A client, who’s also a close personal friend, suggested that we attend the New York State Bar Association Tax Section (NYSBA) annual luncheon on January 26, 2010. Since Internal Revenue Service (IRS) Commissioner Douglas Shulman was the featured speaker and rubber chicken was on the menu, we couldn’t refuse. After all, it’s only lunch! Imagine our surprise (and the surprise of the hundreds of other tax professionals in the room) when the Commissioner announced -- as we ate -- that the IRS was releasing guidance that would require taxpayers to disclose, in narrative form, the items comprising their FIN 48 reserve on their federal income tax returns. After the collective gasp subsided, you could have heard a pin drop. This White Paper describes the proposal and what looks like a related announcement on when disclosure is considered sufficient to be able to avoid penalties.

The impetus for the new disclosure rules was spelled out by the Commissioner in his NYSBA speech. The Commissioner noted that the IRS spends up to 25 percent of each audit “searching for issues.” Thus, the new reporting requirement, if adopted, would be 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.”1 In other words, according to the Commissioner, the goal of the new disclosure is to help the IRS auditor “cut-tothe- chase” more quickly; instead of having to find the facts, the facts will be more transparent and the IRS would be able to spot the legal issues more quickly. The Commissioner stated that the proposal would not result in the IRS asking for accounting work-papers in circumstances other than in which it would currently ask for such materials (such as in connection with listed transactions).2

The Commissioner added, “We do not believe we will be adding substantial new work or burden on taxpayers. 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.” The Commissioner, therefore, says that the added burden will be insignificant; all that is going to be required is to compile a summary of the uncertain tax positions stated in the entity’s financial statement and present it in the new schedule. Thus, taxpayers who have been struggling since the issue of FIN 48 (see discussion below) to identify what items they must disclose in their financial statement under FIN 48 would have a lot more at stake.

The collective indigestion crystallized itself in Announcement 2010-9 (the Announcement), which was waiting in all of our email in-boxes when we returned from the luncheon. The good news is that the Announcement only presages what’s to come. Rather than simply imposing this requirement for the 2010 filing season with respect to 2009 returns, the Announcement solicits comments on the new proposal. Comments are due by March 29, 2010. We cover the proposal in the following order. First, who’s affected? Second, what will be required to be disclosed? Last, how will the required information be reported to the IRS?

Who Will Be Affected by the New Disclosure Rules?

This new reporting requirement is proposed to apply to (i) “business taxpayers” (ii) with total assets in excess of $10 million (iii) who have one or more uncertain tax positions. This includes a taxpayer that is required to prepare financial statements, or a taxpayer that is included in the financial statements of a related entity that prepares financial statements of that taxpayer or related parties. In what may be the broadest sweep of what constitutes a related entity, three sets of related party rules are referenced: Sections 267(b), 318(a) and 707(b) of the Internal Revenue Code of 1986, as amended (the Code).

It is clear that a business taxpayer need not prepare audited financial statements in accordance with generally accepted accounting principles (GAAP) to be subjected to the proposed filing requirement. The Announcement specifically states that taxpayers using International Financial Reporting Standards (IFRS) and other accounting standards are proposed to be subject to the new reporting rules. It is less clear whether business entities such as family partnerships that do not prepare financial statements are proposed to be subject to the new rules.

The Announcement seems to assume that any taxpayer that is a business taxpayer will be preparing financial statements that require some determination as to the risk inherent in uncertain tax positions. Clearly, private funds, such as hedge funds and private equity funds, are not contemplated to be exempted from the proposed rules.

Business Taxpayers & the $10 Million Threshold

It’s not yet clear when a taxpayer will be considered to be a “business taxpayer.” For example if a hedge fund, investment partnership or like entity is only engaged in investment activity, will it be considered to be a “business taxpayer?” If a non-U.S. taxpayer with more than $10 million in assets has less than $10 million in assets invested in the United States, will it be considered to have assets in excess of $10 million? One clue that business taxpayers may include entities engaged only in investment activities is the statement that “a taxpayer who prepares financial statements . . . that . . . determines its United States federal income tax reserves under FIN 48” is a business taxpayer. This language implies that business taxpayers are not limited to taxpayers engaged in the conduct of a trade or business. If business taxpayers do not include investment funds, however, will an off-shore investment fund that has a risk that it is engaged in a U.S. trade or business be considered a business taxpayer?3

Uncertain Tax Positions

Once a taxpayer has determined that it is a “business taxpayer” with more than $10 million in assets, the next inquiry is whether it has one or more “uncertain tax positions.” Uncertain tax positions include amounts reserved pursuant to FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109 (FIN 48). FIN 48 requires taxpayers who are subject to financial accounting reporting to identify and quantify for financial accounting purposes a tax position relating to a specific federal tax return for which a taxpayer is required to reserve an amount. If a business taxpayer does not maintain a FIN 48 reserve (either because it does not keep audited financials or otherwise), it may still have an uncertain tax position. Specifically, a taxpayer that has not established a tax reserve because it expects to litigate with the IRS or has determined that the IRS does not audit the issue is still considered to have an uncertain tax position.

FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes.4 The evaluation of a tax position in accordance with FIN 48 is a two-step process:

Recognition: The enterprise determines whether it is “more likely than not” that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position, under the presumption that such tax position will be examined by the IRS.

Measurement: A tax position that meets the more-likely-than-not recognition threshold is measured to determine the amount of benefit to recognize in the financial statements. The tax position is measured at the largest amount of benefit that is greater than 50 percent likely to be realized upon ultimate settlement.

The Announcement does not define the term “tax position” but makes direct reference to FIN 48. Paragraph 4 of FIN 48 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. Furthermore, FIN 48 provides that “the term ‘tax position’ also encompasses, but is not limited to: (a) a decision not to file a tax return; (b) an allocation or a shift of income between jurisdictions; (c) the characterization of income or a decision to exclude reporting taxable income in a tax return and (d) a decision to classify a transaction, entity, or other position in a tax return as tax exempt. For this purpose, “a ‘tax position’ can result in a permanent reduction of income taxes payable, a deferral of income taxes otherwise currently payable to future years, or a change in the expected realizability of deferred tax assets.”

What’s Proposed to Be Disclosed to the IRS?

The new schedule, which is proposed to be attached to the taxpayer’s federal income tax return, will require taxpayers to provide information about their uncertain tax positions that affect their U.S. federal income tax liability. The required information includes (i) a concise description5 of each uncertain tax position for which the taxpayer or a related entity has recorded a reserve in its financial statements (in compliance with FIN 48) and (ii) the maximum amount of potential U.S. federal income tax liability attributable to each such uncertain tax position (determined without regard to the taxpayer’s risk analysis regarding its likelihood of prevailing on the merits).

According to Announcement 2010-9, to be considered “sufficient,” the description of each uncertain tax position must include: (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.

In addition, for each uncertain tax position, the taxpayer will have to disclose the amount of U.S. federal income tax that would be due if such position would be disallowed in its entirety on audit. This amount is the maximum tax adjustment for the position reflecting all changes to items of income, gain, loss, deduction, or credit if the position is not sustained.

The Announcement also notes that the IRS is “evaluating options for penalties or sanctions to be imposed when a taxpayer fails to make adequate disclosure.” Interestingly, almost simultaneous with the release of Announcement 2010-9, the IRS released Revenue Procedure 2010-15. In this Revenue Procedure, the IRS has set forth standards as to when an item is adequately disclosed for the purpose of avoiding the substantial understatement penalty.6 This penalty can be reduced “if the relevant facts affecting the item’s tax treatment are adequately disclosed in the return.”7 Revenue Procedure 2010-15 notes that “a potentially controversial item may involve a portion of the aggregate amount disclosed . . . The [IRS] will not be reasonably apprised of a potential controversy by the aggregate amount disclosed.” In other words, it appears that the IRS believes that it is now incumbent on taxpayers to disaggregate tax items and provide granular reporting of items.8 Separately, the Commissioner has stated that the if the IRS does not get the information it wants, it will be “discussing penalties.”9

How Is the Information Proposed to Be Reported to the IRS?

The Announcement makes clear that the information on uncertain tax positions will be required to be provided on a schedule to be attached to the normal tax returns that a taxpayer is required to file. For example, a corporate taxpayer will attach the schedule to a Form 1120. Given the sensitivity of the information and how it would be required to be presented, it is likely that attorneys may become more involved in preparing actual tax returns than they have been in the past. It is likely that this level of assistance may turn the attorneys into tax return preparers.

The IRS Has Requested Comments

As noted above, the IRS asked interested parties to comment on the proposal by March 29, 2010. The IRS said that it is particularly interested in comments regarding the following topics (among others):

  1. How the maximum tax adjustment should be reflected on the schedule;
  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. Whether the scope of the Announcement should be modified regarding the uncertain tax positions for which information is required to be reported;
  5. Whether transition rules should be used or criteria modified to either include or exclude certain businesses taxpayers (e.g., the proposed threshold of $10 million total assets);
  6. 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
  7. 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.


FIN 48 has been a challenging pronouncement with major implications for financial and tax reporting. FIN 48 raised the bar for recognition of tax benefits in a company’s financial statements to more-likely-than-not and created a mini-revolution in how companies should account for uncertain income tax positions. FIN 48 also significantly increased the calculation and documentation requirements that were imposed on impacted companies. Because FIN 48 applies to all of the entity’s tax positions, the impact to corporations is significant and requires additional tracking and documentation from every entity and location.

One issue that is sure to be joined by the proposed reporting regime is its impact on the attorney work-product doctrine and the tax adviser privilege.10 In the same way that the disclosure of financial work-papers have been a contentious issue between the IRS and taxpayers,11 the disclosure of the information behind FIN 48 and like reserves is sure to raise privilege issues. Hopefully, the IRS will take these considerations into account in proposing any rules, rather than leaving it to taxpayers to challenge disclosures in court proceedings.

Until today, the taxpayers’ efforts to comply with the requirements of FIN 48 were only reflected in the taxpayers’ financial statements. Now, if the new disclosure is adopted, taxpayers will have to worry about what positions to report to the IRS. We’re fortunate to have worked at accounting firms, as well as law firms, and can see this issue from multiple perspectives. Please let us know if you’d like to be involved with the submission of comments to the IRS.