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Mary Bernard
Uncertain Tax Positions

Does the new Uncertain Tax Position Statement reveal FASB Interpretation No. 48 (FIN 48)-created roadmap?

October 28, 2010
by Mary Bernard, CPA

The Internal Revenue Service (IRS) recently posted the final version of Schedule UTP, Uncertain Tax Position (UTP) Statement, to its website. Comments were solicited earlier this year on the draft of the form to report tax positions taken that affect US federal income tax liabilities of certain corporations that issue audited financial statements.

Roadmap

Schedule UTP’s proposal raised many concerns among practitioners who claimed that the IRS was requiring a detailed roadmap of all UTPs that would affect who was audited and what issues and resources should be addressed. It was thought that the adversarial nature of our tax system was being contravened by the requirement of self-reporting possible audit issues. In order to remove the appearance of requiring the reporting of a risk assessment, IRS issued Announcement 2010-76 in September. In this announcement, the IRS expanded its policy of restraint in connection with its decision to require the completion of Schedule UTP and refrained from requesting particular documents that related to UTPs and the workpapers used to complete the schedule. This policy of restraint, however, does not create or imply the application of attorney-client privilege, the tax advice privilege under Internal Revenue Code section 7525 or the work-product doctrine to any document of any taxpayer or third party.

Entities Impacted

Corporations filing U.S. Corporation Income Tax Returns on Forms 1120, 1120-F (Foreign Corporations), 1120-L (Life Insurance Company) or 1120-PC (Property and Casualty Insurance Company) are required to attach Schedule UTP if:

  1. The corporation has assets that equal or exceed $100 million (for 2010 and 2011 tax years);
  2. The corporation issued audited financial statements, separately or with a related party, to report all or a portion of the corporation’s operations for any portion of the corporation’s tax year; and
  3. The corporation has one or more tax positions that must be reported.

What Is an Uncertain Tax Position?

A tax position taken on a tax return means a tax position that would result in an adjustment to a line on that tax return if the position is not sustained. If multiple tax positions impact a single-line item, each tax position is a separately reportable position on the tax return.

A tax position must be reported if a reserve was recorded under applicable financial accounting standards or if no reserve was created due to the expectation of litigation. The analysis of whether a reserve is recorded is determined by reference to decisions made by the corporation for purposes of the entity’s audited financial statements. The financial statements may be prepared based on U.S. Generally Accepted Accounting Principles (GAAP), International Financial Reporting Standards (IFRS) or other country-specific accounting standards. The analysis of reserves must be consistent with the method used in preparing the financial statements.

The concept of a tax reserve is taken directly from FASB Interpretation No. 48 (FIN 48). The draft instructions for Schedule UTP define a reserve as follows:

“In general, a corporation or a related party records a reserve with respect to a tax position taken by the corporation when any of the following occurs in an audited financial statement of the corporation or related party:

  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,
  2. A reduction in a deferred tax asset or an increase in a deferred tax liability with respect to the tax position or
  3. Both (1) and (2) above.”

In the draft of the Schedule UTP, the IRS was originally requested that reporting of uncertain tax positions include the rationale for the position taken as well as the maximum tax adjustment due to this position. After reviewing responses from the comment period, these requirements were eliminated. The objection to including corporations with $10 million in assets in this reporting requirement resulted in a five-year phase-in based on the corporation’s asset size. Beginning in 2010, corporations with $100 million in assets are included. This asset threshold is reduced to $50 million beginning with 2012 tax years and further reduced to $10 million beginning with 2014 tax years.

Ranking

Having eliminated the requirement to report the maximum tax adjustment, the IRS included instead a ranking of the uncertain positions. In addition, any tax position that exceeds 10 percent of the aggregate amount of the reserves for all of the tax positions reported on the schedule must be indicated as such. The size of each tax position is determined on an annual basis and is the amount of the U.S. federal income tax reserve recorded for that position. If a reserve is reported for multiple positions, then a reasonable allocation of the reserve among the tax positions reported must be made in determining the size of each tax position. The relative size is determined by dividing the position by the sum of all the sizes of tax positions disclosed. For this purpose, the positions with expectation of litigation are disregarded.

In lieu of disclosing the relative tax values involved, tax positions must be ranked in order of largest to smallest. Positions with expectation of litigation may be assigned any order. Transfer pricing positions must be separately identified as such in the resulting ranking presented.

Concise Description

In disclosing UTPs, a concise description of the tax position is required. This description must include relevant facts affecting the tax treatment of the position and information that can reasonably be expected to inform the IRS of the identity of the tax position and the nature of the issue. It is expected that the description will not exceed a few sentences. “Available upon request” will not be considered an acceptable description. The IRS has eliminated the proposed requirement that taxpayers include the rationale and nature of the uncertainty in the concise description.

The following is an example of an acceptable concise description detailed in the form instructions:

“The Corporation incurred costs during the tax year to clean up environmental contamination that was caused by its activities in prior years at site A, which contains both its manufacturing facility and its corporate headquarters. The issue is the allocation of the cleanup costs between X’s production and nonproduction activities under section 263A.”

Administrative Practice Tax Positions

As Schedule UTP was originally proposed, corporations would have been required to report tax positions for which the corporation recorded no reserve because it determined that it is the IRS’s administrative practice not to raise the issue during an examination. The IRS has decided that it would be unduly burdensome for corporations to identify, describe and quantify these positions and it would provide the IRS very little useful information. Therefore, it has eliminated the proposed requirement; however, the IRS has stated it will continue to explore ways to assess the impact of these tax positions on overall tax compliance.

Transition Rule

As 2010 is the first year of this disclosure requirement, only tax positions taken after January 1, 2010, are required to be reported. Even if a reserve is recorded on financial statements issued in 2010 relating to a tax position, this position need not be disclosed if the position was taken prior to January 1, 2010 and has no impact on the 2010 tax return if the position is not sustained. If, however, the reserve for the uncertain tax position involves continuous years, as in the case of an uncertain five-year amortization of an expense, the position must be reported in each of the years affected by this reserve.

Conclusion

The IRS has internally explained the use of Schedule UTP as providing information regarding trends and areas requiring further guidance to address uncertainties in the law. The Service will also create a working group to study and revise Schedule M-3, Net Income (Loss) Reconciliation for Corporations with Total Assets of $10 Million or More, to eliminate duplication of reporting. Schedule M-3 will most likely be revised to remove the information provided by the Schedule UTP. While some guidance on areas of concern is provided in the instructions, further clarification is still needed to properly implement the level of reporting sought by the IRS.

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Mary F. Bernard, CPA, is director — income/franchise tax, at the Dallas, Texas-headquartered tax services firm of Ryan. Bernard formerly worked as principal, director of State & Local Tax Services, at Providence, RI-basedKahn, Litwin, Renza & Co., Ltd.