With year-end financial reporting nearly done for corporate tax departments, thoughts are now turning to IRS tax filings and dreaded new measures intended to help government auditors sniff out more tax dollars.

Companies with $100 million or more in assets will be required to include Schedule UTP with their 2010 tax return, a new form from the Internal Revenue Service that requires companies to disclose and rank their uncertain tax positions. The form is expected to serve as a de facto cover sheet to the tax return, giving IRS examiners and auditors a roadmap to the shakiest positions in the overall filing.

Tax departments planning to file the 2010 corporate returns in September are now taking steps to determine how their work preparing for year-end financial statements can feed into the UTP filing. Experts say companies are deciding which uncertain positions to report, how to rank them, and how to describe them to the IRS.

The stakes are high for the largest companies, according to Kathy Petronchak, a director with Deloitte Tax. During a recent Webcast on Schedule UTP, Petronchak described a professional conference where an IRS commissioner said the agency is allocating audit resources so that all companies reporting $20 billion or more in assets will face an audit. For companies in the $10 billion to $20 billion range, audit coverage will be 80 percent; and for companies in the range of $5 billion to $10 billion, audit coverage will be 50 percent, Petronchak said. “We can expect the IRS to be looking closely, particularly at those with $10 billion or more in assets,” she said.

Wayne Corini, a partner with accounting firm BDO, says many of his clients are already assessing what they will be reporting in financial statements to determine what information should transfer to the Schedule UTP. For example, if a company has booked a reserve in the financial statements for a tax position taken in 2010, that must be reflected in the UTP, he says. Companies can, however, remove from the UTP any reserve taken for positions that aren't related to federal tax, such as uncertainties around state or local taxes.

Some tax staff have questioned what to do with reserves or uncertainties that predate the 2010 financial statements or tax return, Corini says. Schedule UTP distinguishes between tax positions taken in the current year and those from prior years, but Corini says for 2010 tax returns companies are only required to report positions taken in 2010 or positions where a reserve was booked or altered in 2010. “If you've got a reserve that was hung up a few years ago and it's still hanging around, you are not required to disclose that on the UTP,” he says.

The Litigation Snafu

Perhaps the biggest debates are over how to fulfill the disclosure requirement for uncertain positions that don't have a reserve, says Mike Dolan, a director in the national tax practice of KPMG and former deputy commissioner at the IRS. The IRS requires companies to include on the UTP any position where no reserve was recorded because of an expectation to litigate. “There are a lot of people who still can't get their heads around precisely what that means,” he said.

In its Webcast, Deloitte says the requirement would apply when a company intends to litigate a particular position, where it assesses the probability of settling with the IRS to be less than 50 percent, and where it believes it is more likely than not to prevail in litigation on the merits of the position. “The IRS is saying if a taxpayer has not recorded a reserve because it expects to litigate … we want to know about that,” says John Keenan, a director with Deloitte Tax.

“We can expect to see the IRS will be looking closely particularly at those with $10 billion or more in assets.”

—Kathy Petronchak,

Director,

Deloitte Tax

Companies are also sorting through exactly what to include in the “concise description” that the IRS requires regarding each uncertain position, Dolan says. Tax staff are weighing the merits and risks of saying as much or as little as possible in those descriptions. “Some are worried that if they say too much, they might be waiving some kind of privilege they would otherwise be entitled to,” he says. “Others say if they describe it fully, [the IRS] will see it's not a terribly significant transaction.” Tax staff likely will proceed with lots of trial-and-error, drafting and redrafting those descriptions before the process is complete, adds John Aksak, managing director with tax consulting firm True Partners.

Then there's the question of how to rank positions in the UTP. The ranking should be based on materiality, but some companies are having trouble with that, according to John Bennecke, also a managing director at True Partners. They hear the message from the IRS that the intention is to identify the most significant issues that require examination quickly, but tax professionals have a difficult time with the notion that they're essentially expected to help the IRS do its job. “None of us grew up that way as tax professionals,” he says.

Another wrinkle to the UTP analysis is its relationship to the recent codification of the “economic substance doctrine,” says Randy Robason, partner in charge of tax accounting and risk advisory services at Grant Thornton. The doctrine was included in the healthcare reform law to give sharper teeth to the idea that a transaction must have a real economic purpose (beyond simply avoiding taxes) to pass muster with the IRS.

UTP OVERVIEW, REQUIREMENTS

Who Must File Schedule UTP?

Schedule UTP Reporting Requirements

Source: Deloitte Webcast: IRC Section 6662 and Schedule UTP.

The IRS has already cracked down on clearly abusive measures meant to shelter income from tax, and plenty of clear-cut transactions easily qualify as having economic substance. “The difficult part is that about 95 percent of what goes on in the real world falls between those two extremes,” says Robason. “If you're structuring a transaction today, there's always a question in the back of your mind: What could be attacked by Treasury at their discretion?”

As companies sort through their uncertain positions for UTP purposes, they should also consider the economic substance doctrine, he says, which is driving even greater conservatism and uncertainty in tax work these days.

Robason worries markets could see more for 8-K filings like the one filed recently by Weatherford International, citing a $500 million restatement related to taxes. The company reported a material weakness because of inadequate staffing and technical expertise, ineffective review and approval practices, inadequate processes around reconciliation of tax accounts, and inadequate controls over the quarterly tax provisioning process. “Every significant company out there is dealing with those exact same four items,” he says.