Kip Dellinger

Uncertain Tax Positions: The Proposed IRS Disclosure Regime

How does it impact private entities?

October 14, 2010
by Kip Dellinger, CPA

On September 8, 2010, the Internal Revenue Service (IRS) used its rule-making authority to make clear that it intends to require certain corporation taxpayers to disclose Uncertain Tax Positions (UTPs) on a schedule attached to the taxpayer’s return beginning with returns filed for calendar year 2010. The Service amended the regulations under Section 6012. That Section requires corporations to file income tax returns and, historically, the IRS has been granted broad authority to prescribe the form and content of returns. The proposed regulation addition authorizes the IRS to require that certain corporations must disclose UTPs in accordance with forms, instructions or other appropriate guidance provided by the IRS. The IRS followed that release with Announcements 2010-75 and 2010-76.

Issued September 24, 2010, they significantly revised the initial reporting requirements previously proposed in Announcement 2010–30 issued in March and accompanied by proposed Schedule UTP and related instructions.

Reader Note: Don’t miss Kip Dellinger’s session at the upcoming AICPA National Tax Conference, October 25 – 26, 2010 in Washington, DC.

Certainly, in view of the language of the regulations, the cliché that the “devil is in the details” is appropriate and both the initial and final 2010 Schedule UTP and its instructions represent those details.  The January 2010 proposal requested comments from impacted parties and the comments were voluminous. According to the initial proposals, corporate taxpayers with total assets of $10 million or more would be required to comply with the disclosure regime. While that threshold remains, the revisions to the disclosure regime provide that it will be phased in between 2010 and 2014; for tax years beginning in 2010 and 2011, the threshold for filing UTP will be $100 million, for 2012 and 2013 it will be $50 million and for 2014 it arrives at $10 million.

The new guidance also clarifies that IRS is only requesting disclosure of federal UTPs that are reserved in an Entity’s audited financial statements under U.S. GAAP, IFRS or other accounting standards because they are determined to be material for financial statement purposes — a separate or different meaning for tax disclosure is not required.

ASC 740.10 requires a determination, for purposes of reporting under generally accepted accounting principles of tax liabilities under FAS 109 — Accounting for Income Taxes (ASC Topic 740) of whether a claimed tax benefit may be recognized for financial statement purposes and, if so, in what amount. The financial statement issuer must believe that any tax benefit claimed meets a “more likely than not” confidence threshold in the event it were to be challenged by a tax authority. Even if it meets that threshold, if there is sufficient uncertainty that the position would be sustained in full, the financial statement issuer must estimate the amount of benefit that would be realized upon settlement with the tax authority. Similar rules regarding tax accruals are contained in IAS 12.

The draft Schedule UTP required disclosures of the gross potential tax amount (maximum tax adjustment or “MTA”) of the UTP for each Federal position, that is, before the financial statement “measurement” estimate of settlement. For transfer pricing and valuation UTP items, no dollar amount was required, but multiple items of this type were to be ranked in size of potential adjustment for each category. Under the new proposal regime (released as a “final” document by IRS), this basic process is to be followed for all other UTPs treated as a single category. A position, if any, that exceeds 10 percent of the Entity’s total reported UTP reserve for financial statement purposes (i.e. including state, local and foreign UTPs) is to be identified.

Further, entities were to include in a concise description of each UTP in which they described the rationale for claiming the tax benefit attributable to the UTP. This requirement is eliminated in the final guidance.

The guidance also clarifies that the disclosure regime only applies to subject entities whose financial statements are audited. The disclosure regime does not apply with respect to review or compilation financial statements even when those statements contain Income Tax reserves.

In addition, as initially proposed, the taxpayer was required to disclose UTPs that were not reflected in the financial statement estimates because the taxpayer believes that the tax treatment, while not in strict compliance with tax law, would not be challenged because IRS administrative practice accepts the taxpayer’s treatment. The revisions do not require reporting of these types of positions, the IRS clearly having listened to affected parties and concluded that there is little to be gained from requiring them to be disclosed.

Also, not reported for financial statement tax accrual purposes but required to be disclosed on Schedule UTP, are financial statement positions with respect to which the taxpayer intends to litigate, if challenged and believes it would prevail. With regard to the later two types of UTPs, representatives of the IRS indicate that the Service is considering eliminating the extended reporting obligation; however, IRS has not — to date — withdrawn or replaced those proposals. The provision was retained in the revised guidance, but they can be assigned any rank by the reporting entity without consideration to the amount of the position.

Privilege and Similar Work Product Assertions by Entities

Announcement 2010-76 addresses subject taxpayer concerns about the intrusion into privileged communication between the entities and their tax advisers; this Announcement states that IRS will retain a policy of restraint with respect to requests for tax accrual work papers (and the continued policy of not requesting “tax exposure analyses” contained in “tax provision reconciliation” work papers). It also states that the IRS will generally respect applicable or appropriate privilege and work product claims consistent with existing law and will generally assert that those privileges are waived by sharing the information with auditors.

The impact of this portion of the guidance on private entities is likely to be quite different than for public companies in most cases. Public companies criticized the proposals as intrusive and also asserted that they intensify the ongoing debate over a taxpayer-financial statement issuers’ right to seek attorney-client and work-product privileges to protect disclosure of certain communications pertaining to advice with respect to tax positions taken by them. These privileges — particularly work product privilege claims for information shared with an “independent auditor” — are themselves subject to uncertainty and recently have been the subject of significant litigation.

However, the auditor-tax adviser “service model” for public companies most often involves companies that prepare their own tax returns and obtain “filing advice” from tax lawyers. This information is shared with the auditor CPA firm for purposes of evaluating a company’s tax provision; companies contend that the limited purposes of sharing this information does not constitute a “waiver” of privilege with respect to preventing discovery of a company’s communications with tax counsel. The recent guidance confirms that the IRS generally agrees with the impacted party’s position with regard to this “service model.”

But the “service model” for CPA firms and private companies is generally very different from the public company service model. Most private companies do not prepare their tax returns internally and most private companies engage the same CPA to perform their audit or review services and to prepare their tax returns and to provide their significant tax advice.

Consequently, the outcome of the ongoing controversy with respect to privilege and work product privileged communications with CPAs is inapplicable. Information and communications related to tax return preparation is virtually never subject to privilege claims because it is communicated for the purpose of preparing a tax return — a document that is intended to be provided to the government. While all sorts of objections might be raised by these companies when the IRS seeks CPA tax and related work papers, they are not likely to be sustained and the costs of defending against IRS pursuit of the information would likely be prohibitive. So, to a large degree, when it comes to asserting privilege claims, private companies and their CPA firms do not really have “a dog in the fight.” CPAs as advisers to their clients should be aware of and make their clients aware of the limitations on privilege claims.

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Kip Dellinger, CPA, is senior tax partner at Los Angeles, CA-based Kallman And Co. LLP. He is a past-Chair of the AICPA Tax Divisionís Tax Practice Responsibilities Committee and is the author of the Practical Guide to Federal Tax Practice Standards (CCH, 2007). He developed and teaches full day courses on Tax Practice Standards, Conduct and Quality Control for California CPAs, FIN 48: Uncertain Tax Positions and Quality Control in a Tax Practice for the Education Foundation of the California Society of CPAs. He will be a presenter at the AICPA National Tax Conference, held October 25-26, 2010 in Washington, DC.