On April 19, 2010, the Internal Revenue Service (“IRS”) issued IRS Announcement 2010-30 accompanied by the release of a highly-anticipated draft schedule and instructions to be used by certain corporate taxpayers to report uncertain tax positions on their annual income tax returns. Although the draft schedule provides space for reporting current and prior year tax positions, a transition rule provides that tax positions taken in a taxable year beginning before December 15, 2009, or in a short tax year beginning on or after December 15, 2009, and ending before January 1, 2010, would not need to be reported. The draft schedule would require a concise description of each reported tax position as well as information about its magnitude, but would not require disclosure of the taxpayer’s risk assessments or tax reserve amounts.
In IRS Announcement 2010-9, the IRS announced that it was developing a tax return schedule that would require certain business taxpayers to report uncertain tax positions on their annual income tax returns.1 For more information about IRS Announcement 2010-9, please see our memorandum entitled “Disclosure to Internal Revenue Service of Uncertain Tax Positions,” dated January 26, 2010. The IRS invited public comment on the proposal and recently extended the original comment period until June 1, 2010.2 Nearly four months after the proposal was first announced, the IRS has now released a draft schedule, referred to as “Schedule UTP,” and accompanying instructions which include a number of helpful examples.
Beginning with the 2010 tax year, the draft schedule and instructions would require the following taxpayers that issue or are included in an audited financial statement and have at least $10 million of assets to file Schedule UTP with their annual tax return: (1) corporations required to file a Form 1120, U.S. Corporation Income Tax Return; (2) insurance companies required to file a Form 1120 L, U.S. Life Insurance Company Income Tax Return or Form 1120 PC, U.S. Property and Casualty Insurance Company Income Tax Return; and (3) foreign corporations required to file Form 1120 F, U.S. Income Tax Return of a Foreign Corporation. Significantly, IRS Announcement 2010-30 explains that, pending consideration of additional public comments, tax-exempt organizations and regulated investment companies, real estate investment trusts, partnerships and other pass-through entities would not be required to file Schedule UTP for the 2010 tax year. However, corporations otherwise required to file Schedule UTP would be required to report tax positions taken by partnerships and other pass-through entities in which the corporation holds an interest.
Taxpayers that would be required to file Schedule UTP would have to report any tax position taken in a tax return for which the taxpayer or a related party3 (1) has recorded a reserve on an audited financial statement or (2) has not recorded a reserve on an audited financial statement as a result of either (a) an expectation of litigating the tax position or (b) a determination that, based upon prior IRS administrative practices and precedents, the IRS has a practice of not challenging the tax position during examination.4 The draft instructions clarify that an expectation of litigating the tax position would have to be based on a determination that, if the IRS had full knowledge of the tax position, the probability of settlement would be less than 50%. In general, a reserve would be recorded with respect to a tax position if, on the taxpayer’s audited financial statements, there is (1) an increase in a liability for income taxes payable or a reduction of an income tax refund receivable with respect to the tax position or (2) a reduction in a deferred tax asset or an increase in a deferred tax liability with respect to the tax position (although, as described below, reporting on Schedule UTP would not be required until the tax position is first reflected on an income tax return). Although the initial recording of a reserve would trigger an obligation to report a tax position taken in a tax return, subsequent adjustments to the amount reserved for the tax position would not.
The draft instructions also explain that a tax position would have to be analyzed on the basis of the unit of account used in the audited financial statements in which the reserve for the tax position is recorded.5 This unit of account is intended to reflect both the level at which the taxpayer accumulates information to support the tax return and the level at which the taxpayer anticipates addressing the issue with the IRS. The unit of account used by a GAAP or modified-GAAP taxpayer for reporting a tax position on Schedule UTP would have to be the same unit of account used by such taxpayer in its audited financial statements. In the case of audited financial statements prepared under other accounting standards, a unit of account based on an entire tax year or entire income tax return for a tax year could not be used as the basis for determining a tax position to be reported on Schedule UTP, even if that is the level of detail used in such other accounting standards. Rather, in such cases, a unit of account that could be used as the basis for determining a tax position to be reported on Schedule UTP would be any level of detail that is consistently applied and reasonably based on the items of income, gain, loss, deduction or credit.
