## Facts

- The IRS challenged transfers from a related corporation to a partnership as disguised gifts; the taxpayers treated them as loans.
- In consolidated Tax Court proceedings, the IRS sought electronically stored information (ESI) contained on two backup tapes, requesting either production of responsive ESI or production of the tapes themselves.
- The IRS asserted the tapes were needed to evaluate metadata, document creation dates, and transfers relevant to the dispute.
- The taxpayers argued the request was overbroad and unduly burdensome, estimating manual review would take months and cost at least $450,000.
- The taxpayers also asserted the tapes contained privileged and confidential information requiring screening before any production.
- As an alternative to manual review or producing the tapes to the IRS, the taxpayers sought permission to use predictive coding (technology-assisted review) to identify responsive, non-privileged ESI.
- The IRS opposed predictive coding as unproven and preferred direct access to the tapes, proposing a clawback arrangement for privileged material.
- The Court heard expert testimony that predictive coding is widely used, reliable, and cost-effective for sorting large volumes of information.

## Issues

1. Whether a producing party in Tax Court discovery may use predictive coding to search backup tapes for responsive, non-privileged ESI, rather than manually reviewing all tape contents or producing the tapes to the requesting party.

## Decision

- The Court granted the IRS’s motion to compel in part, requiring production of discoverable ESI from the backup tapes.
- The Court authorized the taxpayers to use predictive coding as the method to identify responsive, non-privileged ESI for production.
- The ruling was an interlocutory discovery order and did not decide the merits of the tax characterization dispute.

## Legal Principles

- Discovery of ESI must be managed with attention to relevance, proportionality, cost, and burden, while protecting privileged and confidential information.
- Technology-assisted review, including predictive coding, may be a reasonable and permissible method for identifying responsive ESI when manual review would be disproportionately expensive or time-consuming.
- A producing party may be allowed to conduct an initial review process that preserves privilege screening, instead of turning over entire data repositories to the requesting party.
- Objections to the adequacy of a predictive-coding process may depend on implementation and results, rather than a categorical rejection of the method.

## Conclusion

The Tax Court allowed the taxpayers to use predictive coding to locate and produce responsive, non-privileged ESI from backup tapes, treating the method as an acceptable and proportional discovery tool that can reduce burden while maintaining privilege protections.


Dynamo Holdings Ltd. P’ship v. Comm’r, 143 T.C. No. 9 (2014)