IRS Preps Push to Disclose Uncertain Tax Positions

The Internal Revenue Service is gearing up a new campaign to have companies disclose the uncertainty they have about positions they’re claiming on the corporate tax return.

Its plan: to require any company with assets of at least $10 million to complete a new schedule with its tax return that notes any positions that may carry some uncertainty, and the maximum dollar amount the company might potentially pay if the claim flunked a legal challenge.

That scenario is exactly what companies feared in 2005 and 2006, when the Financial Accounting Standards Board adopted Financial Interpretation No. 48, Accounting for Uncertainty in Income Taxes. FIN 48 requires companies to report in their financial statements where they have some uncertainty about tax positions they’ve taken in their tax returns; when FASB debated the idea five years ago, critics said such disclosure would be a roadmap for the IRS to decide whom it would audit.

Shulman

Now, apparently, the IRS wants exactly that. When IRS Commissioner Doug Shulman announced the initiative at a meeting of the New York State Bar Association in January, he said companies complying with FIN 48 are already doing much of the work that would go into the new tax disclosure requirement. “We are asking for more transparency,” he said. “We do not believe we will be adding substantial new work or burden on taxpayers.”

Not all tax experts agree that’s the case. Christopher Arndt, managing director for RSM McGladrey, notes that FIN 48 sets a threshold for certainty—“more likely than not”—which has been pegged at 51 percent or greater. The IRS requires companies to have “substantial authority” for making a tax claim in their tax returns, which the tax profession estimates at only 30 to 40 percent.

But the IRS announcement does not specify the agency’s threshold for “uncertainty,” so tax experts aren’t sure that the information they capture in their FIN 48 compliance processes will also be enough to comply with the IRS plan. In other words, if the IRS wants disclosure of anything less than 100 percent certainty but more than the 51 percent threshold, companies might not have all the evidence they need to justify positions in that 51 to 99 percent range.

“FIN 48 says you have to book a reserve unless you think it is more likely than not that you will prevail,” Arndt says. “That is a much higher standard than ‘substantial authority’ on tax returns … It’s a completely different way of analyzing what the issues are. The process to accumulate that information as part of the audit process will significantly change, I think, if companies now have to report that on their tax return.”

Shulman said the IRS is planning the new requirement in pursuit of “certainty, consistency, and efficiency for us and taxpayers.” The disclosure would give an IRS examiner or auditor a high-level view of the tax return to help plan the examination or the audit, he said.

Browne

Jim Browne, a partner with the law firm Strasburger & Price, questions that logic. He says the plan suggests examiners or auditors will gravitate toward the items with the biggest potential dollar loss—but those items aren’t necessarily the ones with the most uncertainty. “You may have a very high level of confidence that this item is correct, but it happens to be a big item in the tax return,” he says.

The IRS is accepting comments on the proposed disclosure requirement through March 29, and tax experts are advising companies to take advantage of the comment period to be sure the IRS is aware of all concerns and issues.

The Paperwork Question

Another key difference between FIN 48 and the proposed IRS requirement is that the IRS is not asking for the analysis or judgment behind the uncertainties, Browne says.

“We are asking for more transparency. We do not believe we will be adding substantial new work or burden on taxpayers.”

—Doug Shulman,

Commissioner,

Internal Revenue Service

Indeed, asking for those analyses is a sensitive matter the IRS wants to handle delicately. Companies enlist tax advisers to compile plenty of documentation, called tax accrual work papers, to develop their tax plans and support the tax positions they take in their tax returns. Such documentation has long been subject to protection under attorney-client privilege rules, although court cases have established that the IRS can ask for those documents anytime it wishes. In response, the IRS has long followed a “policy of restraint,” promising it won’t ask for the work papers unless it finds evidence of abusive tax sheltering.

FIN 48, however, complicated that arrangement considerably. Auditors started demanding to see tax accrual papers so they can attest what the company discloses in its financial statements, jeopardizing the papers’ legal protections. Textron Inc. then filed a lawsuit seeking to shield its papers from government scrutiny, but lost that argument in federal appeals court last year. The company has petitioned the U.S. Supreme Court to hear its case, but the court has not yet decided whether to take up the question.

Werner

“The whole purpose of the policy of restraint was that the IRS wants people to be free to get the best tax advice they can, without worrying about it being available to the IRS,” says Kenneth Werner, a partner with the law firm Richards, Kibbe & Orbe. “They don’t want to discourage people from getting tax advice.”

