In the past, corporations could take uncertain tax positions on their tax filings and leave it at that.
But under Schedule UTP (Uncertain Tax Positions) proposed by the IRS on April 21, corporations will have to take it a step further as they will be required to disclose the uncertain tax positions that they have taken on their tax returns and provide to the IRS a clear and concise statement of the issues involved and the code section related to it, says John Brogan, a shareholder at Burr Pilger Mayer.
“An uncertain tax position is any position that is not more likely than not to be sustained upon audit by the IRS,” Brogan says. “If there’s not a 51 percent chance of it being sustained by the IRS, then it is going to be an uncertain tax position.”
Smart Business spoke with Brogan about what the new rule will mean for corporations and their tax filings.
What will the proposed change mean for businesses?
Businesses will need to pay more attention when their financial statements are being prepared, and they will have to pay a great deal of attention to any reserves that are established for uncertain tax positions.
It will take more time and more effort, because it actually rolls backward. Normally, audited financial statements would be prepared in a short period after the close of the corporation’s fiscal year and the tax return would be prepared later. The Schedule UTP relates to the tax return, but what gets disclosed on the schedule is going to directly relate to the determination of what went into making financial reserves as much as six months earlier.
The thing that is surprising is that historically there were very few areas where disclosure of aggressive tax positions was required, notably when taxpayers take positions that are contrary to Treasury regulations. There’s also a disclosure requirement for companies involved in listed transactions (i.e. structured tax shelters)
But what’s required for disclosure under Schedule UTP includes a much broader range of transactions, things that it would be easy for a taxpayer to not even identify as uncertain tax positions. There are a lot of novel situations, and no rules that are necessarily controlling the tax treatment of that.
Although the schedule has only been proposed by the IRS, I predict it will be effective for 2010 tax returns because it will be difficult for the IRS to back down on this position.
What will the impact be of this increased disclosure?
With the knowledge that uncertain tax positions are being analyzed for financial statement purposes and that they are ultimately going to wind up on tax return disclosures, I think it’s fair to assume that this will attract an increased number of IRS audits.
The whole point of it is to make it easier for the IRS to do its job. It is basically saying that you need to provide it with a path to exactly what you are doing and why it might be incorrect.
And a taxpayer who decides not to disclose an item on its tax return or even identify the items as an uncertain tax position, runs the risk that this nondisclosure will heighten the IRS’s tendency to assess penalties for failure to disclose. There is not a specific penalty designated for failure to disclose these positions, but, clearly, it’s going to be a factor in whether penalties are assessed.
It’s a no-win situation. If you put the UTP on your tax form, you’re going to likely draw an IRS audit. But if you don’t put it there and the issue is identified by the IRS, it’s likely to say that your mistake was not made in good faith.
How can corporations begin preparing for implementation?
The first step is to consult with their tax advisers and redouble their efforts to identify any uncertain tax positions that they have or that they anticipate taking and to spend more time identifying the risks involved and the likelihood of a position being sustained on audit.
Historically, reserves have been set up for tax exposures with a view of the likelihood of a particular issue being detected. But the Financial Accounting Standards Board interpretation of FIN 48 clearly directs filers not to take into account detection risks.
Would the new rule apply to all businesses?
At least for 2010, it would only be applicable for regular corporations and only for corporations that have at least $10 million in assets. However, the IRS has left the door open to expand the scope of Schedule UTP in future years to smaller corporations as well as to noncorporate entities such as partnerships or LLCs.
How will the new rule impact accounting practices?
It may not facilitate efficient administration of taxes because there’s going to be a tendency to over-disclose, and it can be fairly subjective. An IRS agent could look at a particular issue and set of facts and say that clearly you don’t have a 50 percent chance of sustaining this position on audit. But an accountant could look at the same set of facts and honestly believe that the taxpayer has a strong case.
It’s not going to be easy to administer because taxpayers are going to be reluctant to make this disclosure. Because while the IRS says it’s not going to be an automatic trigger for an audit, that is likely to be the case.
John Brogan is a shareholder with Burr Pilger Mayer. Reach him at (650) 855-6888 or email@example.com.