Best Practices for Creating, Maintaining, and Protecting State Income Tax Audit Files

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Introduction

This decade has brought significant change to the legal landscape facing large, multistate taxpayers. The Sarbanes-Oxley Act of 2002 created sweeping rules that increased financial oversight and forced taxpayers to reevaluate the provision of non-audit services by public accounting firms. Management must now evaluate income tax positions for financial statement purposes using the heightened more-likely-than-not standard of FASB Interpretation No. 48 (FIN 48). These changes have led taxpayers to create and maintain more detailed documentation to support their income tax return positions.

As the volume of tax-related documentation has increased, taxpayer expectations of maintaining any protection from the disclosure of those documents have eroded to the point that many taxpayers now assume that all documents must be turned over in the context of state tax litigation. The First Circuit’s recent decision in United States v. Textron1 has furthered this perception. Workproduct protection, however, remains a fundamental component of the American judicial system and qualifying documents can retain protection — even in the context of state taxation.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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