In two announcements on September 24, the IRS unveiled a number of significant changes to its plan to require certain business taxpayers to report uncertain tax positions on their tax returns (Announcements 2010-75 and 2010-76). The changes come in response to numerous comments received on the proposal and on the draft form (Schedule UTP) and instructions, which were released in April. Along with the announcements, the IRS released a final Schedule UTP, Uncertain Tax Position Statement, and instructions.
As originally proposed (Announcement 2010-9), the schedule would require:
(1) A concise description of each uncertain tax position for which the taxpayer or a related entity has recorded a reserve in its financial statements, and
(2) The maximum amount of potential federal tax liability attributable to each uncertain tax position (determined without regard to the taxpayer’s risk analysis regarding its likelihood of prevailing on the merits).
According to the IRS, many commentators expressed concerns about how the IRS would use the reported information, about how the new reporting requirement would affect the IRS’ existing policy of restraint, about the reporting requirement’s burden on affected corporations, and about how the reporting requirement would affect the relationship between corporations and the IRS or between corporations and their advisers or independent auditors. Some commentators questioned the IRS’ authority to require reporting of uncertain tax positions with the corporation’s tax return.
The AICPA previously raised numerous concerns and made many specific recommendations regarding the IRS’s original proposal in a comment letter on June 1, 2010. The AICPA urged the IRS to improve the use and management of the significant amount of disclosed information it already possesses. If the IRS went forward with the proposal, the AICPA recommended that the filing threshold be significantly elevated in order to exempt many small businesses. The AICPA also recommended that the IRS pilot the proposed uncertain tax position program and reserve judgment about its expansion until it could evaluate the consequences.
The major changes the IRS made in response to the comments received from the AICPA and others were:
- A five-year phase-in of the reporting requirement based on a corporation’s asset size;
- No reporting of a maximum tax adjustment;
- No reporting of the rationale and nature of uncertainty in the concise description of the position; and
- No reporting of administrative practice tax positions.
The IRS also made numerous other changes and clarifications.
The draft release of Schedule UTP narrowed the initial filing requirement to corporations that issued audited financial statements and file Form 1120, U.S. Corporation Income Tax Return; Form 1120-F, U.S. Income Tax Return of a Foreign Corporation; Form 1120-L, U.S. Life Insurance Company Income Tax Return; or Form 1120-PC, U.S. Property and Casualty Insurance Company Income Tax Return.
In Announcement 2010-75, the IRS retains the filing requirement for taxpayers required to file the previously identified list of federal tax forms, but institutes a five-year phase-in of the requirement for corporations with assets under $100 million. Corporations with total assets of $100 million or more must file Schedule UTP starting with 2010 tax years. Starting with 2012 tax years, the total asset threshold will be reduced to $50 million. Starting with 2014 tax years, it will be reduced to $10 million.
The IRS stated that it will consider whether to extend the Schedule UTP reporting requirement to other taxpayers—such as passthrough entities or tax-exempt organizations—for 2011 or later tax years.
No Reporting of a Maximum Tax Adjustment
The draft schedule and instructions proposed that the corporation report a maximum tax adjustment for each tax position listed on the schedule, other than transfer pricing and other valuation positions. Many commentators expressed concern that computing the maximum tax adjustment for each uncertain tax position would be unduly burdensome, would provide the IRS with misleading information about the riskiness of the position and its magnitude, or would not provide a meaningful basis for determining the issues or returns to examine.
Based on the commentary, the IRS removed the proposed requirement to report the maximum tax adjustment. Instead, corporations will be required to rank their reported tax positions (including transfer pricing and other valuation positions) based on the federal income tax reserve (including interest and penalties) recorded for the position taken in the return, and to designate those tax positions for which the reserve exceeds 10% of the aggregate amount of the reserves for all of the tax positions reported on the schedule.
The IRS expects that this ranking method will allow it to more accurately evaluate the materiality of the issues reported on the schedule and that the ranking method will impose less burden on corporations. This method relies on the reserve computations that corporations perform for audited financial statement purposes, but does not require disclosure of the actual amounts of the tax reserves.
No Reporting of the Rationale and Nature of Uncertainty
Commentators also expressed concern about the requirement that the rationale for an uncertain tax position, as well the nature of the uncertainty, be disclosed as part of the concise description. They noted that these disclosures are not required by FASB Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxes, and that they conflict with both the IRS’s policy of restraint and its objective not to require taxpayers to disclose their assessment of their positions’ strengths and weaknesses. In response to these comments, the IRS has eliminated the proposed requirement to include the rationale and nature of the uncertainty in the concise description.
No Reporting of Administrative Practice Tax Positions
The proposal also required corporations to report tax positions for which the corporation recorded no reserve because it determined that it is the IRS’s administrative practice not to raise the issue during an examination. Many commentators said it would be unduly burdensome for corporations to identify, describe and quantify these positions, and would provide the IRS very little useful information. The IRS has agreed that these concerns about the administrability of the requirement outweigh the value of the information and thus eliminated the proposed requirement. However, the IRS stated it will continue to explore ways to assess the impact of these tax positions on overall tax compliance.
Consistency Between Schedule UTP Reporting and Financial Statement Reserve Decisions
Corporations filing Schedule UTP must report tax positions taken in a return for which reserves were created under applicable financial accounting standards or for which no reserve was created because of an expectation to litigate. The final instructions clarify that Schedule UTP seeks the reporting of tax positions consistent with the reserve decisions made by the corporation for audited financial statements purposes. Corporations are not required to report tax positions that are either immaterial under applicable financial accounting standards or are sufficiently certain so that no reserve is required under those standards. The IRS stated that a tax position that a corporation would litigate, if challenged, but that is clear and unambiguous or is immaterial is therefore not required to be reported on Schedule UTP.
