Editor: Michael Dell, CPA
Procedure & Administration
In his keynote address before the American Bar Association in Toronto on September 24, IRS Commissioner Douglas Shulman announced the much-anticipated release of the final schedule (Schedule UTP) and instructions for disclosing uncertain tax positions, as initially outlined in Announcement 2010-9. Final Schedule UTP differs from the draft schedule in several respects, including:
- For 2010, only corporations with $100 million or more of assets must file Schedule UTP. For corporations with assets below $100 million and greater than or equal to $10 million, the requirement to file Schedule UTP will be phased in over five years.
- Final Schedule UTP drops the draft schedule’s requirement to include a maximum tax adjustment with each tax position disclosed. Instead, the final schedule requires filers to rank their tax positions on an annual basis by the amount of the U.S. federal income tax reserve recorded for each tax position.
- The concise description requirement no longer requires filers to include a rationale and reasons for the uncertainty. Instead, the description must give the IRS sufficient information to reasonably identify the tax position and the nature of the issue.
- Final Schedule UTP eliminates the draft schedule’s requirement to disclose tax positions for which filers did not record a reserve based on an IRS administrative practice of not examining the position.
With the final schedule and instructions, the IRS issued an internal directive for all Large Business and International (LB&I) Division personnel outlining the planned treatment of Schedule UTP information. It also issued Announcement 2010-76, which outlines modifications to the IRS’s policy of restraint, with the guidance package.
Who Must File Schedule UTP
For 2010, corporations with total assets of $100 million or more must file Schedule UTP if:
- They file Form 1120, U.S. Corporation Income Tax Return; Form 1120-L, U.S. Life Insurance Company Income Tax Return; Form 1120-PC, U.S. Property and Casualty Insurance Company Income Tax Return; or Form 1120-F, U.S. Income Tax Return of a Foreign Corporation;
- They or a related party issued audited financial statements reporting all or a portion of their operations for all or a portion of their tax year; and
- They have tax positions subject to disclosure on Schedule UTP.
Form 1120 filers meet the $100 million threshold if the amount reported on page 1, item D, of Form 1120 is $100 million or more. Form 1120-L and 1120-PC filers satisfy the threshold if the higher of their beginning or end-of-year total assets on accompanying Schedule L is $100 million or more. Form 1120-F filers must use worldwide assets to determine whether they meet the threshold, even when filing a protective Form 1120-F.
For corporations with less than $100 million in assets, a five-year phase-in of the Schedule UTP applies. Under the phase-in rule, the total asset threshold will drop to $50 million or more in 2012 and $10 million or more in 2014.
The IRS notes that Compliance Assurance Program (CAP) filers are subject to Schedule UTP filing requirements. In Announcement 2010-75, however, it also announced that it will expand the CAP and make it permanent. It expects to issue details on the program changes shortly, as well as guidance on how CAP filers should comply with Schedule UTP’s disclosure requirements.
As for passthrough entities and tax-exempt organizations, the IRS will consider whether they should be subject to the filing requirement in 2011 or later.
What Must Be Disclosed
The final instructions require filers to disclose each federal income tax position taken on their income tax return if (1) the position is taken on a tax return for the current or prior tax year and (2) either the corporation or a related party recorded a reserve for U.S. federal income tax in an audited financial statement for the position or did not record a reserve for the tax position based on an expectation of litigation.
To be consistent with the determinations made by the corporation or a related party under applicable accounting standards, the final instructions do not require filers to disclose tax positions for which no reserve was required either because (1) the amount was immaterial for audited financial statement purposes or (2) the amount was sufficiently certain so that no reserve was required. As such, a tax position that a filer would litigate if challenged but that is clear and unambiguous or immaterial for audited financial statement purposes is not required to be disclosed.
Finally, the IRS notes that transfer-pricing-related tax positions and valuation-related tax positions are subject to disclosure and are ranked along with all other tax positions disclosed.
The instructions define a related party as an entity with a relationship to the corporation as described in Secs. 267(b), 318(a), or 707(b). A related party may also be an entity that is included in consolidated audited financial statements in which the filer is included.
To address taxpayer concerns, the instructions provide that corporations must disclose only their own tax positions and not those of a related party.
Tax Position Taken in a Return
A tax position taken in a tax return is one that would result in an adjustment to a line item on that tax return (or would be included in a Sec. 481(a) adjustment) if the position were not sustained. The taxpayer should report each tax position separately on Schedule UTP if multiple tax positions affect a single line item on the tax return.
Audited Financial Statement
The final instructions define an audited financial statement as a financial statement in which an independent third party expresses an opinion under GAAP, IFRS, or another country-specific accounting standard, including a modified version of any of these (for example, modified GAAP). The instructions indicate that compiled or reviewed financial statements are not audited financial statements.
Record a Reserve
For purposes of Schedule UTP disclosures, the instructions provide that corporations or related parties record a reserve for a tax position when a reserve for federal income tax, interest, or penalties is recorded in the corporation’s or related party’s audited financial statements.
