On January 26, 2010, the IRS announced that it intends to require certain business taxpayers to disclose information about uncertain tax positions taken on their tax returns. The proposal, contained in Announcement 2010-9, represents a meaningful departure from the IRS policy of "restraint" in connection with obtaining information from taxpayers' tax accrual work papers. In a speech, the IRS Commissioner explained that mandatory disclosure advances transparency and is intended to help the IRS determine the "nature and materiality of a taxpayer's uncertain tax positions" in order to "cut down the time it takes to find issues and complete an audit."
The new reporting requirements will apply to business taxpayers with total assets of $10 million or more that prepare financial statements that (i) report federal income tax reserves for uncertain positions under FIN 48 or other accounting standards, or (ii) are included in the financial statements of a related entity that reports federal income tax reserves for uncertain positions under FIN 48 or other accounting standards. In addition, even if a taxpayer does not establish a reserve in connection with a particular uncertain position, the taxpayer will be required to disclose it if (i) the taxpayer expects to litigate the position or (ii) the taxpayer believes the position will not be examined by the IRS. Thus, the proposed tax return disclosure exceeds current financial reporting requirements and may apply to tax positions that are not covered by FIN 48.
The IRS anticipates that Announcement 2010-9 will be followed by a notice of proposed rulemaking to require businesses to file a schedule relating to tax return disclosure of uncertain tax positions and, ultimately, by final regulations.
Reason for the Proposal
The IRS's purported objective in initiating this new requirement is to enable its auditors to spend more time analyzing issues, rather than identifying them. Except in limited circumstances for purposes of penalty avoidance, IRS forms do not currently require taxpayers to identify and explain uncertain tax positions. The IRS believes the new proposed schedule will assist IRS examination teams to become more efficient, speedier, and more focused on significant issues.
Currently, notwithstanding that the U.S. Supreme Court ruled that the IRS may obtain a taxpayer’s tax accrual work papers (see United States v. Arthur Young, 465 U.S. 805 (1984)), the IRS has had a "policy of restraint." Under the policy of restraint, the IRS would request a taxpayer's tax accrual work papers only if (1) the taxpayer participated in listed transactions, (2) the taxpayer is being investigated for criminal violations or other unusual circumstances, or (3) in litigation of a tax dispute. Typically, absent a court order, taxpayers claim the work product privilege to refuse to disclose their tax accrual work papers. However, whether tax accrual work papers are covered by the work product privilege has been called into doubt by the IRS victory in United States v. Textron, 577 F.3rd 21 (1st Cir. 2009). Textron requested that the Supreme Court hear its case. If the Supreme Court grants certiorari, soon we will know whether the work product privilege extends to tax accrual work papers.
Notwithstanding the broad disclosure requirements described in Announcement 2010-9, at the same time, the IRS announced that?at least for now?it intends to retain its longstanding policy of restraint as it applies to tax accrual work papers. However, after Announcement 2010-9, it is unclear how meaningful that policy remains.
Requirements of the Proposed Schedule
The proposed 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;
(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); and
(iii) Disclosure of positions for which no reserve has been recorded because the taxpayer expects to litigate the position or has determined that the IRS has a general administrative practice not to examine the position.
In no case will the amount of any reserves set aside for uncertain tax positions have to be disclosed.
The schedule will require a concise description of each uncertain tax position with sufficient detail so that the IRS can determine the nature of the issue. 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.
Penalties for Noncompliance
Despite having an arsenal of return-related penalties currently at its disposal, the IRS is evaluating whether additional penalties or sanctions should be levied if a taxpayer fails to make adequate disclosure of its uncertain tax positions when the proposed disclosure rules are in effect. One option being considered is new legislation imposing a penalty for failure to file the schedule or to make adequate disclosure.
Release of Schedule and Request for Public Comments
The IRS intends to publish the new schedule as soon as possible and invites the public to submit comments on the proposal by March 29, 2010. The IRS is particularly interested in comments regarding:
1. How the maximum tax adjustment should be reflected on the schedule so that it provides the IRS with an objective and quantifiable measure of each reported tax position (e.g., specific dollar amount or by appropriate dollar ranges);
2. What alternative methods of disclosure of the amount at issue would allow the IRS to identify the relative importance of the uncertain tax positions;
3. Whether the calculation of the maximum tax adjustment should relate solely to the tax period for which the return is filed or to all tax periods to which the position relates, and whether net operating losses or excess credits should be taken into account in determining the maximum tax adjustment;
4. How the related entity rules should be applied;
5. Whether the scope of Announcement 2010-9 should be modified regarding the uncertain tax positions for which information is required to be reported (e.g., positions for which no tax reserve has been established because the taxpayer determined the IRS has a general administrative practice not to examine the position);
6. Whether transition rules should be used or criteria modified to either include or exclude certain business taxpayers (e.g., the proposed threshold of $10 million total assets);
7. How the new schedule should address taxpayers that initially did not record a reserve for an issue but in later years do record a reserve; and
8. Whether the list of information proposed to be included should be modified, including whether certain information should be requested in some circumstances upon examination rather than with tax return.
The schedule described in Announcement 2010-9 has the potential to create onerous burdens on business taxpayers and to cause them to face serious consequences for noncompliance. In addition, we anticipate that state and local tax authorities would also use this information to audit taxpayers' state and local tax returns. This proposal has very significant ramifications. We urge interested parties to respond to the IRS request for comments if they hope to achieve substantial modification?or withdrawal?of the proposal, and we will be pleased to assist clients that wish to submit comments.