The proposal required a corporation to report a tax position taken in a return for which no reserve was recorded based on the corporation’s expectation to litigate the position. Commentators suggested eliminating this requirement, either because it would be unduly burdensome to identify, describe and quantify these positions, or because requiring reporting of these positions on Schedule UTP departs from the IRS’ stated objective of consistency with financial accounting standards. However, the final schedule and instructions retain the requirement to report tax positions taken in a return for which no reserve was recorded because of an expectation to litigate the position and incorporate revised instructions to clarify the meaning of expectation to litigate. The final instructions clarify that a corporation may rely on the reserve decisions it made for financial statement purposes to complete Schedule UTP and thus the corporation is not expected to reassess at the time the schedule is completed those reserve decisions previously made for financial statement purposes. The final instructions do not provide guidance on how a corporation documents an expectation to litigate a position. However, the IRS states in Announcement 2010-75 that it expects that a corporation would continue to document its decision in the same way as it substantiates any decision not to record a reserve in its financial statements.
Other Changes and Clarifications
Schedule UTP requires the reporting of U.S. federal income tax positions but not foreign or state tax positions. Under the general reporting instructions, however, a corporation is required to report a U.S. federal income tax position taken in a return that arises out of uncertainty with regard to a foreign tax position (for example, foreign tax credits) if a reserve for U.S. federal income tax was recorded to reflect that uncertainty.
The final instructions clarify that:
- A tax position is reported on Schedule UTP once (1) a reserve for a tax position is recorded and (2) a tax position is taken on a return regardless of the order in which those two events occur.
- Corporations report their own tax positions on Schedule UTP and do not report the tax positions of a related party.
- Tax positions taken in years before 2010 need not be reported in 2010 or a later year even if a reserve is recorded in audited financial statements issued in 2010 or later.
- Schedule UTP need not be filed for short tax years ending in 2010.
- Worldwide assets are used to determine whether a corporation that files a Form 1120-F (including a protective return) must file Schedule UTP.
The IRS revised the definition of audited financial statement to clarify that an audited financial statement is one on which an independent auditor expresses an opinion. Compiled or reviewed financial statements are excluded from the definition of audited financial statement.
The definition of “record a reserve” was revised to clarify that it includes the recording of a reserve for U.S. federal income tax, interest or penalties, and to reinforce that temporary differences must be reported on Schedule UTP.
For corporations included in multiple audited financial statements, the instructions clarify that recording a reserve in any audited financial statement in which the corporation is included triggers reporting of the tax position if the tax position is taken on a return filed by the reporting corporation.
The IRS has also issued a directive concerning the use of Schedule UTP by IRS personnel. The directive outlines the various uses for the information reported on the schedule and indicates that initial processing of Schedule UTP information will be centralized to ensure appropriate review to identify trends and areas requiring further guidance to address uncertainty in the law.
The final instructions do not provide specific instructions regarding penalties. The IRS stated it intends to review Schedule UTP compliance and will take appropriate enforcement action in those instances in which there appears to be a failure to complete the schedule or a failure to report whether the corporation is required to complete the schedule.
The IRS stated it recognizes that today’s announcements do not address all comments or concerns that were raised, and it stated it will continue to consider these issues and how best to provide further guidance.
Policy of Restraint
In Announcement 2010-76, the IRS said that it is expanding its policy of restraint in connection with its decision to require certain corporations to file Schedule UTP and it will forgo seeking particular documents that relate to uncertain tax positions and the workpapers that document the completion of Schedule UTP. It stated that other than requiring the disclosure of the information on the schedule, the requirement to file Schedule UTP does not affect the policy of restraint.
Under the IRS’s policy of restraint, if a document is otherwise privileged under the attorney-client privilege, the tax advice privilege in Sec. 7525, or the work product doctrine, and the document was provided to an independent auditor as part of an audit of the taxpayer’s financial statements, the IRS will not assert during an examination that privilege has been waived by such disclosure.
In its announcement, the IRS stated that taxpayers may redact the following information from any copies of tax reconciliation workpapers relating to the preparation of Schedule UTP that they are asked to produce during an examination:
(a) Working drafts, revisions or comments concerning the concise description of tax positions reported on Schedule UTP;
(b) The amount of any reserve related to a tax position reported on Schedule UTP; and
(c) Computations determining the ranking of tax positions to be reported on Schedule UTP or the designation of a tax position as a major tax position.
The AICPA appreciates the efforts of the IRS to revise and clarify its original proposal and to reduce the burden the disclosure of uncertain tax positions will place on taxpayers. The IRS has listened to commentators, including recommendations included in the AICPA’s comment letter of June 1, 2010. This is reflected in the many changes throughout the latest IRS announcements and final 2010 Schedule UTP and instructions.
However, the AICPA is still concerned regarding:
- The burden this will place on smaller taxpayers when it is fully phased-in in 2014 because the threshold was not increased;
- The potential burden this may place in future years on passthrough entities and tax-exempt organizations;
- Duplicative reporting and the ultimate benefit to the government of the information received.
The AICPA will continue to raise appropriate issues with the IRS on this matter and push for a study period as outlined in its initial comment letter. It will continue to communicate the concerns and advocate for its members regarding the disclosure of uncertain tax positions.