Tax Alert
May 2010
Authors:
Ronald D. Kerridge
ron.kerridge@klgates.com
+1.214.939.5774
Adam J. Tejeda
adam.tejeda@klgates.com
+1.212.536.4888
K&L Gates includes lawyers practicing out
of 36 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.
IRS Releases Draft Schedule and Instructions
for Uncertain Tax Positions Proposal
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). On April 19, 2010, in Announcement 2010-30,
the IRS released a draft schedule (“Schedule UTP”) and draft instructions to provide
further explanation of the IRS’s proposal.
The authors of this Tax alert will be participating in a panel discussion addressing the
issues presented herein, “Reporting Uncertain Tax Positions: Implications of the
New IRS Return Schedule,” sponsored by Strafford Publications, on May 6, 2010.
Information regarding this panel discussion can be found by going to
http://www.straffordpub.com/products/reporting-uncertain-tax-positionsimplications-of-the-new-irs-return-schedule-2010-05-06.
The proposed requirement to disclose uncertain tax positions has been met with
disfavor by corporate taxpayers. According to IRS Chief Counsel William Wilkins,
issue identification is a central objective of the proposal. Understandably, many
taxpayers fear that the IRS will use Schedule UTP as a roadmap for audit and set up
everything disclosed on the new Schedule UTP with the amount of the maximum tax
adjustment (“MTA”), discussed below, as the proposed adjustment. IRS officials
have been disputing this fear and reiterating that the purpose behind the proposed
Schedule UTP is to increase the efficiency of the audit process. Speaking at the 60th
Tax Executives Institute Midyear Conference in Washington, D.C., Heather Maloy,
commissioner of the IRS Large and Midsize Business Division, said fears are
unfounded that auditors would use the positions reported in the new schedule as the
basis for an audit adjustment or use the MTA as reported on Schedule UTP as a
starting point for an audit.
Although Schedule UTP is designed to help the IRS identify and prioritize issues in
an audit, the IRS previously announced in Announcement 2010-9 that it would not
otherwise alter its “policy of restraint” as to when it requests tax accrual workpapers
during the course of examinations. Even though Schedule UTP is less detailed than
customary tax accrual workpapers, by requiring certain taxpayers to file Schedule
UTP, it appears that the IRS is eroding its “policy of restraint” regarding tax accrual
workpapers.
Furthermore, the proposed schedule, if adopted, may indirectly alter the reporting
standard that applies for determining when a position must be disclosed on a tax
return. Existing corporate 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
Tax Alert
not substantial authority, but only if those positions
are disclosed on the return. On the other hand, as
described below, a taxpayer subject to the Schedule
UTP filing requirements must report uncertain tax
positions on Schedule UTP if the taxpayer or a
related party has recorded a reserve with respect to
such tax position in an audited financial statement.1
In general, the requirement to record a reserve in an
audited financial statement, such as those prepared
based on United States GAAP, 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.2 Congress
recently conformed the tax standard for avoiding
penalties to the MLTN standard, but then retreated
in the face of substantial criticism. However,
corporate taxpayers required to file Schedule UTP
described in Announcement 2010-30 may be
required to satisfy a higher level of authority with
respect to uncertain tax positions than those
currently required in order to avoid penalties.
The IRS invites public comment on the draft
Schedule UTP and instructions, which should be
submitted by June 1, 2010. While the window of
opportunity to submit comments regarding the
proposed Schedule UTP and instructions is closing,
please contact us if you would like assistance in
submitting such comments or to otherwise discuss
the impact Schedule UTP may have on your
organization.
Schedule UTP and accompanying instructions will
be finalized after the IRS has received and
considered all of the comments regarding the overall
1
For purposes of draft Schedule UTP, audited financial
statements generally refer to financial statements prepared
based on United States Generally Accepted Accounting
Principles (“GAAP”), International Financial Reporting
Standards (“IFRS”), or other country-specific accounting
standards, including a modified version of any of the
aforementioned standards (for example, modified GAAP).
2
Accounting standards other than United States GAAP may
incorporate a standard other than the MLTN standard in
determining whether a reserve must be recorded in audited
financial statements.
proposal and the draft Schedule UTP and
instructions.
Brief Summary of Draft Schedule UTP
and Instructions
In general, the draft Schedule UTP and instructions
provide that, beginning with the 2010 tax year, a
corporation must file Schedule UTP with its federal
income tax return if:
1. The corporation files 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;
2. The corporation has assets equal to or
exceeding $10 million;
3. The corporation or a related party issued an
audited financial statement and the audited
financial statement covers all or a portion
of the corporation’s operations for all or a
portion of the corporation’s tax year; and
4. The corporation has one or more tax
positions (i.e., generally, a tax position that
would result in an adjustment to a line item
on a tax return if the position is not
sustained) that (i) the corporation or a
related party has recorded a reserve with
respect to such tax position in an audited
financial statement or (ii) the corporation or
a related party decided not to record a
reserve with respect to such tax position
based on an expectation to litigate or an
IRS administrative practice of not
challenging the tax position during an
examination.
The draft instructions to Schedule UTP also provide
that, for 2010 tax years, the IRS will not require a
Schedule UTP from Form 1120 series filers other
than those identified above (such as real estate
investment trusts or regulated investment
companies), pass-through entities, or tax-exempt
organizations. The IRS will determine the timing of
the requirement to file Schedule UTP for these
May 2010
2
Tax Alert
entities after comments have been received and
considered.