While the initial recording of a reserve will trigger reporting of a tax position, subsequent increases or decreases in the tax position’s reserve amount will not require the tax position to be disclosed. Three examples are included in the instructions to illustrate the rules for recording a reserve.
Reserve Not Recorded Based on Expectation of Litigation
The instructions outline the circumstances under which a corporation or related party must disclose a tax position for which no reserve is recorded based on an expectation of litigation. Those positions must be disclosed when (1) the corporation or related party determines that the probability of settling with the IRS is less than 50% and (2) the corporation determines that it is more likely than not to prevail on the merits in litigation.
The final instructions do not require disclosure of tax positions taken in tax years before 2010, regardless of whether or when a tax reserve was recorded for the position. To illustrate how the transition rule works, the instructions include an example.
The final instructions direct calendar-year filers or filers whose fiscal year begins in 2010 and ends in 2011 to include the 2010 Schedule UTP with their 2010 federal income tax return. The instructions do not require filers to complete Schedule UTP for a short tax year that ends in 2010.
To allow the IRS to evaluate a position’s materiality, the final instructions require filers to rank the tax positions disclosed on the Schedule UTP based on the amount of recorded U.S. federal income tax reserve for that position. According to the instructions, the size of a tax position for ranking purposes is determined on an annual basis and is the amount of U.S. tax reserve recorded.
Announcement 2010-75, however, indicates that the ranking is based on the recorded U.S. federal income tax reserve (including interest and penalties). The inclusion of interest and penalties could make calculating the size of each tax position for ranking purposes more complicated.
The instructions also require filers to designate tax positions for which the reserve exceeds 10% of the aggregate amount of the reserves for all tax positions disclosed on the schedule, except for positions based on an expectation to litigate. Filers are not required to disclose the actual amounts of the tax reserves.
For reserves that cover multiple tax positions, filers must make a reasonable allocation of the reserve among the various tax positions to determine their respective sizes. Filers do not need to determine a size for tax positions that they expect to litigate. Instead, the instructions permit them to assign these positions any rank.
The determination of the size of a tax position taken by an affiliated group filing a consolidated return is determined at the affiliated group level for all members of the affiliated group.
Filers must include a concise description of the tax positions disclosed on Schedule UTP. The instructions indicate that the description should include relevant facts about the position’s tax treatment and information sufficient to reasonably identify the tax position and inform the IRS of what the issue is. Filers are not required to provide an assessment of the hazards of the tax position or an analysis of the position’s strengths and weaknesses. The instructions include three examples, each of which sets out hypothetical facts and a sample description that the IRS would consider to be sufficient disclosure.
Consistency Between Schedule UTP and Financial Reporting
Announcement 2010-75 notes that filers must identify a unit of account based on FIN 48 principles or consistently apply another level of detail that allows the IRS to reasonably identify the tax position and its underlying issue. As such, IFRS or other non-U.S. GAAP filers may not use their entire tax year as a unit of account. The instructions require the unit of account used by a GAAP taxpayer for reporting a tax position on Schedule UTP to be the same unit of account used by the taxpayer for GAAP reporting. The instructions include an example of two taxpayers that each report under U.S. GAAP and use different units of account for reporting tax positions in connection with the research credit.
The final instructions do not address the possible imposition of penalties on filers that fail to disclose tax positions on Schedule UTP or that disclose them inadequately. The IRS notes in Announcement 2010-75 that it will “review compliance regarding how the schedule is completed by corporations and . . . take appropriate enforcement action, including . . . opening an examination or making another type of taxpayer contact.”
Minimizing Duplicate Reporting
To minimize duplicate reporting, the final instructions treat the “complete and accurate” disclosure of a tax position on “the appropriate year’s” Schedule UTP as satisfying the requirement to file Form 8275, Disclosure Statement, or Form 8275-R, Regulation Disclosure Statement. Similarly, the instructions treat the complete and accurate disclosure of tax positions on Schedule UTP as satisfying the disclosure requirements of Sec. 6662(i), provided the disclosed position is not a reportable transaction.
The IRS also plans to revise Schedule M-3, Net Income (Loss) Reconciliation for Corporations with Total Assets of $10 Million or More, to reduce duplicate reporting. As part of the revision process, it will form a working group and collaborate with external stakeholders to develop “appropriate revisions,” beginning in 2011.
Exchange of Information
Responding to taxpayer concerns, in Announcement 2010-75 the IRS also stated that it would refrain from exchanging information disclosed on the Schedule UTP with foreign governments unless the United States had a reciprocal arrangement with another country to share uncertain tax position information. Before disclosing the information under a reciprocal agreement, however, the IRS would consider other factors, such as the relevance of the information to the foreign government.
