United States: Tax Flash: IRS Makes Significant Changes in the Final Form and Instructions for the Disclosure of Uncertain Tax Positions

The IRS on Sept. 24 released the final tax return schedule and instructions for reporting "uncertain tax positions" on tax returns. The IRS made several significant departures from the draft version.

The final form and instructions delay the effective date for taxpayers with under $100 million in assets and provide that taxpayers will now NOT need to disclose:

• the maximum potential tax adjustment for each position;

• the rationale of each position and the reason for uncertainty; and

• positions for which no reserve is recorded due to IRS "administrative practice."

The new disclosure initiative was first introduced in Announcement 2010-9 on Feb. 16, and the draft form and instructions were released on April 19.

The new IRS material includes general guidance (Announcement 2010-75), a change to its policy of restraint (Announcement 2010-76), a directive for IRS LB&I personnel (formerly LMSB), and the final Schedule UTP (Uncertain Tax Position Statement) and instructions.

Effective date

Schedule UTP is required for applicable taxpayers with $100 million or more in assets for the 2010 tax year (calendar year 2010 or fiscal year beginning in 2010 and ending in 2011). Corporations with assets of $50 million or more must file beginning in the 2012 tax year, and corporations with $10 or more million in assets must file beginning in the 2014 tax year.

Who is covered

The schedule is required for the following taxpayers who file audited financial statements, meet the asset test and have uncertain positions:

• Corporations filing Form 1120

• Insurance companies filing Form 1120 L or Form 1120 PC

• Foreign corporations filing Form 1120 F

The IRS has indicated in the guidance that it is considering an expansion of the schedule in the future to apply to other types of taxpayers, including real estate investment trusts, regulated investment companies, pass-through entities and tax-exempt organizations.

Positions that must be reported

Corporations will be required to report any federal income tax position for which a tax "reserve" has been established in an audited financial statement. Under U.S. GAAP, this means unrecognized tax benefits or adjustments to existing deferred tax accounts (which the IRS guidance and this alert will refer to as a "reserve") established under FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109 (FIN 48), which was incorporated into Topic 740, Income Taxes of the Accounting Standards Codification (ASC 740).

The schedule will also require the reporting of positions in which a reserve was not recorded because the taxpayer expects to litigate the position. The IRS removed a proposal to require taxpayers to disclose positions in which a reserve was not recorded because the IRS has a general administrative practice not to examine it.

The final instructions clarify that taxpayers do not need to report positions for which a reserve was not required because the position is "immaterial" or "sufficiently certain" under financial accounting standards. The instructions also clarify that foreign or state tax positions do not need to be disclosed unless a federal income tax position that requires a reserve arises out of the uncertainty of the foreign position.

Corporations must report prior year positions if they have not been reported on a previous tax return. Under a transition rule, taxpayers do not need to report tax positions taken in any tax year beginning before Jan. 1, 2010, even if a reserve is recorded for the tax position in a financial statement issued in 2010 or later.

What must be reported

With respect to each uncertain tax position, taxpayers must report:

• the primary Code sections (up to three) relating to the position;
• whether the position involves a temporary difference (timing) or permanent difference or both;
• the EIN of any pass-through related to a tax position;
• the year of the tax position (for reporting past positions); and
• a concise description of the position.

The IRS removed a requirement asking taxpayers to disclose the maximum potential tax adjustment if the position were disallowed in its entirety on audit. Instead, taxpayers will be required to rank each tax position based on the size of the income tax reserve (including interest and penalties) and to note any tax positions with a reserve exceeding 10 percent of the total amount reserved for all reported positions. Taxpayers do not need to disclose the actual reserve amount and can assign any rank to positions included because of an expectation of litigation.

The IRS overhauled the instructions for providing a concise description of each position. Taxpayers will not be required to include the rationale for each position and the reasons for determining it is uncertain. Instead, they must include a description of the relevant facts affecting the position's tax treatment and information that can reasonably be expected to apprise the IRS of the identity of the position and the nature of the issue. This is based on and is consistent with the level of information required to be reported on Form 8275.

Positions that must be reported

Corporations will be required to report any federal income tax position for which a tax "reserve" has been established in an audited financial statement. Under U.S. GAAP, this means unrecognized tax benefits or adjustments to existing deferred tax accounts (which the IRS guidance and this alert will refer to as a "reserve") established under FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109 (FIN 48), which was incorporated into Topic 740, Income Taxes of the Accounting Standards Codification (ASC 740).

