So It Begins: The Final Schedule UTP Is Out

By Jonathan Prokup

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.

For more information, see Announcement 2010-75, Announcement 2010-76, the Schedule UTP and Instructions, as well as the IRS’s related internal directive and Commissioner Shulman’s remarks to the ABA meeting.

The final schedule still requires taxpayers to identify each uncertain position and the Code section(s) that is/are implicated by the position as well as give a concise description of the each position.  At the same time, a number of important changes have been made, including:

  • Ranking of Reserves; No Reporting of Maximum Exposure.  Whereas the draft schedule required that taxpayers generally disclose a maximum tax adjustment for each position, the final schedule requires only that each reported position be ranked based on the size of the reserve recorded for each such position.
  • No Disclosure of Rationale/Nature of Uncertainty.  One of taxpayers’ most significant concerns with the draft schedule was that it would have required an explanation of the rationale for the uncertain positions.  Taxpayers protested that such information should be protected as a form of work product.  In response to the objections, the IRS has eliminated the requirement to include the rationale and nature of the uncertainty.  Only a concise description “that reasonably can be expected to apprise the Service of the identity of the tax position and the nature of the issue” is required.
  • No Disclosure of “Administrative Practice” Positions.  The draft schedule required taxpayers to report positions for which no reserve was recorded because of an administrative practice by the IRS not to raise the issue during examinations.  Acknowledging concerns about the administrability of the proposal, the IRS has eliminated the requirement, but “will continue to explore ways to assess the impact of [such] positions on overall tax compliance.”
  • No Disclosure of Immaterial/Sufficiently Certain Positions.  In response to taxpayer comments, the final instructions clarify that corporations need not report positions that are either “immaterial” or “are sufficiently certain so that no reserve is required” under applicable financial accounting standards.  Therefore, according to the Announcement, a tax position that the taxpayer would litigate, if challenged, but that is clear and unambiguous or is immaterial is not required to be reported.
  • Retained Reporting of “Expectation to Litigate” Positions.  The final schedule and instructions still require taxpayers to report positions for which no reserve was recorded because of an expectation to litigate (and win) the position.  Under the new instructions, such a position must be disclosed (even absent a reserve) if (i) the taxpayer determines that the likelihood of settling with the IRS is less than 50 percent and (ii) no reserve was recorded because the taxpayer both expects to litigate the position and concludes that it is more likely than not to prevail on the merits of the issue.
  • Phase-In of Reporting Requirement.  For 2010, the disclosure requirement applies only to companies with more than $100 million of assets.  This threshold amount will be reduced over five years to $10 million.

Contemporaneous with the issuance of the final Schedule UTP and instructions, the IRS also announced an expansion of its “policy of restraint”.  In particular, examination teams will no longer take the position that a disclosure of tax accrual workpapers to an independent auditor waives the protection of the work product doctrine.  (The policy nominally applies to the attorney-client and tax-practitioner privileges as well; but if, for example, a document protected by the attorney-client privilege is disclosed to an independent auditor, that disclosure typically waives the privilege.)  The policy is still subject to the usual limitations, such as not applying where a taxpayer has claimed the benefits of one or more “listed” transactions.

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On the whole, the revisions to the schedule and instructions are a welcome step in the right direction to protecting the rights of taxpayers.  Nevertheless, the requested disclosures still leave a number of important questions unresolved.

As my colleague Phil Karter previously noted, the requirement that taxpayers report positions for which no position is recorded yet litigation is expected may raise questions about the scope of work-product protection for materials related to that position.  If a taxpayer does not disclose such a position, the government would likely argue that the scope of materials that could be protected by the work-product doctrine would be much narrower.  Presumably, the argument would be that the taxpayer did not “anticipate” litigation (as is required for documents to be protected under the work-product doctrine) until sometime after the taxpayer had filed its tax returns and prepared its financial statements.

Also, the final schedule and instructions contain a variety of ambiguities that may be sorted out only after some scuffling between the IRS and taxpayers.  (Just what is a position that a taxpayer expects to litigate but that is “clear and unambiguous”?  Revenue agents are likely to have a very different perspective from a taxpayer about how “clear and unambiguous” the taxpayer’s position is.)  Unfortunately, these ambiguities in the substantive disclosures are compounded by ambiguities in the penalties that might or might not be applied in the case of failures to adequately disclose positions on the schedule.  The IRS has thus far declined to provide specific guidance regarding penalties, stating only that it will “review compliance regarding how the schedule is completed by corporations and… take appropriate enforcement action” where it determines there has been insufficient disclosure.

Finally, we note the Announcement’s acknowledgment that “[s]ome commentators questioned the Service’s authority to require reporting of uncertain tax positions.”  As we discussed earlier, the IRS issued proposed regulations under Code section 6011, authorizing the use of Schedule UTP.  We speculated that this may have been a pre-emptive effort to establish the IRS’s authority to mandate the use of the schedule.

Because the Announcement was silent on this point, we can only continue to speculate about whether the Service has the authority to require taxpayers to complete the schedule.  The Service may argue that the changes (especially the elimination of the requirement to disclose the rationale for, and nature of, each position) have obviated any concerns about implicating, and violating, the work-product doctrine; but only time (and perhaps one or more court opinions) will bear this out.

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