One of our readers recently emailed us with a question about the application of the new Schedule UTP to deferred tax assets. The question is straightforward enough: must uncertain positions involving deferred tax assets be reported on Schedule UTP and, if so, when must they be reported? The explanation, thanks to confusion created by several examples in the final Schedule UTP instructions, is anything but straightforward. Let’s start with a little background.
Posted tagged ‘FIN 48’
The Reporting Requirements for Deferred Tax Assets Under Schedule UTP: IRS Instructions Muddy The WatersNovember 23, 2010
The Internal Revenue Service on Friday released the final version of the much-anticipated Schedule UTP (and accompanying instructions) as well as additional guidance about changes that had been made the schedule. At the same time, the IRS also announced an expansion of the Compliance Assurance Program (CAP) as well as some other minor matters. In the face of much criticism of the draft Schedule UTP and instructions, the IRS made a numbers of significant adjustments; however, several issues remain unresolved.
By David L. Bernard
TaxBlawg’s Guest Commentator, David L. Bernard, is the recently retired Vice President of Taxes for Kimberly-Clark Corporation, a past president of the Tax Executives Institute, and a periodic contributor to TaxBlawg.
As the IRS sifts through dozens of comment letters on the proposed disclosure of uncertain tax positions, in-house tax officers have to wonder what’s next. Over the last decade, CTO’s have been hit with a barrage of new demands and worries. We have seen the rise of FIN 48 (now ASC 740-10), Sarbanes-Oxley and the resulting increased focus on controls, increasingly burdensome quarterly and annual attest firm reviews, listed transactions disclosures, the electronic filing mandate (Everson’s legacy), Schedule M-3, and now the still proposed UTP disclosure.
Notwithstanding the new challenges, the number one performance metric used to judge a tax department’s performance is still the effective tax rate (“ETR”). CTO’s and their staffs continue to be measured by their delivery on the ETR at a time when most at the IRS seem to believe that all tax planning is bad, outside counsel is becoming more cautious, attest firms are insisting to review opinions (thus jeopardizing privilege), budgets and head count have been cut and, oh by the way, “cash is king”.
By Phil Karter
Last week, at the TEI Midyear Conference in Washington, LMSB Commissioner Heather Maloy told corporate tax executives attending the conference that “trust” was the key to successfully implementing the new reporting requirements for uncertain tax positions first set forth in Announcement 2010-9. As reported in the April 14th edition of Tax Notes, 2010 TNT 71-2, Maloy also told the attendees that enhanced transparency through the use of this reporting mechanism would be “mutually beneficial” in terms of improved issue resolution and efficiency.
Last month, I commented on an aspect of Announcement 2010-9 that had received relatively little attention, namely the requirement that taxpayers must file the new disclosure form not only when recording a reserve in their financial statements, but also when expecting to litigate “uncertain tax positions” even if no reserves are recorded. (For earlier commentary, click here.) The concern I articulated was whether the failure to disclose a tax position for which no reserve was claimed would precipitate an attack on taxpayer claims of work product, which rely on an “anticipation of litigation” standard.
The proposed new Schedule UTP and its accompanying instructions, released in draft format yesterday, don’t help us much in forecasting an answer to this question. A single example of the expectation to litigate is provided in the proposed instructions:
A corporation takes a position that it can exclude certain income from its 2010 tax return. On September 30, 2010, the corporation determines that, if the IRS had full knowledge of the tax position, there is less than a 50% probability of settling the issue with the IRS. The corporation also determines that, if the tax position were litigated, it has a 60% probability of prevailing in the litigation. Based upon these determinations, the corporation did not record a reserve for the tax position. Because the corporation made a decision not to record a reserve with respect to its 2010 tax position based on a determination, consistent with applicable accounting standards, that it will litigate, rather than settle, the issue with the IRS and that the corporation will prevail in the litigation, and because that decision was made more than 60 days before filing its 2010 tax return, the corporation must report this tax position on the Schedule UTP filed with its 2010 tax return.
On its face, the lesson from this example seems clear enough. A taxpayer who concludes it has a more likely than not chance of winning an issue in litigation should recognize the entire tax benefit in its financial statements under FIN 48 and claim no reserve.
Nonetheless, the unlikelihood of settling an issue the taxpayer believes is better than a 50% bet means that litigation is a virtual certainty unless the dollars involved do not justify the litigation cost. How can a taxpayer afford not to file Schedule UTP in that instance and still feel assured that any legal analysis of the issue retains its protected status as attorney work product? The answer is that it can’t – at least not without clarification from the Service about whether and when an attack on work product claims will be raised if the Schedule is not filed (or a working assumption that work product protection may not attach). Even that may not be enough. In refund suits, litigation strategy is the province of the DOJ Tax Division. Absent the public articulation of a coordinated and consistent policy of restraint over when and when not to dispute work product claims on the basis of a taxpayer’s failure to file Schedule UTP, taxpayers can take little comfort that they won’t wind up in a discovery dispute over legal analysis that has been traditionally the beneficiary of robust protection from disclosure. Of course, that may all be part of the plan. Nonetheless, the ability to “trust” the push toward greater disclosure may require the Service and DOJ to “verify” their ultimate intentions.
Finally, consider the circumstances where a taxpayer believes it is “spot-on” on an issue that has been litigated successfully by other taxpayers before, only to be challenged again, perhaps in another jurisdiction. Such a case would not require the establishment of a reserve and the taxpayer may have had good reason to believe the issue would not be challenged or, if challenged, would likely be settled favorably. Should a Schedule UTP be filed in that instance? Arguably not, but how does a taxpayer prove it believed litigation was unlikely? Such a circumstance is arguably a classic Catch-22. On one hand, the taxpayer needs to document the basis for its analysis that litigation was unlikely to justify its decision not to file the schedule. On the other hand, if the taxpayer’s prediction is wrong and the issue is disputed, it will be difficult to claim work product protection for the analysis because it is unlikely to satisfy the anticipation of litigation requirement.
The moral of the story is that a decision not to file Schedule UTP should be well documented, but with the working assumption that the legal analysis supporting the decision will likely be subject to disclosure if the matter ends up in litigation unless it fits under the umbrella of attorney-client privilege.
By Phil Karter
Predictably, there has been a good deal of consternation accompanying the release of IRS Announcement 2010-09, which continues the trend away from the Service’s traditional “policy of restraint” in seeking to uncover uncertain tax positions. The first chink in this long-standing policy of restraint was exhibited in Announcement 2002-63, where the Service expanded the circumstances under which it would seek tax accrual workpapers. Prior to the earlier Announcement, workpaper demands were limited to workpapers relating to listed transactions provided such transactions had been disclosed. Thereafter, a taxpayer who engaged in more than one listed transaction, whether previously disclosed or not, was subject to a demand to disclose all workpapers. The IRS’s summons enforcement action in Textron relied on Announcement 2002-63 to seek all of the taxpayer’s workpapers (arguing that six separate SILO transactions fit within the scope of its new policy).
Announcement 2010-09 goes significantly further in eroding the policy of restraint by placing the onus on the taxpayer to make its own affirmative disclosures of uncertain positions rather than requiring the Service to deduce them from the taxpayer’s workpapers. What has received little attention, however, are the implications of the Service’s intention to require the new disclosure form not only for taxpayers who record a reserve in their financial statements for uncertain tax positions, but also taxpayers who “expect to litigate the position.”