The IRS has released a draft schedule and instructions for reporting uncertain tax positions (UTPs) that we described in an earlier Alert.
In view of the significant ramifications of the proposal, interested parties should respond to the IRS request for comments if they hope to achieve substantial modification?or withdrawal?of the draft schedule or instructions. Comments on the proposal, which the IRS spells out in Announcement 2010-30, the schedule, and the instructions are due the IRS by June 1, 2010.
If the current drafts are adopted as proposed, beginning with the 2010 tax year, taxpayers that have recorded reserves for UTPs and have assets equal to or exceeding $10 million will have to file Schedule UTP if they or a related party issue audited financial statements. This requirement would apply only to:
- Corporations filing Forms1120
- Insurance companies filing Forms 1120-L or Forms 1120-PC
- Foreign corporations filing Forms 1120-F
After the IRS reviews comments it receives, it may require that Schedule UTP be filed by other taxpayers with holdings that cross the $10 million asset threshold, such as REITs, mutual funds, S corporations, partnerships, and tax-exempt organizations.
Tax Positions Subject to Reporting. A tax position must be reported on a Schedule UTP attached to a particular year’s tax return if, at least 60 days before filing the return, the taxpayer or a related party has recorded a reserve in an audited financial statement regarding a tax position taken in the return or a decision has been made not to record a reserve based on litigation expectations or knowledge of IRS administrative practices.
The 60-day window is undoubtedly intended to ease compliance in situations where financial and tax reporting dates coincide. As a further concession, the draft Schedule UTP requires taxpayers to disclose when they have determined not to record a reserve only when the decision is based upon IRS administrative practice?not upon anticipation of litigation. For a UTP to be subject to the reporting requirement it does not matter whether the reserve was recorded for a UTP taken in the current year’s return or in a prior year’s return.
However, because of two significant limitations, not all UTPs that are cumulatively reflected in the tax reserve need be reported each year.
First, a corporation is not required to report a UTP taken in a tax year beginning before December 15, 2009, or beginning on or after December 15, 2009, and ending before January 1, 2010, regardless of whether or when a reserve was recorded with respect to that UTP. Thus, UTPs taken in most tax years beginning before 2010 are exempt from disclosure.
Second, UTPs disclosed on previously filed Schedules UTP do not have to be disclosed a second time, even though they continue to be reflected in the reserve.
However, when the same UTP (for example, continued amortization of an otherwise nondeductible expenditure) is taken in a tax year subsequent to the one for which the original disclosure was made, neither of these exceptions to disclosure will apply; a new disclosure must be made on Schedule UTP.
Items to be Reported. For each UTP, taxpayers will be required to report:
- The relevant primary Internal Revenue Code sections
- Whether the UTP creates a temporary difference, a permanent difference, or both
- Whether the UTP relates to a tax position of a pass-through entity
- Whether the UTP is being reported because of an IRS administrative practice
- The maximum tax adjustment The year(s) in which the position has been taken (subject to the exceptions to disclosure outlined above)
- A “concise description” of the UTP, not to exceed a “few sentences” “in most cases”
Illustrative Examples. The instructions to the draft Schedule UTP provide examples of:
- Events triggering the recording of reserves
- The application of the reporting requirement to taxpayers not filing consolidated tax returns
- Determinations of an IRS administrative practice and of an expectation of litigation UTPs arising from permanent and temporary differences
- UTPs arising from the utilization of expiring net operating loss carryforwards
- Determinations of the maximum tax adjustment
- “Concise descriptions” of disclosed UTPs
The instructions also include a chart illustrating when and where to report UTPs on Schedule UTP, a determination that depends on the tax year the UTP is taken, the date on which a reserve is set aside, and the date on which the next tax return is to be filed after it has been decided to adjust the reserve.
In spite of some sugar coating in its packaging, the Schedule UTP is likely to create unwelcome compliance burdens for business taxpayers if it is incorporated as part of the annual tax return filing. It seems unlikely that a return filed without a Schedule UTP would be deemed an unfiled return with consequent nonfiling penalty and statute of limitations consequences. However, it is unclear what other sanctions under current law the IRS could impose for noncompliance. In this latest announcement, the IRS has given no further indication whether (as suggested in Announcement 2010-9) it will seek legislation imposing a penalty for failure to file Schedule UTP or to make adequate UTP disclosure. Although IRS spokespersons have assured taxpayers that the disclosed UTPs will not produce automatic audit adjustments, it is not clear what administrative steps will be taken to prevent that result.