In January, the Internal Revenue Service (the Service, or IRS) put taxpayers on notice that it was considering changes to the reporting of Uncertain Tax Positions (UTPs).1 The Service has developed Schedule UTP, which requires a specified class of corporations to provide a concise description of each uncertain tax position for which the corporation or a related entity has recorded a reserve in its financial statements or for which no reserve has been recorded because of an expectation of litigation. These uncertain tax positions are identified while preparing financial statements under applicable accounting standards, such as Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109 (FIN 48).2 The Service is requesting this information to further transparency in tax reporting.

In a recent speech, Commissioner Douglas Shulman stated that transparency is essential to the successful operation of the self-assessment tax system. According to the commissioner, implementing Schedule UTP is expected to provide greater certainty regarding a taxpayer’s tax obligations, consistent treatment across taxpayers, and more efficient use of government and taxpayer resources by focusing on issues and taxpayers that pose the greatest risk of tax noncompliance.3 Of course, Schedule UTP also allows the Service to obtain key information regarding uncertain positions and, thus, prioritize issues and taxpayers for examination.

Although taxpayers and practitioners have raised a number of issues and concerns regarding the disclosure requirements, the IRS has pressed forward with the initiative, and on September 7, the Service released proposed regulations requiring the filing of Schedule UTP.4 The Service also released the final UTP Schedule and Instructions effective for the 2010 tax years.5 These documents are available at,,id=221533,00.html.

Prop. Treas. Reg. §§ 1.6012-2(a)(4), (5) and Schedule UTP

Prop. Treas. Reg. § 1.6012-2(a)(4) is extremely brief, because Schedule UTP and its Instructions contain most of the rules. Generally, a corporation is required to file Schedule UTP with its tax return and disclose certain positions if the corporation (i) files Form 1120 (or related forms for foreign corporations, life insurance companies, or property and casualty insurance companies), (ii) meets a phased-in, total assets threshold, and (iii) has issued (or a related party has issued) an audited financial statement that covers all or a portion of the corporation’s operations for the tax year. The positions to be reported include both positions for which the corporation recorded a reserve in the audited financial statement and also positions for which no reserve was recorded based on the taxpayer’s expectation to litigate the position or IRS administrative practice of not challenging the position. Reporting is required if (i) a reserve was recorded or the decision was made not to record a reserve based on the expectation to litigate and (ii) the position was taken on a return, regardless of the order in which these events occur.

In reporting the uncertain tax position, the corporation must include "a concise description of the tax position, including a description of the relevant facts affecting the tax treatment of the position and information that reasonably can be expected to apprise the Service of the identity of the tax position and the nature of the issue."6 Two contentious items—requiring the rationale and nature of uncertainty in the description and the inclusion of the maximum tax amount (MTA)—were removed.

Prop. Treas. Reg. § 1.6012-2(a)(5) provides that the Schedule UTP filing requirement applies to returns filed for tax years beginning after December 15, 2009, and ending after the date of publication of the adoption of final regulations. In other words, the IRS will require a Schedule UTP to be filed with the 2010 tax year return.

Service Response to Certain Comments from Taxpayers and Practitioners

Taxpayers and practitioners made a number of comments regarding the requirement to disclose uncertain tax positions and the draft UTP schedule and instructions. These comments ranged from urging complete withdrawal of Schedule UTP to mere definitional or amount limitation issues. The IRS acknowledged some of these issues in subsequent announcements, the draft and final schedules and instructions, and public statements, but many serious issues remain.

As a preliminary matter, concerns were raised regarding which companies should be required to file Schedule UTP beginning in 2010. Initially, the Service proposed that all companies with $10 million or more in assets and with audited financial statements should complete the schedule. In response to comments, however, a five-year phase-in applies to the reporting requirement. Corporations with assets equal to or exceeding $100 million must file Schedule UTP beginning in the 2010 tax year. Corporations with assets equal to or exceeding $50 million will file beginning with the 2012 tax year, and those with $10 million or more in assets will begin with the 2014 tax year.

Another serious area of concern was the MTA with respect to each tax position included on Schedule UTP. The Service sought information regarding the size of each reported issue to prioritize audit selection and issue focus. The MTA was to be determined by taking the item of income, gain, loss, or deduction and multiplying it by 35 percent. No considerations were made for the likelihood of success on the merits, and commenters argued that the large MTAs could be far greater than likely examination adjustments. Furthermore, large MTAs could become targets for examination without the proper level of consideration and analysis by the IRS. Eventually, the MTA was eliminated, and taxpayers are not required to assign a specific number to any position on the schedule. Instead Schedule UTP requires companies to rank the positions by the reserve amount, taking into account potential interest and penalties.