Significantly, the draft instructions provide that a taxpayer would not be required to include a tax position on Schedule UTP until the tax year in which the tax position is actually taken in a tax return. For this purpose, a tax position is taken in a tax return if there would be an adjustment to a line item on that tax return (or the tax position would be included in a Section 481(a) adjustment) if the position was not sustained. Because a line item on a tax return may be affected by multiple units of account, each unit of account that affects a line item on a tax return would have to be reported separately on Schedule UTP. Moreover, a taxpayer would not be required to report a tax position that was taken in a prior year tax return if the taxpayer reported that position on a Schedule UTP filed with the prior year tax return. However, if a transaction results in a taxpayer taking tax positions in tax returns for more than one year (and a decision whether to reserve has been made, as discussed below), then the tax positions arising from that transaction would have to be reported on Schedule UTP and attached to the tax return for each year in which a tax position with respect to the transaction is taken. This would be the case even if the transaction or a tax position resulting from the transaction was disclosed in a Schedule UTP filed with a prior year’s tax return.
Schedule UTP is comprised of three parts. Part I would be used to report tax positions taken in the tax return for the current tax year if, with respect to that tax position, (1) the decision to record a reserve or (2) the decision not to record a reserve on the basis of an expectation of litigation or an IRS administrative practice, was made at least 60 days before the current year tax return is filed.6 For each tax position, the taxpayer would be required to list the primary Code sections relating to the tax position, categorize the tax position as a temporary or permanent difference and provide the employer identification number of any related pass-through entity if the tax position relates to a tax position of a pass-through entity.7 Part I would also allow a taxpayer to check a box if it is unable to obtain sufficient information from one or more related parties and, as a result, is unable to determine whether a tax position taken in the current year’s tax return is required to be reported.
Part I would also require that, for each tax position that is not a valuation tax position or a transfer-pricing tax position, the taxpayer must state the maximum tax adjustment (“MTA”) amount with respect to that tax position. The MTA for a tax position is an estimate of the maximum amount of potential U.S. federal income tax liability (exclusive of interest or penalties) associated with the tax year for which the tax position was taken. In particular, for a tax position that relates to items of income, gain, loss and deduction, the MTA would be determined by multiplying the total amount of the item by 0.35 (35%).8 For a tax position that relates to an item of credit, the MTA would be determined by estimating the total amount of the credit.9 Additionally, each item of income, gain, loss, deduction or credit relating to a tax position taken in a tax return would have to be determined separately and could only be offset by other items relating to the same tax position.10
Although a determination of a MTA amount would not be required for valuation or transfer-pricing tax positions, the taxpayer would be required to rank such tax positions with respect to other valuation or transfer-pricing tax positions, respectively, according to either the estimated adjustment to U.S. federal income tax that would result if the tax position was not sustained or, if applicable, the amount recorded as a reserve for that tax position. The taxpayer would be allowed to choose either method and would not be required to describe the method chosen or to report the reserve or adjustment amounts for the reported positions. However, the method selected would have to be consistently applied to all valuation positions and transfer-pricing positions reported on Schedule UTP. If a tax position is a valuation tax position, the draft instructions would require a taxpayer to enter “V” for valuation under the MTA column heading followed by a number representing the ranking of the tax position within all reported valuation tax positions (e.g., V1, V2 etc.). If a tax position is a transfer-pricing tax position, the taxpayer would be required to enter “TP” for transfer pricing followed by a number representing the ranking of the tax position within all reported transfer-pricing tax positions (e.g., TP1, TP2 etc.).
Part II of the draft schedule would be used to report tax positions taken in a prior tax year that have not already been reported on a Schedule UTP if, with respect to that tax position, (1) the decision to record a reserve or (2) the decision not to record a reserve on the basis of an expectation of litigation or an IRS administrative practice, was made at least 60 days before the current year tax return is filed. However, the draft instructions make clear that a corporation would not be required to report a tax position taken in a taxable year beginning before December 15, 2009, or in a short tax year beginning on or after December 15, 2009, and ending before January 1, 2010. Accordingly, disclosures on Part II would not be required for the 2010 tax year. For each tax position listed in Part II, the taxpayer would be required to provide the same information as in Part I, as well as state the prior tax year in which the tax position was taken. Additionally, Part II would allow a taxpayer to check a box if it was unable to obtain sufficient information from a related party to determine whether a tax position is required to be reported.