Schedule UTP, Part I
Final Schedule UTP is divided into three parts. Part I requests information on current-year tax positions and is divided into six columns, (a)–(f). These columns request the following information:
- Column (a) requires corporations to number their tax positions.
- Column (b) requests the primary Code sections related to the tax position and allows corporations to list up to three.
- Column (c) asks the corporation to indicate, by checking the appropriate box, whether the tax position creates temporary or permanent differences. If the tax position creates both, the corporation must check both boxes.
- Column (d) is used if the tax position relates to a passthrough entity. If so, the corporation must provide the employer identification number of the passthrough entity to which its tax position relates, or enter “F” for a foreign entity without such a number.
- Column (e) asks the corporation to indicate if the tax position is major by checking a box if the tax position is greater than or equal to 10% of all tax positions listed on the form.
- Column (f) requires the corporation to rank the tax positions from largest to smallest. To identify the type of position and rank, corporations must enter a “T” in column (f) for transfer-pricing-related tax positions, followed by a number representing that tax position’s rank (e.g., T1). A “G” must be entered for all other tax positions. Positions with an expectation of litigation may be assigned any ranking number.
To address taxpayer concerns over the related-party provisions, Part I asks the corporation to indicate by checking a box if it was unable to determine whether it had tax positions to disclose because it could not obtain sufficient information from one or more related parties.
Schedule UTP, Part II
Part II is used to report tax positions for prior tax years that have not previously been reported. Its format mirrors columns (a)–(f) of Part I and also includes the same related-party checkbox.
Column (g) in Part II asks corporations to list the prior tax year in which the tax position was taken and the last month of that tax year, using a six-digit number (e.g., 201012 for tax positions in tax years ending December 31, 2010, that were not disclosed on a 2010 Schedule UTP).
The instructions for Part II indicate that the IRS does not expect corporations to complete Part II for 2010 tax years.
Schedule UTP, Part III
Part III of the draft form provides space for corporations to provide a concise description of each of their numbered tax positions, as discussed above.
Internal Directive for LB&I Personnel
As part of its implementation of Schedule UTP, the IRS also issued an internal directive for all LB&I Division personnel outlining the planned treatment of Schedule UTP information. According to the directive, the IRS will centralize initial processing of Schedule UTP information to identify trends, determine compliance with the schedule, and note areas where further guidance may be needed.
The directive reminds LB&I examiners of the need to approach tax positions on audit with impartiality and to be mindful of “their responsibility to apply the law as it currently exists, not how we would like it to be.” It emphasizes that tax positions are uncertain for a number of reasons, including ambiguity in the law. As such, items disclosed on Schedule UTP may not require an examination or an audit adjustment. The directive also reminds examiners that Schedule UTP is not intended as a substitute for other examination tools or for independent judgment, nor should it be used to shortcut other parts of the audit process.
Policy of Restraint
To address taxpayer concerns over Schedule UTP’s effect on attorney-client privilege, tax practitioner privilege, the work-product doctrine, and the IRS’s policy of restraint, IRS Announcement 2010-76 describes changes to the policy of restraint as it affects information requested under the final Schedule UTP. The IRS intends to modify Internal Revenue Manual (IRM) Section 4.10.20 to incorporate the announced changes.
The policy of restraint as outlined in the announcement states that the IRS will not assert that privilege has been waived when an otherwise privileged document is provided to an independent auditor as part of an audit of the taxpayer’s financial statements. That exception does not apply if the taxpayer has taken actions that would otherwise waive the privilege or if the IRS makes a request for tax accrual workpapers under IRM Section 22.214.171.124 because of unusual circumstances or because listed transactions are involved.
The policy of restraint also states that taxpayers may redact certain information from requested tax reconciliation workpapers related to the preparation of Schedule UTP, including information related to the development of the concise description of tax positions, the amount of any reserve related to a tax position, and computations to determine the ranking of tax positions reported on the schedule or the designation of a tax position as a major tax position.
LB&I examiners are instructed to engage with taxpayers early on to eliminate uncertainty as quickly as possible and to discuss the issues disclosed on the Schedule UTP in advance of issuing the initial information document requests. The directive states that current quality review standards will be adjusted to ensure that LB&I examiners follow the processes outlined in the directive.
In response to comments received from taxpayers and others, the IRS made a number of improvements to the earlier proposed requirements. However, the final guidance introduces new requirements that are complex and require further clarification.
The issuance of a final schedule and instructions makes it important for companies with assets of $100 million or more that issue audited financial statements to prepare for filing the Schedule UTP with their 2010 tax returns. Companies can also obtain further clarity on their uncertain tax positions and consider other methods to mitigate risk. Tax return reporting will require planning for new procedures and controls that need to be implemented in order to report all the information required. Planning for the changes to compliance processes and procedures should begin as soon as possible so that necessary data are captured during the provision cycle.
Michael Dell is a partner at Ernst & Young LLP in Washington, DC.
For additional information about these items, contact Mr. Dell at 202-327-8788 or email@example.com.