Reporting of Uncertain Tax Positions on the Tax Return

At the New York State Bar Association Tax Section meeting on January 25, IRS Commissioner Douglas Shulman announced the good news – the IRS has no current intention to change its policy of restraint in asking for disclosure of a taxpayer’s tax accrual work papers. But that news was balanced by news that, quite frankly, may be more onerous. While the IRS will leave the Fin 48 work papers alone (absent unusual circumstances), that is because taxpayers will now be required to disclose with their tax returns any uncertain tax position. The outline of the proposal is found in Announcement 2010-9.

One attendee at the meeting described the reaction of the audience to the announcement by Commissioner Shulman as follows: One half of the attendees turned absolutely white, and the other half were busy lifting their jaws off of the floor. Such reactions seem completely understandable given the scope of the Announcement.

Under the proposal, business taxpayers with total assets of $10 million or more and one or more uncertain tax positions will be required to complete a new schedule to be attached to the 1120 or other business return. The schedule will require:

• a concise description of the uncertain tax position, and
• the maximum amount of the potential federal tax liability attributable to each uncertain position.

As currently contemplated, there’s not a lot of wiggle room on what comprises a concise description. It would need to contain:

• the Code sections implicated
• the tax years to which the position relates
• information on whether it is a permanent or timing difference for any tax item
• a statement as to whether the position involves a determination of value of any property or right, and
• a statement as to whether the position involves a basis computation.

There is little guidance in the Announcement on when there is an uncertain tax position. Clearly, if the taxpayer has put up a FIN 48 reserve, or other reserve for taxes under its accounting standards, such as the International Financial Reporting Standards, the Announcement assumes there is an uncertain tax position. It also provides that if no FIN 48 reserve has been provided because the taxpayer expects to litigate the issue, or the taxpayer has determined that the IRS has a general administrative practice to not exam the issue, the issue is still an uncertain tax position that must be disclosed. There are other exceptions to FIN 48 disclosure – for example if there is sufficient third-party indemnification for the tax risk, a FIN 48 reserve may not be needed. That is because FIN 48 is looking to provide an accurate financial picture of the taxpayer. The Announcement has a different goal – to make it easier for the IRS to quickly and efficiently identify significant issues and prioritize the focus of audits. Presumably any exceptions to FIN 48 that do not support the goal of the Announcement will not be respected for purposes of the schedule.

Once a taxpayer has a disclosable uncertain tax position, it needs to list on the schedule the maximum amount of potential federal tax liability if the position were disallowed in its entirety on audit. There is no offset for evaluation of ability to settle, or the possible outcome of litigation. Thus, the amount recorded for FIN 48 purposes may be considerably less than what will need to be on the schedule. Based on the request for comments we expect to see considerable attention paid to the parameters of the definition of "maximum."

This tax return reporting requirement may drive changes in taxpayer reporting under FIN 48. Assume a taxpayer takes a tax position for which it has an opinion that the position "should" be sustained. In certain circumstances, even with a "should" opinion taxpayers may decide to put up a reserve to be conservative. Once that reserve is put on, the Announcement would require that it be disclosed on the schedule, with the maximum federal tax liability at risk reported. If it is not included in the FIN 48 reserve, as currently worded in the Announcement, no reporting would be required with the tax return. Given the competing interests, it will not be as attractive to be conservative.

The reporting may also have an effect on allocation of tax risks in transactions. If in fact a position is covered by insurance, and does not need to be included in a FIN 48 reserve because of the lack of risk, it is unclear whether the position would have to be disclosed under the Announcement. It is not specified as an uncertain position, but it would be consistent with the intent of the Announcement, which is to enable the IRS to streamline audits and make more informed decisions on the areas that should be given priority.

The reporting is expected to be required for tax returns filed after the release of the schedule. Corporate returns for calendar year 2009 may well be subject to the reporting requirement if the schedule is released before the filing date.