Tax Alert
February 2010
Authors:
Roger S. Wise
roger.wise@klgates.com
IRS Announces Plans to Require Disclosure of
Uncertain Tax Positions
202.778.9023
Adam J. Tejeda
adam.tejeda@klgates.com
212.536.4888
K&L Gates includes lawyers practicing
out of 35 offices located in North
America, Europe, Asia and the Middle
East, and represents numerous GLOBAL
500, FORTUNE 100, and FTSE 100
corporations, in addition to growth and
middle market companies,
entrepreneurs, capital market
participants and public sector entities.
For more information, visit
www.klgates.com.
On January 26, 2010, the Internal Revenue Service (“IRS”), in Announcement 20109, announced that it is developing a schedule that would require many large business
taxpayers to disclose uncertain tax positions on their tax returns (but not the amount
of the reserve or risk assessment). Although this schedule is designed to help the
IRS identify and prioritize issues in an audit, the IRS would not otherwise alter its
“policy of restraint” as to when it requests tax accrual workpapers during the course
of examinations. As discussed below, the announcement may be an effort by the IRS
to solidify its recent victory on tax accrual workpapers in Textron.1
According to the announcement, a business taxpayer with total assets in excess of
$10 million would be required to disclose uncertain U.S. federal income tax positions
(“uncertain tax positions”) on a schedule to be filed with the taxpayer’s annual tax
returns if the taxpayer (i) prepares financial statements or is included in the financial
statements of a related entity that prepares financial statements and (ii) is required to
establish income tax reserves under FASB Interpretation No. 48 (“FIN 48”),2 or
other accounting standards (such as International Financial Reporting Standards)
relating to such uncertain tax positions. Additionally, uncertain tax positions would
include tax positions with respect to which the taxpayer has not established a reserve
because the taxpayer expects to litigate the position or the taxpayer has determined
that the IRS has a general administrative practice not to examine the position.
The schedule would require:
•
a concise description of each uncertain tax position for which the taxpayer or
related entity has recorded a reserve in its financial statements, and
•
the maximum amount of potential federal tax liability attributable to each
uncertain tax position if such position were disallowed in its entirety on
audit (determined without regard to the taxpayer’s risk analysis regarding its
likelihood of prevailing on the merits).
The description would need to be in sufficient detail so that the IRS could determine
the nature of the issue which, as currently contemplated, would include the rationale
for the position and a concise general statement of the reasons for determining that
the position is an uncertain tax position. However, the schedule would not request
the amount of the reserve or the taxpayer’s risk assessment.
1
United States v. Textron Inc. and Subsidiaries, 577 F.3d 21 (1st Cir. 2009) (en banc).
The relevant portions of FIN 48 are now codified in FASB Accounting Standards Codification
subtopic 740-10, Income Taxes (FASB ASC 740-10).
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Tax Alert
The announcement states that the IRS may seek
legislation imposing a penalty for failure to file the
schedule or to make adequate disclosure (no
indication of such a penalty was included in the
President’s 2011 budget proposal).
The IRS anticipates publishing a notice of proposed
rulemaking on this topic and has invited public
comment on the proposal by March 29, 2010.
Based on a speech delivered to the New York State
Bar Association by Commissioner of Internal
Revenue Douglas Shulman, the purpose of the
proposed schedule is to increase the efficiency of the
audit process. In his prepared remarks,
Commissioner Shulman stated that the goals of the
proposal are “to cut down the time it takes to find
issues and complete an audit… ensure that both the
IRS and taxpayer spend time discussing the law as it
applies to their facts, rather than looking for
information… and to help [the IRS] prioritize
selection of issues and taxpayers for examination.”
In other words, the schedule could provide an audit
“roadmap” for the IRS. This roadmap would be
imperfect because the schedule would only include
the maximum possible exposure with respect to each
uncertain tax position, rather than the reserve
amount or risk assessment for each such position. In
Textron, the First Circuit recently upheld the right of
the IRS to request tax accrual workpapers over
taxpayer claims of privilege and work product
protection. The proposed schedule may represent an
effort by the IRS to stake out a defensible position
on this issue that could withstand likely Supreme
Court review of the case.
The proposed schedule, if adopted, indirectly alters
the reporting standard that applies for determining
when a position must be disclosed on a tax return.
Existing business tax returns generally do not
require taxpayers to identify and explain uncertain
tax positions underlying their returns, so long as
there is “substantial authority” that such positions
would be sustained if litigated. Substantial authority
is a standard that may be satisfied even if the
taxpayer or tax return preparer determines that the
tax return position has less than a 50% chance of
success if litigated. A taxpayer may avoid penalties
for positions for which there is not substantial
authority, but only if those positions are disclosed
on the return. FIN 48, by contrast, incorporates a
“more likely than not” (“MLTN”) standard,
requiring affected taxpayers to establish a reserve
with respect to a particular tax position if the
taxpayer determines that it has a 50% or less chance
of success in defending such position in litigation.
Congress recently conformed the tax standard for
avoiding penalties to the FIN 48 MLTN standard,
but then retreated in the face of substantial criticism.
Accordingly, business taxpayers required to file the
schedule described in Announcement 2010-9 would
be required to satisfy a higher level of authority
with respect to uncertain tax positions than those
currently required in order to avoid penalties.
Certain taxpayers are also already required to file
Schedule M-3, explaining book/tax differences in
their returns (many of which are timing issues). The
IRS may intend that the schedule will do a better job
of identifying key issues for audit than has been the
case with Schedule M-3.
Commissioner Shulman downplayed the burden of
additional disclosure requirements on affected
taxpayers. “We [the IRS] do not believe we will be
adding substantial new work or burden on
taxpayers. These taxpayers are already required to
establish tax reserves for uncertain tax positions in
determining their financial statement income under
US or foreign accounting standards, such as FIN 48.
So the work is already being done. We are asking
for more transparency.”
.
February 2010
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Tax Alert
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February 2010
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