IRS Committed to Requiring Taxpayer Disclosure of Uncertain Tax Positions
On April 18, 2010, Internal Revenue Service (IRS) issued its long-awaited draft schedule for disclosure of uncertain tax positions, creatively named Schedule UTP, and a companion announcement, Announcement 2010-30. The form itself is accompanied by nine pages of instructions with numerous examples.
Notwithstanding push-back from the taxpayer and practitioner communities, IRS appears committed to pursuing this form of disclosure as a means to streamline and focus its resources. IRS indicates Schedule UTP will first be effective for returns filed for taxable years beginning in 2010. As a consequence, uncertain tax positions being taken in first quarter earnings releases may create disclosure obligations in the 2010 return.
The Schedule itself is divided into three parts. In the first part, the taxpayer lists each current year uncertain tax position providing a number, primary code sections, whether the effect of the item is timing or permanent, the employer identification number of any pass-through entity item, whether the administrative practice rule applies and the maximum tax adjustment. In the second part, the taxpayer lists each prior year uncertain tax position providing the same information as for a current year uncertain tax position as well as the year of the uncertain tax position. In the third part, the taxpayer must provide a short description for each uncertain tax position listed in the first and second parts. The uncertain tax position numbers must be sequential and no numbers should be skipped. The taxpayer must also check a box if it was unable to determine whether there were uncertain tax positions taken by related parties.
Who Must File?
Schedule UTP must be filed by any corporation (or a related party) that has over $10 million in assets and uncertain tax positions in audited financial statements. For this purpose, uncertain tax positions include not only positions for which reserves are recorded, but also positions for which no reserve is recorded because the company plans to litigate the issue. In other words, if IRS knew of the item and the chance of settlement is less than 50% then a reserve may not be recorded if the company plans to litigate the issue. Such an item would nevertheless be disclosed on Schedule UTP. Also, uncertain tax positions include those for which no reserve is recorded because IRS, as an administrative practice, does not raise the issue. For example, the item would not be reserved if past IRS administrative practices and precedents indicate IRS will not challenge the treatment in an examination. Nevertheless, such an item would be disclosed on Schedule UTP.
When is Disclosure Required?
To be disclosed, the uncertain tax position must be reserved or a decision reached not to reserve 60 days or more before the tax return is filed. Positions reserved or decided within 60 days of filing the return would generally be reported in the following year as a prior year item. Audited financial statements for this purpose include quarterly audited earnings releases as well as non-GAAP audited financial statements that require a reserve for uncertain tax positions. Each unit of account identified for purposes of preparing the audited financial statements must be reported in Schedule UTP with the consequence that a single line on the tax return may have multiple Schedule UTP disclosures. Prior year disclosures appear to include any uncertain tax positions in ANY prior tax return—no limit is stated in the instructions. The only exception is a transition rule that limits disclosure generally to tax years beginning after December 15, 2009. Further, if the uncertain tax position is recurring, e.g., an accounting method, then it must be reported separately for each affected year in which a reserve is established.
Disclosure is limited to Forms 1120, 1120F, 1120PC and 1120L. Determination of whether assets equal or exceed $10 million is based on information reported in Part 1, Box D of Form 1120 or the higher of the beginning or end of year amounts on Schedule L of Forms 1120F, 1120PC or 1120L. These disclosures extend to protective filings. Only one Schedule UTP is required for a consolidated return, with no need to designate the member of the group with the uncertain tax position.
What Information is Disclosed?
Part III of Schedule UTP requires a brief description of the uncertain tax position. IRS provides several examples that illustrate the detail required by the description. Each example is in a three part, three sentence format stating in one sentence each: the facts, the treatment followed in the return and the issue presented by that treatment.
The taxpayer must also disclose the maximum tax adjustment from disallowance of the uncertain tax position. The calculation of the maximum tax adjustment that is reported is determined for each item separately and is based on the maximum adjustment possible multiplied by the tax rate without any reduction for other items such as net operating losses or credits. If there are several components of the position, they may be netted against one another for purposes of calculating the maximum tax adjustment. There should be one calculation for a position for an affiliated group. A special calculation is permitted for valuation and transfer pricing tax positions using the amount recorded as a financial statement reserve, or by the estimated tax return adjustment that would be imposed if the position were sustained.
Reporting on Schedule UTP will be treated as disclosure on Form 8275 or 8275R.
What Reporting Triggers Disclosure?
An uncertain tax position must be reported on an audited financial statement or a decision must have been made not to disclose based on an intention to litigate the position or because of an IRS administrative practice. An audited financial statement for this purpose is any statement on which an unrelated third party expresses an opinion under any accounting standard. Recording a reserve includes increasing a liability for income taxes payable, decreasing an income tax refund receivable, reducing a deferred tax asset or increasing a deferred tax liability. It includes an audited financial statement for the taxpayer or a related party. The initial recording triggers the reporting but subsequent increases or decreases do not. These adjustments may relate to items flowing through partnerships in which the corporation has invested on Schedule K-1. Related parties for this purpose include any entity related to the taxpayer under Sec. 267(b), 318(a), or 707(b) and any entity included in the consolidated return.
What are the Planning Opportunities?
The following planning opportunities are apparent from the draft Schedule UTP:
- The ability to file a return within 60 days after a reserve is established or a decision is made without disclosure may defer the reporting to the following year. By that time, the taxpayer may have resolved the issue.
- Book and tax units of account are the same. Consideration should be given to whether the taxpayer could support the use of a unit of account that presents the position in the most favorable light.
- It may be possible to resolve uncertain tax positions through opinion letters, method changes, IRS rulings, pre-filing agreements or audit settlement before disclosure is required.
- The assets reported on the tax return are the basis for determining whether the taxpayer is over the $10 million cut-off for disclosure. This reporting should be examined for appropriateness if the company is near the $10 million cut-off level. There are limited opportunities to use the tax books for this purpose.