of drafts of an expert witness’s report.  In 2010 FRCP 26(b)(4) was amended to provide that drafts of expert witness reports and certain pretrial communications between experts and counsel were not subject to discovery.  In the recent amendments, the Tax Court provided the same discovery protection in its proceedings.

The limitation on the discoverability of drafts of expert reports and communications between experts and counsel should be viewed as a welcome development for many practitioners.  Counsel and an expert often must work together to make sure that the expert’s report addresses the particular issue involved in the case and on which the expert has been retained to opine.  The ability to do so without fear of ghostwriting allegations may promote more precise and helpful reports.  Parties are always free to cross-examine experts regarding the preparation of reports and, ultimately, that may be a more efficient and practical forum to raise any concerns regarding whether the expert or counsel drafted the report.