The Internal Revenue Service is pushing a dramatic expansion of how tax returns must report the certainty of the tax positions they claim, imposing new burdens on tax preparers and essentially forcing the already unpopular rule for financial statements onto the corporate tax return.
The change in tax compliance is part of a provision in a federal appropriations bill signed by President Bush in late May. It says that preparers of tax returns—from the Big-4 firms handling returns for global corporations to the storefront shops helping sole proprietors and individuals—are held to a higher standard of certainty about the assertions contained in a tax return when signing the return as preparer.
Charnas
Previously, preparers could submit returns with tax positions that were “no-frivolous,” having a realistic possibility of success, says Douglas Charnas, a partner with law firm McGuireWoods. Under the new requirements, preparers must have a reasonable belief that a particular tax position is “more likely than not” the correct tax treatment.
That “more likely than not” standard is the same one the Financial Accounting Standards Board established in Financial Interpretation No. 48, which took effect earlier this year. FIN 48 requires companies to demonstrate a tax position is more likely than not to be sustained by tax authorities before reporting its effect in their financial statements. Corporate America has deep fears that the IRS will use those disclosures to determine who gets an audit, and how. The IRS itself has said it will do precisely that with FIN 48 data.
Wilson
The new law also imposes new penalties on preparers who fail to meet the standard, says Pete Wilson, managing director at accounting firm RSM McGladrey. Moreover, it extends the standard to cover preparers of not only income tax returns, but also returns for employment, excise, estate and gift taxes, as well as returns for exempt organizations.
“My sense in talking to people is that this has come as a surprise,” Charnas says. “You get blindsided every now and again by provisions that get slipped in at the last minute but you usually have a sense for what’s on the table. It surprised me because I wasn’t paying attention to the bill.”
Wilson says tax authorities and legislators have been vocal about their desire to close the “tax gap,” or the difference between what taxpayers should be paying and what actually goes into federal coffers. He says the goal of the provision is essentially to discourage taxpayers from taking aggressive tax positions. “There may be cases where a taxpayer won’t take a position because it’s hard to meet the more-likely-than-not standard,” he says. “That's what Congress was thinking.”
The IRS-issued transitional guidance in Notice 2007-54 shortly after the bill—the U.S. Troop Readiness, Veterans’ Care, Katrina Recovery, and Iraq Accountability Appropriations Act—was signed, promising it will determine whether it needs to issue more authoritative guidance about how the new standard should be implemented. “That notice put the public on notice that we are considering whether regulations or other published guidance are needed to implement the recent legislation,” IRS spokeswoman Michelle Lamishaw says.
The standard does not apply to taxpayers who prepare and sign their own tax returns, and in-house professional staff members for companies have not been considered preparers for purposes of such penalties, Lamishaw says. “The recent legislation did not change this result. The penalties at issue are directed a third parties who act as paid preparers.”
That effectively means virtually all large, public companies will be touched by the new standard, according to William Stromsem, director of the tax division at the American Institute of Certified Public Accountants. Companies rely in varying degrees on inside and outside resources to prepare a tax return, but an outside preparer’s signature is almost always on the return when submitted to tax authorities, he says.
“If you do a good job with the FIN 48 analysis, you’ve probably done all the work you need to do to come to a determination for the tax return. It’s possible you could have a disagreement between whoever did the FIN 48 work and whoever is preparing the return, but I don’t think there’s anything in the standard that creates a huge amount of work.”
— Pete Wilson
Managing Director
RSM McGladrey
“I would say almost all large publicly traded companies would have a tax return preparer who would be signing their return,” Stromsem says. “That adds a certain level of assurance to the return. It generally shows the IRS that this is something that has been reviewed by a competent professional who is subject to penalties, and it’s been signed off on. I think most public companies would have a CPA signing off on the tax return as preparer.”
The FIN 48 Experience
Wilson says the standard now imposed on the tax return itself shouldn’t significantly increase the workload for tax professionals because they’ve already done much of the documentation to meet FIN 48 requirements.
“If you do a good job with the FIN 48 analysis, you’ve probably done all the work you need to do to come to a determination for the tax return,” he says. “It’s possible you could have a disagreement between whoever did the FIN 48 work and whoever is preparing the return, but I don’t think there’s anything in the standard that creates a huge amount of work.”
Stromsem notes some subtle but important differences between how the threshold of certainty applies to financial reporting compared with how it will apply to the tax return. “With FIN 48, you can’t book anything unless you’re more likely than not it will be sustained on audit,” he said. “Then you go through the second test to determine the amount that can be booked. In the tax return, if you determine it’s more likely than not, you take the full amount. The standard is similar but the outcome is different.”
The AICPA is concerned now about the tension the new standard will create between taxpayers and return preparers, who are now held to different standards of certainty for filing tax returns, Stromsem says. The AICPA is lobbying Congress to reconsider.
“The pressure behind this is the tax gap,” he contends. “If you raise the standard, it will bring in more money and stop people from playing too fast and loose with the IRS … In our view the higher standard isn’t necessary for preparers. Having two different standards will build tension in the CPA-client relationship that we’d rather not have.”
Wilson says the news of the provision is trickling slowly to corporations, in part because there’s uncertainty about how it will be applied. None of the Big-4 firms contacted by Compliance Week could provide background or analysis of the new provision.
“Businesses are finding out about this by hearing about it from their CPA firm,” he explains. “The problem is there’s not a heck of a lot to tell at this point. We know what the statute says, but we’re waiting for additional guidance from the IRS. We’re looking for more education around this. It’s important for corporations to understand that this is out there.”
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