Tax Accounting
The new IRS Schedule UTP, Uncertain Tax Position Statement, reporting uncertain tax positions has been interpreted as requiring corporate taxpayers to disclose their FIN 48 positions. While this proposition is not exactly correct, it has certainly caused concern among corporate taxpayers. In preparing for disclosure of uncertain tax positions on the Schedule UTP, it is important to understand the differences between financial statement reporting and federal income tax return disclosure.
Financial Accounting Standards Board (FASB) Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxes, issued in June 2006 (and now located in Topic 740 of FASB’s Accounting Standards Codification), has been effective for public reporting companies since 2007. Under FIN 48, a reporting company has to identify all its open tax positions and determine whether it is more likely than not that each tax position can be sustained on its technical merits. If so, the company must calculate how much of the tax benefit taken on the return can be reported in the financial statements. This is done according to the measurement system provided in the interpretation. For open tax positions that do not meet the more likely than not (MLTN) standard, the company may not report any benefit from the position unless, and until, the uncertain position is resolved in the taxpayer’s favor or the statute of limitation for that issue expires.
Last year, the IRS proposed the new Schedule UTP to be filed with tax returns for calendar year 2010 by taxpayers that file Forms 1120, U.S. Corporation Income Tax Return; 1120-PC, U.S. Property and Casualty Insurance Company Income Tax Return; 1120-L, U.S. Life Insurance Company Income Tax Return; and 1120-F, U.S. Income Tax Return of a Foreign Corporation, where the Schedule L balance sheets in those forms report total assets of $100 million or more (T.D. 9510; Announcement 2010-75). (There are transition rules that reduce the total asset threshold for filing to $10 million for 2014 tax returns.) IRS guidance for Schedule UTP does not specifically define what constitutes an uncertain tax position. Instead, the IRS refers to “a tax position relating to a specific federal tax return for which a taxpayer is required to reserve an amount under FIN 48” (Announcement 2010-9). Schedule UTP requires taxpayers to list uncertain tax positions, but the schedule is significantly different than the FIN 48 disclosure for the financial statement.
In preparing a financial statement, FIN 48 requires a company to review each tax position (subdivided into units of account) and prepare an analysis of whether the position meets the MLTN standard. The company’s analysis will be subject to review by the company’s auditors before the financial statement can be certified. The MLTN standard also applies to past tax positions that may be open to adjustment under the statute of limitation.
Schedule UTP requires taxpayers to provide the relevant Internal Revenue Code sections associated with the uncertain tax position and also requires a “concise description” of the tax position, including a description of the relevant facts. Taxpayers must list “uncertain tax positions” on the schedule by ranking the positions in order of size (based on the actual tax reserve amounts for each uncertain tax position), but they are not required to disclose the amount of potential tax liability related to the uncertain tax position. In 2010, Schedule UTP looks at positions for calendar year 2010 only and does not look at uncertain tax positions in previously filed returns.
The FASB illustrative guidance for applying FIN 48 provides an example with the research tax credit demonstrating the analysis required for recording a tax position for financial statement purposes (FIN 48, Appendix A, ¶A5). In the example, the taxpayer determines that a unit of account is each project that makes up qualified research for the credit. In analyzing the projects, it is determined that in one project, the activities may not meet the statutory definition of research and therefore do not reach the MLTN standard needed to sustain any tax benefits associated with the project. Consequently, the taxpayer can realize a tax benefit in its financial statement for those activities that meet the MLTN standard but not for the activity that may fall short of the standard.
Disclosures of tax positions that do not meet the MLTN standard are done in a “tabular” manner under FIN 48. The disclosure in the financial statement shows a liability for unrecognized tax benefits (a reduction to retained earnings) with additions to the balance for current positions and reductions to the liability as positions from prior years become settled. Interest and penalties, if applicable, are recorded as an operating expense or as part of the income tax expense, at the election of the company. FIN 48 does not require a detailed item-by-item disclosure in the financial statement, although determining the overall liability requires an item-by-item analysis.
Schedule UTP requires a similar analysis, but the information disclosed with the tax return specifies only the issue for which a FIN 48 liability was determined, the applicable Code sections, a concise description of the issue, and whether the issue has a permanent or a temporary tax effect. Schedule UTP does not require a disclosure of the amount of potential adjustment or the amount of unrealized tax benefit under FIN 48.
In the FIN 48 example above concerning the research tax credit, the financial statement would show an increase in unrecognized tax benefits but would not identify the issue associated with the increase. For Schedule UTP, the taxpayer would list the Code section related to the issue (Sec. 41), rank the research tax credit position relative to other issues that are uncertain under FIN 48, and provide a concise description of the issue.
The instructions to Schedule UTP provide some guidance concerning a concise description of the issue. The description need only “reasonably apprise” the IRS of the issue and in most cases “should not exceed a few sentences.” As a consequence, taxpayers must identify the issue but need not provide a detailed analysis. Generally, Schedule UTP does not require more information than a taxpayer would have provided in disclosing a position on Forms 8275, Disclosure Statement, or 8275-R, Regulation Disclosure Statement.
In the example of the research credit, merely identifying that some of the research expenses may not meet the definition of “qualified research” may be enough to apprise the IRS of the nature of the issues. Identification of the specific activities and why the activity is uncertain is probably not required in the Schedule UTP disclosure. However, because there are many unanswered questions regarding the sufficiency of disclosure through a “concise statement,” it is anticipated that the IRS will issue further guidance.
One significant difference between FIN 48 and Schedule UTP is the reporting of a tax position the client intends to litigate. For FIN 48 purposes, a taxpayer can fully realize a tax benefit if it expects to litigate the “winner take all” position and believes that it will more likely than not prevail in court. Schedule UTP requires the taxpayer to disclose the position to the IRS even if no adjustment was made under FIN 48 and all the benefit is reported in the financial statement.
While new Schedule UTP plays off the FIN 48 analysis, there are significant differences in what a taxpayer must disclose to the IRS on Schedule UTP and the determination of a tax benefit for financial statement purposes. Taxpayers can expect more guidance from the IRS.
EditorNotes
Neal Weber is managing director-in-charge, Washington National Tax, with RSM McGladrey, Inc., in Washington, DC.
For additional information about these items, contact Mr. Weber at (202) 370-8213 or neal.weber@mcgladrey.com.
Unless otherwise noted, contributors are members of or associated with RSM McGladrey, Inc.