Part III would require a concise description of each tax position listed in Part I or Part II. The description would have to include information that “reasonably can be expected to apprise the IRS of the identity of the tax position and the nature of the uncertainty” as well as the following information: a statement that the position involves an item of income, gain, loss, deduction, or credit against tax; a statement whether the position involves a determination of the value of any property or right or a computation of basis; and the rationale for the position and the reasons for determining the position is uncertain. The draft instructions provide several sample descriptions and explain that, in most cases, the description should not exceed a few sentences. The sample descriptions illustrate the fact that the IRS is expecting taxpayers to be very specific in describing each uncertain tax position and it seems likely that these descriptions would be used to guide IRS revenue agents to the issues on which they need to focus during an examination. Importantly, Schedule UTP and the accompanying draft instructions would not require a taxpayer to disclose its risk assessment or tax reserve amounts, although IRS Announcement 2010-9 asserted that the IRS would have the power to compel production of such information pursuant to United States v. Arthur Young.11
The draft instructions also provide that an affiliated group of corporations filing a consolidated return would be required to file a Schedule UTP for the affiliated group as a whole and would not be required to identify the member of the group to which the tax position relates or which member recorded the reserve for the tax position. Moreover, the determination of a MTA amount for a tax position taken in a tax return filed by an affiliated group would have to be determined at the affiliated group level and would be required to take into account all items of income, gain, loss, deduction or credit with respect to that tax position for all members of the affiliated group.
IRS Announcement 2010-30 states that the IRS is continuing to review the extent to which Schedule UTP duplicates other reporting requirements, such as Form 8275, Disclosure Statement; Form 8275-R, Regulation Disclosure Statement; Form 8886, Reportable Transaction Disclosure Statement; and Schedule M-3, Net Income (Loss) Reconciliation for Corporations With Total Assets of $10 Million or More. However, the draft instructions do provide that a taxpayer would be treated as having filed a Form 8275 or Form 8275-R for tax positions that are properly reported on Schedule UTP, thereby reducing the need for separate filings. Moreover, the draft instructions specifically reserved on the issue of the penalties that would be imposed on taxpayers who do not fully comply with Schedule UTP.
Although both Schedule UTP and the accompanying instructions currently exist only in draft form, IRS Announcement 2010-30 makes clear that the IRS intends to finalize both documents after reviewing and considering public comments received by June 1, 2010. In the meantime, corporate taxpayers will need to consider whether they will be subject to the new reporting requirements and, if so, how to comply with them. Please contact any of the individuals listed below or the lawyer with whom you normally work if you would like more information on the application of Schedule UTP and the accompany draft instructions to your particular circumstances.
- 2010-7 I.R.B. 408.
- IRS Announcement 2010-17, 2010-13 I.R.B. 515.
- For this purpose, a related party would be defined as any entity that is related to the corporation under Sections 267(b), 318(a), or 707(b) of the Internal Revenue Code of 1986, as amended (the “Code”). Unless otherwise noted, all “Section” references contained in this memorandum are to the Code.
- Schedule UTP would require a taxpayer to check a box if the tax position is reported because it was determined that, based on IRS administrative practice, the IRS would not challenge the position upon examination.
- For example, in a situation involving a research project that results in a $1 million research and experimentation credit, one corporation may conclude that the entire project constitutes a separate unit of account whereas another corporation may instead determine that each component experiment of that project constitutes a single unit of account. See, e.g., FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109, ¶¶ A5-A9 (codified in 2 FINANCIAL ACCOUNTINGS STANDARDS BOARD, ACCOUNTING STANDARDS CODIFICATION 740-10 (2009)).
- If the decision to record a reserve, or the decision not to record a reserve on the basis of an expectation of litigation or an IRS administrative practice, is made within 60 days before the tax return is filed, the taxpayer could choose to report such tax position in either Part I of Schedule UTP for the current tax year or Part II of Schedule UTP for the next tax year.
- The draft instructions define a “pass-through entity” as any entity listed in Section 1(h)(10).
- For example, the MTA for a tax position taken in a tax return claiming a $100 deduction would be $100 x 0.35 or $35.
- For example, the MTA for a tax position taken in a tax return claiming a $50 credit would be $50.
- For example, if a $100 deduction is associated with a tax position taken in a tax return, the taxpayer would be required to report a MTA of $35 on Schedule UTP, even if that deduction is used to offset $100 of income generated by general operations of the business. However, if income of $100 is associated with a tax position taken in a tax return and a deduction of $300 is associated with that same tax position, then the taxpayer would have to report a MTA of $70 [($300 - $100) x 0.35].
- 465 U.S. 805, 815 (1984).