The Internal Revenue Service announced late last month in Notice 2010-9 that it is developing a schedule to be filed with the Form 1120, U.S. Corporation Income Tax Returns, "or other business tax returns," that will require certain business taxpayers to disclose and describe uncertain tax positions on their tax returns each year "in order to improve tax compliance and administration."
The schedule will require companies to provide "(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 total amount of potential federal tax liability attributable to each uncertain tax position."
This new reporting requirement will apply to "business taxpayers" with total assets in excess of $10 million that have one or more uncertain tax positions. Various options for penalties or sanctions for failure to make adequate disclosure are being considered by the IRS.
Companies already are required to perform a detailed analysis of their uncertain tax positions to be documented in their workpapers under FIN 48, Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes. FIN 48 permits businesses to recognize a benefit in their financial reporting for uncertain tax positions that are considered more likely than not to prevail if challenged.
IRS Commissioner Douglas Shulman justified the new reporting requirement in the context of the growing complexity of tax issues and the need to perform "smart" audits.
"Today we spend up to 25 percent of our time in a large corporate audit searching for issues rather than having a straightforward discussion with the taxpayer about the issues," Shulman said in prepared remarks published on the IRS Web site.
"The goals of our proposal are simple: to cut down the time it takes to find issues and complete an audit, ...ensure that both the IRS and taxpayer spend time discussing the law as it applies to their facts, rather than looking for information, ...and to help us prioritize selection of issues and taxpayers for examination," he said.
Corporate tax accountants and lawyers were shocked by the announcement.
"This is a massive, very important shift," Robert Willens, a New York-based accounting and tax expert, said in a New York Times report. "Corporations have treated audits as a game of 'come see what you can find, we're not going to volunteer stuff,' and now the balance of power will shift to the IRS."
Jeremiah Coder, a contributing editor at Tax Analysts, a non-profit organization that studies tax issues, called the announcement "a shock and awe" move. Coder said he expects some large firms to mount a "pushback" to the IRS's justification for the disclosure, according to USA Today.
"This puts the audit relationship [with the IRS] in a more confrontational mode," Matt Miller, senior director of government affairs in Financial Executives International's Washington D.C. office, wrote in an FEI blog post. "It involves the disclosure of exposure items to possible adversaries."
Bruce Wein, head of law firm DLA Piper's U.S. tax practice, told the Associated Press that the new rules are among the most significant tax compliance measures he has seen in his 40-year career.
IRS Notice 2010-9
Notice 2010-9 does not "require the taxpayer to disclose the taxpayer's risk assessment or tax reserve amounts," Shulman said. "We are asking for a list of issues that the taxpayer has already prepared for financial reporting purposes. We are also looking for the maximum exposure, so we can allocate our exam resources appropriately."
The IRS announcement states that, 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 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 IRS has a general administrative practice not to examine the position.
The concise description of each uncertain position 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:
1. The Code sections potentially implicated by the position;
2. A description of the taxable year or years to which the position relates;
3. A statement that the position involves an item of income, gain, loss, deduction, or credit against tax;
4. A statement that the position involves a permanent inclusion or exclusion of any item, the timing of that item, or both;
5. A statement whether the position involves a determination of the value of any property or right; and
6. A statement whether the position involves a computation of basis.
The IRS intends to publish the new schedule as quickly as possible. Public comments should be submitted by March 29, 2010. The notice contains the mailing address for making comments and a list of eight specific comment topics
In the notice, the IRS said it intends to retain the existing policy of restraint for requesting tax accrual workpapers. Currently, IRS auditors do not (although the IRS could legally) request tax accrual workpapers, which would include a company's FIN 48 analysis, except when the taxpayer has entered into "listed transactions" under tax-shelter rules. The IRS said, however, that it will continue to review the policy and to consider additional modifications as appropriate or necessary to ensure it obtains complete and accurate information regarding a taxpayer's uncertain tax positions on a timely basis.
The disclosure rule would not affect corporate filings until at least 2011, Shulman said in an interview at a meeting of the New York State Bar Association's tax section, The New York Times reported.
Notice 2010-9 links the new requirement directly to FIN 48 compliance. "We do not believe we will be adding substantial new work or burden on taxpayers," Shulman said in his remarks. "These taxpayers are already required to establish tax reserves for uncertain tax positions in determining their financial statement income under U.S. or foreign accounting standards, such as FIN 48. So the work is already being done."
FIN 48 analysis requires the identification and measurement of uncertain tax positions. The American Institute of Certified Public Accountants' (AICPA) Practice Guide on Accounting for Uncertain Tax Positions
defines the term "tax position" as a position in a previously filed tax return or a position expected to be taken in a future tax return that is reflected in measuring current or deferred income tax assets and liabilities for interim or annual periods. According to the Guide:
|FIN 48 applies to positions such as: (1) excluding income streams that might be deemed taxable by the taxing authorities; (2) asserting that a particular equity restructuring is tax-free when that position might be uncertain; or (3) the decision not to file a tax return in a particular jurisdiction for which such a return might be required. FIN 48 also significantly changes the treatment of positions that have only timing consequences, such as positions involving depreciation.
FIN 48 also requires subsequent recognition, derecognition, and measurement of uncertain tax positions, requiring analysis of sustainability, the AICPA Guide says.
Assessing an uncertain tax position begins with the initial determination of the position's sustainability. As of each balance sheet date, unresolved uncertain tax positions must be reassessed, and management should determine whether (1) the factors underlying the sustainability assertion have changed and (2) the amount of the recognized tax benefit is still appropriate.