With Announcement 2010-30 (April 19, 2010), the Internal Revenue Service (IRS) published a draft schedule and instructions for taxpayers to use to report their uncertain tax positions. The draft schedule and instructions come on the heels of Announcement 2010-9 and Announcement 2010-17, wherein the IRS announced that certain taxpayers would be required to report “uncertain tax positions” on their federal income tax returns for tax years beginning in 2010.
The schedule is called Schedule UTP and accompanies Form 1120. Taxpayers are invited to submit comments on the draft schedule and instructions as well as the original announcements by June 1, 2010. The schedule and instructions explain which taxpayers are required to complete the schedule, when the schedule must first be filed and what must be included on the schedule. These clarifications and additional details are helpful guidance to taxpayers, but additional questions remain. In particular, this announcement assumes that the IRS has the authority to require a taxpayer to provide this information and does not contemplate a taxpayer’s claim of privilege with respect to some or all of the requested disclosures.
Corporations are required to file Schedule UTP if they have “uncertain tax positions;” they own assets equal to or exceeding $10 million; they or a related party issue audited financial statements; and they are required to file Form 1120 (U.S. Corporation Income Tax Return), Form 1120 L (U.S. Life Insurance Company Income Tax Return), Form 1120 PC (U.S. Property and Casualty Insurance Company Income Tax Return) or Form 1120 F (U.S. Income Tax Return of a Foreign Corporation). Currently, other Form 1120 filers, pass-through entities and tax-exempt organizations are not required to file Schedule UTP, but the IRS may require them to file it in the future.
An “uncertain tax position” includes any U.S. federal income tax position for which a corporate taxpayer has recorded a reserve in an audited financial statement, regardless of the accounting standards used to prepare the financial statement (e.g., U.S. generally accepted accounting principles, International Financial Reporting Standards or other country-specific accounting standards). Additionally, uncertain tax position is defined to include a tax position for which no reserve is recorded, if the corporation or a related party decided not to record a reserve for a position because of “an IRS administrative practice” or “an expectation to litigate.”
Thus, whether an unreserved position must be reported depends on the reason behind the decision not to record a reserve. For example, if the IRS has a practice of not challenging a particular type of tax position during an examination, and that fact causes the corporation not to record a reserve for that tax position, the position must be reported on Schedule UTP. With respect to anticipated litigation, a tax position must be reported if a reserve for that position would have been recorded but for a determination that, if the IRS had full knowledge of the tax position, it is unlikely that settlement with the IRS could have been reached. For this purpose, a settlement is unlikely if the probability of settlement is less than 50 percent. The instructions provide the following example. A corporation must report a tax position on Schedule UTP if the corporation does not establish a reserve for an uncertain tax position based on the corporation’s determination that there is a less than 50 percent chance of a settlement with the IRS, and if the tax position were litigated, the corporation has a 60 percent probability of prevailing in the litigation.
With respect to timing, a tax position must be reported on a return if the decision to record the reserve for that position was made at least 60 days before filing the tax return. Tax positions with respect to the current year are reported in Part I of the schedule. If the decision to record a reserve is made within 60 days of filing a return, that position may be reported on the following year’s return. If the corporation increases or decreases the amount of a reserve in a later year with respect to a previously disclosed position, it need not report the position a second time. Tax positions with respect to a prior year are reported in Part II of the schedule. For example, if a corporation decides to record a reserve for a tax position reflected on the 2010 return on March 15, 2011, and that corporation files its tax return on April 15, 2010, that position may either be reported on Part I of the 2010 Schedule UTP or on Part II of the 2011 Schedule UTP. As a result of the transition rule described below, corporations will not include anything in Part II when they file the schedule for the 2010 tax year.
This new reporting requirement is not retroactive, and the instructions provide a transition rule, as well as a rule to avoid duplicate reporting. Corporations are not required to report an uncertain tax position taken in a tax year beginning before December 15, 2009, or a tax year beginning on or after December 15, 2009, and ending before January 1, 2010, even if a reserve was recorded for that tax position. In addition, by reporting a tax position on Schedule UTP, taxpayers are treated as if they filed Form 8275, Disclosure Statement, or Form 8275, Regulation Disclosure Statement, with respect to that position, and therefore do not need to file the separate form.
