|Uncertain Tax Position Reporting Looking More Likely
Why tax practitioners should consider how Schedule UTP will affect both corporate tax planning and reporting.
June 10, 2010
IRS Announcement 2010-30 revealed the draft Schedule UTP for reporting Uncertain Tax Positions. The finalization of the Schedule seems to be on a fast track as comments must be submitted by June 1, 2010. The IRS proposes to require the Schedule for corporate return years beginning on or after December 15, 2010. The reporting required by this Schedule could bring about the most significant change in corporate tax reporting since the creation of the 20 percent substantial understatement penalty. It is potentially much more significant than recent the codification of the economic substance doctrine.
The Nature of the Filing
Up to now taxpayers have been invited to inform the Internal Revenue Service (IRS) of “tax shelters” or uncertain positions they were taking on their returns in order to avoid or reduce potential penalties. Therefore, such reporting has been “optional” in the sense that failing to report was not the failure to file a required form. The reporting that will be required by Schedule UTP is not optional. If the taxpayer fits the category described in the Schedule’s instructions, it must complete the Schedule and attach it to its Form 1120. Intentional failure to file the Schedule will be a serious error by the taxpayer.
The function of the Schedule is to remove the “audit lottery” from consideration by taxpayers and to give the IRS auditors a roadmap to identify the tax positions about which the taxpayer has sufficient doubt to record a reserve (and in certain other cases). In a change from prior audit practice, the IRS will not be seeking to learn the size of the reserve, although the Schedule does ask the size of the maximum tax adjustment if the taxpayer is wrong about its tax position as reported.
Which Taxpayers Will Have to File Schedule UTP
The IRS has chosen not to require filing by all entities and so partnerships, including limited liability companies treated as partnerships, no matter how large, will not be required to file the Schedule. Individuals will not be required to file the Schedule. It must be filed by a corporation that:
Uncertain Tax Positions
The Schedule did not have to define uncertain tax positions, in contrast with the statutory definitions of “tax shelters,” and other penalty-related positions, because it relies on the U.S. Generally Accepted Accounting Principles (GAAP) or other financial statement audit standards to do that work in identifying the reserve. However, the Schedule’s instructions add two cases in which the taxpayer must report uncertain tax positions for which it does not record a reserve, if:
These two additional cases may turn out to be the most difficult part of completing the Schedule. On the one hand the taxpayer cannot rely on the IRS’s administrative practice to avoid reporting; but on the other hand if it knows the IRS will take an unreasonably harsh view of a position it must report it even if the taxpayer is fairly certain it will win. An example in the instructions shows a taxpayer with a 60 percent chance of prevailing in litigation, which still must report an unreserved tax position on the Form because it knows the IRS probably will not settle the issue if audited.
Details of Reporting
Several important sub-issues are addressed in the instructions:
The instructions give examples that basically describe a transaction in one or two sentences, state in one sentence the tax position taken with regard to the transaction and state in one sentence the “issue” or nature of the uncertainty. The taxpayer is not required to report the degree of uncertainty.
What to Do
It is highly likely that the IRS will finalize this reporting requirement for tax years beginning on or after December 15, 2010, which means that corporations will begin to file these reports in less than two years. However, beginning as early as next January taxpayers will begin to record reserves or decide not to record reserves and thereby trigger a reporting obligation. Therefore, it is not too early to begin to consider how this Schedule UTP will affect both corporate tax planning and reporting.
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Timothy J. Peaden is a partner in Alston & Bird’s State and Local Tax and Federal Income Tax Groups. Peaden is a frequent author and speaker on tax litigation topics. L. Andrew Immerman is a partner in Alston & Bird’s Federal Income Tax and International Tax Groups. Immerman is a frequent author and speaker on domestic and international income tax topics.