This is is a tax procedure case. The IRS filed a motion to compel production of documents (Rule 37 of the Federal Rules of Civil Procedure and Rule 72 of the Tax Court Rules of Practice and Procedure). The partnership asserted that the documents were privileged under section 7525(a).
The section 7525(a) privilege protects tax advice between a taxpayer and a federally authorized tax practitioner (FATP). The section states that this is the same privilege that would exist between a taxpayer and an attorney.
A Federally Authorized Tax Practitioner is defined as "any individual who is authorized under Federal law to practice before the Internal Revenue Service if such practice is subject to Federal regulation under section 330 of title 31, United States Code." Clear as mud. Generally, an attorney, a cpa, and an enrolled agent are allowed to practice before the IRS, but I will need to confirm if this generality applies here.
"Tax Advice means advice given by an individual with respect to a matter which is within the scope of the individual’s authority to practice described in subparagraph (A)." -- subparagraph (A) refers to the paragraph that defines a Federally Authorized Tax Practitioner. Clearer than mud.
There are two important exceptions to this privilege under section 7525(b). The first exception is that the privilege does not apply in criminal proceedings. This makes sense because if you are facing criminal charges you need an attorney not a Federally Authorized Tax Practitioner (though the two can be the same). The second exception is that the privilege does not apply to written communication promoting tax shelters.
It is this second exception that the IRS tries to assert in the present case. The Tax Court focused on two items in denying the IRS's motion. First, the requirement that the communication be written, and second that the communication promote tax shelters.
The IRS argued that notes, written down by the taxpayer, of an oral conversation between the FATP and the taxpayer constituted written communication. The Tax Court rejected this argument for two reasons. First, the communication was not in writing but was oral. Second, the taxpayer did not share his notes with anyone.
In rejecting the promotion requirement, the Tax Court referred to legislative history for guidance on the word "promotion." Specifically referring to a House Conference Report that stated , "[T]he Conferees do not understand the promotion of tax shelters be part of the routine relationship between a tax practitioner and a client." Here, the FATP had a "longstanding" relationship with the taxpayer that existed prior to the transactions at issue. The Tax Court dedicates an entire page to describing their relationship. Among other things, the Tax Court describes their fee arrangement, the length of their relationship, the scope of the services provided, and the FATP's source of knowledge.
As mentioned, the 7525(b) test has two parts; for all practical purposes the IRS lost after the Court determined the communication was not written - the Court even says so on page 8. It is interesting, therefore, that the Tax Court devotes 50% of the opinion (the last seven pages) to discussing the second part of the test. Given the relationship between the FATP and the taxpayer (all on record), perhaps this was a good opportunity for the Court to emphasize factors to consider in determining whether someone is "promoting a tax shelter."
As a final note, like the attorney-client privilege, the privilege here can be waived. There is an ongoing case in the First Circuit, United States v. Textron, Inc., 560 F.3d 513, 2009 U.S. App. LEXIS 10679 (1st Cir. 2009), that will have important implications. I will post an update when the case is over.