Furthermore, comments noted that disclosing positions based on an expectation to litigate are unduly burdensome, difficult to quantify, and require reassessment of the position taken on the audited financial statement when actually filing Schedule UTP. Schedule UTP maintains this reporting requirement, but the instructions clarify that a corporation may rely on the reserve decisions in the financial statements for Schedule UTP reporting. The Service eliminated the requirement that corporations disclose positions for which no reserve was taken based on IRS administrative practice.

Perhaps the most significant concern for practitioners is the issue of privilege and work product. FIN 48 reporting calls for an aggregate disclosure of reserves, but Schedule UTP’s disclosure of individual items and descriptions, it was argued, goes beyond what the IRS can legally require. Disclosing a position with a description of the rationale and nature of uncertainty would reveal confidential information. Some commenters were concerned these disclosures could waive privilege and work product protections. In response to these concerns, the final instructions specify that a taxpayer is not required to disclose a rationale for its position but is only required to disclose information sufficient to identify the issue and relevant facts. These descriptions are designed to be consistent with the requirements for a Form 8275 Disclosure Statement. Further, the instructions provide that the concise description should not include information regarding the corporation’s assessment of the hazards of a tax position or an analysis of the support for or against the tax position.

Many comments showed a concern with the IRS’s handling of the information disclosed. Commenters argued that disclosing amounts and descriptions simply provides the Service with a roadmap of issues for examination. Service employees, however, have argued that Schedule UTP will lead to a new approach to examinations and that the information will not be misused. The newly named Large Business & International division issued a directive noting that Schedule UTP does not serve as a substitute for independent judgment and that special training will be given regarding Schedule UTPs.7 Furthermore, to allay concerns that Schedule UTP would affect the policy of restraint, the Service announced that Schedule UTP disclosures will not affect the protections afforded by the Service’s policy of restraint, that quantification and ranking of issues are protected under this policy, and that the Service will not seek documents that are otherwise privileged.8 Although the Service has indicated its decision that taxpayers have not waived privilege through disclosure to financial advisers, it is important to be aware that the waiver does not apply if other actions have otherwise waived the privilege.

Commenters raised additional issues regarding foreign corporations and related party issues, eliminating duplicative disclosures, definitional issues, potential penalties accompanying the schedule, and dedicating more IRS resources to letter rulings and pre-filing agreements to resolve issues prior to filing. The final instructions address some of these issues—corporations do not report tax positions of a related party, disclosure on Schedule UTP does not require additional filing of Form 8275 or Form 8275-R, and definitions of "audited financial statement" and "record a reserve" were clarified.

Other significant issues remain regarding the treatment of net operating loss carryforwards (NOLs) and accounting method changes. Prop. Treas. Reg. § 1.6012-2(a)(5) provides that reporting is required for positions taken in the 2010 tax year and going forward. Example 8 in IRS Announcement 2010-30, however, treats an expiring NOL from a previous year as a tax position taken when the NOL is used. For accounting method changes, the change from an improper method may give rise to a reserve today for past tax years, because the Service may reexamine previously closed tax years. These issues and others have not been addressed by the Service, but the Service plans to implement Schedule UTP with continued feedback and dialogue with taxpayers and practitioners to work through these and other issues that arise.

Some commenters have questioned whether the Service has the authority to require the disclosures on Schedule UTP. Others, however, have noted that the proposed regulations go beyond any requirements in instituting Schedule UTP, almost as an effort to legitimize the new reporting requirements. A public hearing on the proposed regulations is scheduled for October 19, 2010, and we will closely follow the hearing and other Schedule UTP developments.

Pepper Perspective

With the addition of Schedule UTP, corporate taxpayers will need guidance in a variety of areas to ensure compliance with the new requirements. Reaching higher levels of certainty through tax opinions, private letter rulings, and/or accounting method changes may allow corporate taxpayers to avoid reserves altogether. Unless outstanding issues are resolved in advance of filing, Schedule UTP requires disclosure of improper treatment of items and improper accounting methods. When an item must be addressed, corporations should seek counsel on how to effectively disclose positions and quantify positions for ranking, and they must pay careful consideration to disclosures to maintain privilege and work product protections. Pepper Hamilton LLP’s federal tax expertise and experience with the Service will allow for efficient and effective representation on these issues.