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Michael Petrik
Michael Petrik
Uncertain Tax Position Reporting Proposed

As soon as returns for 2010 are done, why larger business taxpayers may be required to specifically identify their “uncertain tax positions” on their federal income tax returns.

February 11, 2010
Michael Petrik, JD

Internal Revenue Service (IRS) Announcement 2010–9 (January 26, 2010) advises taxpayers that the IRS anticipates publishing a notice of proposed rulemaking to require certain business taxpayers to identify and describe their “uncertain tax positions” on their income tax returns. The Announcement does not state an effective date, but the closing date for comments is March 29, 2010. Therefore, it is unlikely that any new reporting could be required for returns for periods ending before the date of the Announcement. Any such requirement likely would be applicable only to returns for periods ending after the date of a notice of proposed rulemaking or the regulation, which could come later this year.

Taxpayers Affected

The affected taxpayers would be:

  1. Any business taxpayer,
  2. With more than $10 million in total (gross) assets,
  3. Who has at least one “uncertain tax position” that affects its return for the year and
  4. Who determine U.S. federal income tax reserves under FIN 48 or other accounting standards relating to uncertain tax positions.

The Announcement intends to capture uncertain positions affecting related parties. There likely will be detailed guidance on identifying the relevant related entities.

Uncertain Tax Position

The Announcement defines an uncertain tax position as any position for which the taxpayer has established an accounting reserve or for which no reserve has been established because:

  1. The taxpayer expects litigation or
  2. Is relying on the Service’s “general administrative practice not to examine the position” as the reason not to reserve for the position.

These non-reserve cases are unclear; the Announcement specifically asks for comments on the wisdom of the second one.

Taxpayers do establish reserves for positions for which they expect litigation; that is not usually a reason not to establish a reserve, but just the opposite. Perhaps the Announcement is referring to a position to be asserted by amended return as to which the taxpayer expects litigation? Clarification is needed.

As to a general administrative practice not to examine an unreserved position, whose practice does the Announcement have in mind? Large and Mid-Size Business’ (LMSB) or the IRS National Office’s willingness to rule a certain way (the all-cash D reorganization would be an example)? There is little documentary evidence of LMSB administrative practice, and the Chief Counsel’s National Office does not control or direct examinations. Therefore, this category also will need clarification.

Risk Analysis

The Announcement specifically excludes information about the taxpayer’s risk analysis from the information sought. That is, it aims to avoid the disputes over obtaining the taxpayer’s or the taxpayer’s advisor’s evaluation of the uncertain position that estimates the chances of success.

In this regard the Announcement rather skillfully attempts to thread a more fruitful path for the IRS between the acrimonious attempt to obtain taxpayer’s tax accrual workpapers and the difficulties of reverse engineering uncertain tax positions from the book-tax difference disclosures.

But the Announcement states that the Service will continue to use its claimed power to obtain tax-accrual workpapers, while exercising restraint under its pre-existing policy. If and when the new disclosures proposed by the Announcement are required, it seems that the Service will have little legitimate need for the taxpayer’s tax-accrual workpapers or related professional advice. After all, there never has been a good justification for getting into the tax advisors’ thought processes. Rather, once the Service has uncovered uncertain positions, any additional information gathered mostly has been used to try to taint the taxpayer in the eyes of a court.

Information Sought

The information about the uncertain positions, once identified by the taxpayer, that the Announcement says will be sought is fairly generic, with one exception: “… this concise description will include the rationale for the position and a concise general statement of the reasons for determining that the position is an uncertain tax position.”

Taxpayers normally will view the type of information described in this quotation as privileged. Taxpayers will worry that saying anything about such matters could waive the privilege. If the statement contemplates something like “The notes have most of the traditionally accepted characteristics of debt, but the Service might argue otherwise,” then perhaps taxpayers can live with it. But if the Service requires more, difficulties will arise.

Penalties

The Announcement indicates that legislation may be sought to penalize failure to provide the information on uncertain positions.

State Tagalongs?

The proposed reporting obviously will not help the states much in their quest for revenue, but it could give them the idea to require similar self-identification of positions reserved for state taxes. States may have some trouble, however, defining exactly what should be reported because few taxpayers reserve a material amount as to any particular state’s taxes; rather reserves for state tax positions usually apply to multiple states affected by a common transaction or structure.

What to Do Now?

If prior initiatives in this area are any guide, there will be many protests and substantial modifications to this proposal before a final requirement is put in place. However, practitioners should start now to think about how business taxpayers will reserve for transactions occurring in 2010. Reserves and this new reporting should be part and parcel of current transaction planning. It may be that some transactions can be modified enough to preclude any reserve, which looks like the best way out of the reporting.

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Michael Petrik, JD, is chair of the State and Local Practice Group at Alston + Bird LLP. He concentrates his practice on sophisticated, multistate tax planning and disputes for businesses, including income tax, franchise tax, sales/use tax and other state and local taxes.