The schedule will also require the reporting of positions in which a reserve was not recorded because the taxpayer expects to litigate the position. The IRS removed a proposal to require taxpayers to disclose positions in which a reserve was not recorded because the IRS has a general administrative practice not to examine it.

The final instructions clarify that taxpayers do not need to report positions for which a reserve was not required because the position is "immaterial" or "sufficiently certain" under financial accounting standards. The instructions also clarify that foreign or state tax positions do not need to be disclosed unless a federal income tax position that requires a reserve arises out of the uncertainty of the foreign position.

Corporations must report prior year positions if they have not been reported on a previous tax return. Under a transition rule, taxpayers do not need to report tax positions taken in any tax year beginning before Jan. 1, 2010, even if a reserve is recorded for the tax position in a financial statement issued in 2010 or later.

What must be reported

With respect to each uncertain tax position, taxpayers must report:

• the primary Code sections (up to three) relating to the position;
• whether the position involves a temporary difference (timing) or permanent difference or both;
• the EIN of any pass-through related to a tax position;
• the year of the tax position (for reporting past positions); and
• a concise description of the position.

The IRS removed a requirement asking taxpayers to disclose the maximum potential tax adjustment if the position were disallowed in its entirety on audit. Instead, taxpayers will be required to rank each tax position based on the size of the income tax reserve (including interest and penalties) and to note any tax positions with a reserve exceeding 10 percent of the total amount reserved for all reported positions. Taxpayers do not need to disclose the actual reserve amount and can assign any rank to positions included because of an expectation of litigation.

The IRS overhauled the instructions for providing a concise description of each position. Taxpayers will not be required to include the rationale for each position and the reasons for determining it is uncertain. Instead, they must include a description of the relevant facts affecting the position's tax treatment and information that can reasonably be expected to apprise the IRS of the identity of the position and the nature of the issue. This is based on and is consistent with the level of information required to be reported on Form 8275.

IRS administration

In connection with new Schedule UTP, the IRS has made significant changes to its policy of restraint in asking for taxpayer documents and workpapers. Announcement 2010-76 indicates that the policy will be expanded to protect drafts of issue descriptions and to protect information on the quantification of a reserve or ranking of positions for the Schedule UTP. The IRS also said it would not assert during an examination that privilege has been waived because a taxpayer discloses a document to a financial auditor as part of an audit of a taxpayer's financial statements.

The IRS also indicated that a complete and accurate disclosure of a tax return position on a Schedule UTP will fulfill the disclosure requirements otherwise fulfilled by filing a form 8275 or 8275-R.

Implications

The IRS believes focusing on uncertain tax positions will enable it to identify issues of particular interest or significant magnitude more quickly and efficiently. The new LB&I directive indicates there will be a centralized process for reviewing and analyzing Schedule UTPs, and it will be reinforced to examiners that positions could be considered uncertain for many reasons, including ambiguity in the law and a lack of published guidance on the issues.

The disclosures will impact the process businesses use to document positions for financial and tax purposes. Increased IRS examination scrutiny of tax positions is likely. The IRS has heavily emphasized its early resolution programs and currency in the exam cycle. They likely view this schedule as a further step in that direction.

Penalties

The IRS has issued interim regulations (REG-119046-10) that assert its statutory authority to require new reporting on uncertain tax positions. The regulations provide a one sentence addition to Treas. Reg. Sec. 1.6012-2 that requires the schedule be filed under the IRS's statutory authority in Sections 6011 and 6012.

However, the IRS has not offered any information on the potential application of penalties. The IRS said it intends to review compliance on the new Schedule UTP filing requirements and take appropriate enforcement action, such as examination, if a taxpayer fails to complete the form.

Connecting with your advisors

Grant Thornton anticipates that businesses will be concerned about the practical and strategic impact of the policy change on both income tax and financial reporting obligations. Evaluation of issues under the new requirements will require increased understanding of applicable financial accounting and tax standards and stronger coordination of the application of those standards in both financial and tax reporting. Grant Thornton looks forward to assisting businesses address the meaning and impact of the proposed policy on both tax and financial reporting matters.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.