In addition to reporting a tax position related to its own reserves, corporations must report a position if a related party records a reserve for that position on its audited financial statements. For example, assume that a U.S. corporation is related to a foreign corporation that does not do business in the United States. The U.S. corporation takes a position on its tax return, but does not record a reserve with respect to that position on its own audited financial statements. However, the related foreign corporation does record a reserve with respect to that tax position on its own audited financial statements. In this case, the U.S. corporation must report the tax position on Schedule UTP.
A different set of rules applies to consolidated groups. If an affiliated group of corporations files a consolidated return, the group will file a Schedule UTP for the affiliated group. The group does not need to identify the member of the group to which the tax position relates or which member recorded the reserve.
When one tax position affects more than one year’s return, such as amortizing expenditures or carrying forward net operating losses, the instructions explain when the position should be reported. A tax position must be reported in each year that a line item on that tax return would be adjusted if the position was not sustained. For example, if a corporation takes the position that an expenditure may be amortized over five years, but is uncertain whether any amortization deductions will be allowed, it must report the tax position in all five years. If a corporation takes the position that the entire amount of an expenditure may be deducted in a particular year, but is uncertain if the item should instead be amortized over five years, the corporation must report the tax position in all five years. The instructions also provide an example with respect to net operating losses. Assume a corporation has a net operating loss that will expire in 2010, reports income in 2010 which offsets the loss, but is uncertain whether the income should have been reported in 2011. The corporation should report the tax position in 2010 and in 2011.
Once a corporation has decided which tax positions must be reported and when, it must provide certain types of information regarding each uncertain tax position it reports. It must provide the primary sections of the Internal Revenue Code to which the tax position relates (up to three sections), and state whether the position is a permanent position, temporary position or both. An example of a permanent position is the decision to amortize an expenditure when it possibly was not deductible at all. An example of a temporary position is the decision to deduct an entire expense in one year, when it possibly should be amortized over five years. If the tax position taken by the corporation relates to the tax position of a pass-through entity, the corporation must report the employer identification number of the pass-through entity to which the position relates. For example, if a corporation is a partner in a partnership and there is uncertainty with respect to the partner’s distributive share of an item of income, the employer identification number of that partnership should be entered. If the tax position is reported because the corporation determined that the IRS would not challenge the position based on an IRS administrative practice, that must be noted as well. However, the corporation is not required to note whether a position was reported because of an expectation to litigation. Finally, the corporation must provide the “maximum tax adjustment” (MTA) with respect to each tax position, as well as a “concise description” of each position.
The MTA is an estimate of the maximum amount of potential U.S. federal income tax liability associated with the tax year for which the tax position was taken. State, local or foreign taxes are not considered; neither are interest or penalties. The MTA is computed annually. The MTA with respect to a tax position that relates to items of income, gain, loss and deduction is the estimated total amount of an item in dollars multiplied by 35 percent. The MTA with respect to tax credits is the estimate of the amount of a credit in dollars. These items are determined separately and may only be offset by other items relating to that tax position.
The instructions provide a special rule for valuation and transfer pricing tax positions. Corporations do not have to provide MTAs for valuation or transfer pricing tax positions. Instead, corporations should indicate whether the position is a valuation or a transfer pricing position, and then rank the positions based on either the amount recorded as a reserve or the estimated adjustment to U.S. federal income tax that would result if the tax position was not sustained. This method must be applied consistently to all valuation and transfer pricing tax positions that are reported, and should be done separately for valuation and transfer pricing tax positions. Corporations are not required to describe the method chosen or report the amount of the reserve. They simply must indicate whether each position is a valuation or transfer pricing position and provide a number to indicate its rank.
The concise description of each position is entered in Part III of the schedule, and should include the “identity of the tax position and the nature of the uncertainty.” It must include the type of tax item at issue—whether it is an item of income, gain, loss, deduction or credit, or a transfer pricing or valuation position. It should include the rationale for the position and the reason for determining that the position is uncertain. The instructions state that, in most cases, this will not exceed a few sentences. The instructions provide several examples of concise descriptions. They include several sentences that describe the facts that led to the tax item, one sentence with the position that the taxpayer takes on the return and one sentence with alternative treatment.
The draft instructions and schedule provide additional details and clarifications regarding the type of information taxpayers will have to provide. The announcement, however, assumes that the IRS has the authority to require a taxpayer to provide this information and does not contemplate a taxpayer’s claim of privilege with respect to some or all of the requested disclosures. Taxpayers with additional questions should submit them to the IRS before June 1, 2010, so that they can be addressed in the final version.