Reporting Uncertain Tax Positions to the IRS

Procedure & Administration

On January 26, 2010, the IRS issued Announcement 2010-9, indicating that it intends to require certain corporate taxpayers to disclose information about their uncertain tax positions on their tax returns. The IRS’s stated purpose for the disclosure is to improve tax compliance and administration. The disclosure requirements, expected to be effective no earlier than the 2010 tax filing year, include filing a new schedule that the IRS is developing for inclusion with Form 1120, U.S. Corporation Income Tax Return, or other business tax returns. Tax practitioners need to understand the background leading up to the changes and closely follow these potential new regulations and their pervasive effects on clients in order to be prepared for the change and to notify clients.

Disclosure of Uncertain Tax Positions

In the wake of Enron and other financial statement frauds, the information disclosures required under GAAP have increased significantly, including the reporting rules related to uncertain tax positions. In 2006, Financial Accounting Standards Board (FASB) Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxes, replaced Statement of Financial Accounting Standards (FAS) No. 5, Accounting for Contingencies, requiring any uncertain tax positions taken by a company on its tax return to meet a more-likely-than-not standard of being upheld in order to be recorded in its financial statements. (Under the FASB codification of accounting standards, the relevant portions of FIN 48 are now mostly contained in Accounting Standards Codification subtopic 740-10, Income Taxes, FASB ASC 740-10.)

In recent years, the IRS has also been pushing for more disclosure and transparency in tax filings. Some prominent examples of this are the creation of Schedule M-3 in 2004, increased informational reporting requirements, enforcement of foreign bank account reporting, and the complete revamping of Form 990, Return of Organization Exempt from Income Tax.

Affected Parties

The IRS intends for the new schedule to be filed by a business taxpayer with assets in excess of $10 million if the taxpayer has one or more uncertain tax positions of the type required to be reported on the new schedule. This includes taxpayers who prepare financial statements, or are included in the financial statements of related entities that prepare financial statements, if the taxpayers or related entities determine their U.S. federal income tax reserves under FIN 48 or other accounting standards relating to uncertain tax positions involving U.S. federal income tax.

Requirements

The IRS is developing a schedule that will require certain filers to provide information under the new rules; it anticipates releasing a draft version of the schedule in early April. Applicable businesses would have to supply the IRS with (1) concise descriptions of each uncertain tax position for which the taxpayer or a related entity has recorded a reserve on their 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 the likelihood of prevailing on its merits).

The scope of uncertain tax positions required to be disclosed is broader than required by FIN 48. The new schedule will also require disclosure of uncertain tax positions where the taxpayer has not recorded a reserve because of the taxpayer’s expectation of litigation of the matter or the taxpayer’s belief that the IRS has an administrative practice of not challenging the position.

Although the announcement does not specify what constitutes an appropriate concise description, it does provide general guidelines for an adequate description under the new proposed schedule. The necessary information required for the concise description will be determined on a case-by-case basis depending on the taxpayer’s facts and the nature of the underlying transaction. As currently contemplated in Announcement 2010-9, this description will include the rationale for the position and a concise general statement of the reasons for determining that the position is an uncertain tax position. In every situation a sufficient description must contain the following:

• The Code sections potentially implicated by the position;
• A description of the tax years to which the position relates;
• A statement that the position involves an item of income, gain, loss, deduction, or credit against tax;
• A statement that the item involves a permanent inclusion or exclusion of any item, the timing of the item, or both;
• A statement of whether the position involves a determination of value of any property or right; and
• A statement of whether the position involves a computation of basis.

In addition, the schedule will require a taxpayer to specify for each uncertain tax position the entire amount of the U.S. federal income tax that would be due if the position were disallowed in its entirety on audit. This amount is the maximum tax adjustment for the position, reflecting all changes to items of income, gain, loss, deduction, or credit if the position is not sustained.

Discoverability of Tax Accrual Workpapers on Audit

In Announcement 2010-9, the IRS indicates that it will continue to exercise a policy of restraint in demanding tax accrual workpapers, following Internal Revenue Manual Section 4.10.20. The IRS further stated that it will continue to review the policy and to consider additional modifications as appropriate or necessary to ensure that it obtains complete and accurate information regarding a taxpayer’s uncertain tax positions on a timely basis.

Implications

It is too early to say with any certainty how applicable businesses will be affected by these new rules, but it seems clear that if the rules are put in place, it will be substantially easier for the IRS to identify companies with uncertain tax positions and to audit these positions. Because most of the affected taxpayers will already have prepared analyses for their uncertain tax positions, the IRS believes that the new requirements will not create significant additional work. In an effort to enforce compliance, the IRS is contemplating potential sanctions and may have discussions with Congress about new penalties, although congressional approval is not needed to implement the proposal.

Conclusion

To fully appreciate the pervasiveness of Announcement 2010-9, practitioners need to understand the backdrop under which it was made. The IRS is soliciting public comments on the announcement to help shape the final rules; additional guidance should be forthcoming once the IRS has considered those comments. Comments are due by June 1, 2010, and can be e-mailed to announcement.comments@irscounsel.treas.gov, with a subject line that reads “Announcement 2010-9.”

The future regulations will have serious implications for businesses subject to these rules, and practitioners should keep abreast of related updates, future rulings, and the resulting ramifications for ongoing tax compliance and planning for their clients.

Editor: Kevin D. Anderson, CPA, J.D.

EditorNotes

Kevin Anderson is a partner, National Tax Services, with BDO Seidman, LLP, in Bethesda, MD.

For additional information about these items, contact Mr. Anderson at (301) 634-0222 or kdanderson@bdo.com.

Unless otherwise noted, contributors are members of or associated with BDO Seidman, LLP.