But, Browne and Werner both say, the new disclosure requirement comes awfully close to lifting that policy of restraint. “The only thing that they’re not getting is taxpayer judgment,” Browne says. “They’re getting half of what they are saying they won’t ask for.”

Sparagana

The good news is that the IRS says the new disclosures are not likely to be required until companies are filing their 2010 returns next year, says Giovanna Sparagna, a partner at law firm Sutherland Asbill & Brennan. Corporate tax officers had originally feared that the new schedule would be needed for the 2009 returns they are preparing now, and “a lot of people were trying to get their tax returns done quickly to beat the schedule,” Sparagna says. That worry, at least, is off the table.

IRS REQUIREMENTS

Below is an excerpt from the IRS announcement “Uncertain Tax Positions – Policy of Restraint”:

The [Internal Revenue] Service is developing a schedule that will require certain filers to provide information about their uncertain tax positions that affect their United States federal income tax liability. This schedule will be filed with the Form 1120, U.S. Corporation Income Tax Return, or other business tax returns. The schedule will require (i) a concise description of each uncertain tax position for which the taxpayer or a related entity has recorded a reserve in its financial statements and (ii) the maximum amount of potential federal tax liability attributable to each uncertain tax position (determined without regard to the taxpayer’s risk analysis regarding its likelihood of prevailing on the merits).

In addition to those positions for which a tax reserve must be established under FIN 48 or other accounting standards, uncertain tax positions will include any position related to the determination of any United States federal income tax liability for which a taxpayer or a related entity has not recorded a tax reserve because (i) the taxpayer expects to litigate the position, or (ii) the taxpayer has determined that the Service has a general administrative practice not to examine the position. For this purpose, a related entity is any entity that is related to the taxpayer under sections 267(b), 318(a), or 707(b).

The schedule will require a concise description of each uncertain tax position in sufficient detail so that the Service can determine the nature of the issue. The sufficiency of a description will depend on the taxpayer’s particular facts and the nature of the underlying transaction. As currently contemplated, this concise description will include the rationale for the position and a concise general statement of the reasons for determining that the position is an uncertain tax position. To be sufficient, the description must contain:

The Code sections potentially implicated by the position;

A description of the taxable year or years to which the position relates;

A statement that the position involves an item of income, gain, loss, deduction, or credit against tax;

A statement that the position involves a permanent inclusion or exclusion of any item, the timing of that item, or both;

A statement whether the position involves a determination of the value of any

property or right; and

A statement whether the position involves a computation of basis.

In addition, the schedule will require a taxpayer to specify for each uncertain tax

position the entire amount of United States federal income tax that would be due if the position were disallowed in its entirety on audit. This amount is the maximum tax adjustment for the position reflecting all changes to items of income, gain, loss, deduction, or credit if the position is not sustained.

Source

IRS

Still, she says, companies have many other worries to occupy their time. “You wonder once they adopt this policy of asking taxpayers to list their uncertain tax positions whether for prior years you might still get the question from an auditor,” Sparagna says. “That is unclear right now.”

Companies are also fretting about whether the IRS might share what it learns through the new disclosure requirement with other countries under information-exchange treaties. “If foreign countries know that the IRS has this information, foreign treaty partners may start to request such information where relevant to tax positions that may impact the determination of foreign tax,” she said.

Lowell

Cym Lowell, a tax partner with the law firm Gardere Wynne Sewell, said during a recent Thomson Reuter Webcast on the subject that the new filing requirement may compel more corporate taxpayers to look into early workout programs with the IRS. These include pre-filing agreements, private letter rulings, advance pricing agreements for transfer pricing issues, compliance assurance programs, and other arrangements offered by the IRS to work out questions, uncertainties, and sticky issues before they become the subject of audit or litigation.

“We find our clients increasingly have an interest in these programs for a variety of reasons,” he said, including just getting them off the table when dealing with the company’s auditors. Companies are taking a hard look at the cost of taking a tax position that they might later have to defend through documentation, audits, and possible IRS examination or litigation.

Luscombe

Mark Luscombe, a principal federal tax analyst for CCH, says it’s hard to say whether the planned disclosure requirement will drive companies to become more conservative in taking tax positions. That has already been happening thanks to sustained regulatory attacks on tax shelters, he says. “This will probably somewhat continue that trend, just knowing that more detailed information about those transactions will be readily accessible to the IRS,” he says.