The draft instructions to Schedule UTP specifically
provide that a corporation or a related party record a
reserve with respect to a tax position taken by the
corporation when the audited financial statements of
the corporation or related party reflect (i) an increase
in a liability for income taxes payable or a reduction
of an income tax refund receivable with respect to
the tax position, (ii) a reduction in a deferred tax
asset or an increase in a deferred tax liability with
respect to the tax position, or (iii) both (i) and (ii).
The initial recording of a reserve will trigger
reporting of a tax position, but subsequent reserve
increases or decreases with respect to a tax position
taken in a tax return will not.
The draft instructions to Schedule UTP explain that
a tax position is required to be reported on a
Schedule UTP attached to a particular tax year’s
return if (i) at least 60 days before filing the tax
return a reserve has been recorded with respect to
that tax position, or at least 60 days before filing the
tax return a decision was made not to record a
reserve based on an expectation to litigate or an IRS
administrative practice, and (ii) the tax position has
been taken by the corporation in a tax return for the
current tax year or a prior tax year. The reason for
the 60-day cutoff for requiring corporate taxpayers
to report an uncertain tax position on Schedule UTP
appears to be the IRS’s understanding that a
taxpayer may not have solidified its reserve
positions by the time its tax return is filed.
Further, the draft Schedule UTP and instructions
provide that a corporation that reports a tax position
on Schedule UTP is required to provide a concise
description of each tax position and the MTA with
respect to each tax position.
The concise description of each tax position reported
on Schedule UTP should include information that
reasonably can be expected to apprise the IRS of the
identity of the tax position and the nature of the
uncertainty. In particular, the description must
include (i) a statement that the position involves an
item of income, gain, loss, deduction, or credit
against tax; (ii) a statement whether the position
involves a determination of the value of any
property or right or a computation of basis; and (iii)
the rationale for the position and the reasons for
determining the position is uncertain. In most cases,
the description should not exceed a few sentences.
The MTA for a tax position taken in a tax return is
an estimate of the maximum amount of potential
United States federal income tax liability associated
with the tax year for which the tax position was
taken (excluding interest and penalties). A
determination of the MTA is not required for tax
positions related to valuation or transfer pricing
issues. Instead, the MTA reporting requirement is
satisfied by indicating whether the tax position is a
valuation or a transfer pricing tax position and by
providing a ranking of these tax positions based on
either the amount recorded as a reserve for United
States federal income tax for that tax position taken
in the tax return, or the estimated adjustment to
United States federal income tax that would result if
the tax position taken in the tax return is not
sustained.
The draft instructions also provide that a complete
and accurate disclosure of a tax position on the
appropriate year’s Schedule UTP will be treated as
if the corporation filed a Form 8275, Disclosure
Statement, or Form 8275-R, Regulation Disclosure
Statement, regarding the tax position. A separate
Form 8275 or Form 8275-R need not be filed to
avoid penalties with respect to that tax position.
*
*
*
Circular 230 Notice
To ensure compliance with requirements imposed by the IRS, we
inform you that any U.S. federal tax advice contained in this
communication (including any attachments) is not intended or written to
be used, and cannot be used, for the purpose of (i) avoiding penalties
under the Internal Revenue Code of 1986, as amended or (ii)
promoting, marketing or recommending to another party any
transaction or matter addressed within.
May 2010
3
Tax Alert
Anchorage Austin Beijing Berlin Boston Charlotte Chicago Dallas Dubai Fort Worth Frankfurt Harrisburg Hong Kong London
Los Angeles Miami Moscow Newark New York Orange County Palo Alto Paris Pittsburgh Portland Raleigh Research Triangle Park
San Diego San Francisco Seattle Shanghai Singapore Spokane/Coeur d’Alene Taipei Tokyo Warsaw
Washington, D.C.
K&L Gates includes lawyers practicing out of 36 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.
K&L Gates is comprised of multiple affiliated entities: a limited liability partnership with the full name K&L Gates LLP qualified in Delaware and
maintaining offices throughout the United States, in Berlin and Frankfurt, Germany, in Beijing (K&L Gates LLP Beijing Representative Office), in
Dubai, U.A.E., in Shanghai (K&L Gates LLP Shanghai Representative Office), in Tokyo, and in Singapore; a limited liability partnership (also named
K&L Gates LLP) incorporated in England and maintaining offices in London and Paris; a Taiwan general partnership (K&L Gates) maintaining an
office in Taipei; a Hong Kong general partnership (K&L Gates, Solicitors) maintaining an office in Hong Kong; a Polish limited partnership (K&L
Gates Jamka sp. k.) maintaining an office in Warsaw; and a Delaware limited liability company (K&L Gates Holdings, LLC) maintaining an office in
Moscow. K&L Gates maintains appropriate registrations in the jurisdictions in which its offices are located. A list of the partners or members in each
entity is available for inspection at any K&L Gates office.
This publication is for informational purposes and does not contain or convey legal advice. The information herein should not be used or relied upon
in regard to any particular facts or circumstances without first consulting a lawyer.
©2010 K&L Gates LLP. All Rights Reserved.
May 2010
4