Perhaps in anticipation of the Supreme Court of the United States granting Textron’s petition for certiorari, the Internal Revenue Service (IRS) is proposing once again to modify its “Policy of Restraint” with respect to a taxpayer’s tax accrual workpapers. In Announcement 2010-9, the IRS announced that it proposes to require business taxpayers to disclose their “uncertain tax positions” on a new schedule to be attached to their federal tax returns. The IRS is also evaluating whether to seek legislation to impose a penalty for failure to file the schedule or to make adequate disclosure. Finally, the Announcement seeks comments on the proposal described in the Announcement, which must be filed by March 29, 2010.
The Announcement proposes to require a business taxpayer or related entity to annually disclose its uncertain tax positions by providing a concise description of each uncertain tax position for which the taxpayer or a related entity has recorded a reserve on its financial statements. To be sufficient, the description must contain the following:
The Code sections potentially implicated by the position
A description of the taxable year or years to which the position relates
A statement that the position involves an item of income, gain, loss, deduction, or credit against tax
A statement that the position involves a permanent inclusion or exclusion of any item, the timing of that item, or both
A statement whether the position involves a determination of the value of any property or right
A statement whether the position involves a computation of basis.
In addition, the schedule would require the disclosure of the maximum amount of potential federal tax liability attributable to each uncertain tax position (determined without regard to the taxpayer’s risk analysis regarding its likelihood of prevailing on the merits).
IRS Commissioner Shulman, in his January 26, 2010, comments to the New York State Bar Association Tax Section, declared that the “proposal does not require the taxpayer to disclose the taxpayer’s risk assessment or tax reserve amounts.”
FIN 48 establishes a threshold for recognizing the benefits of a tax return position in a company’s financial statement as “more likely than not” (MLTN) to be sustained by the taxing authority. Moreover, FIN 48 imposes an ongoing obligation to evaluate a change in circumstances, including, for example, new case law that may cause a redetermination of the MLTN recognition threshold. Accordingly, as a practical matter, the IRS’s proposal appears to require a taxpayer to identify the tax positions for which the taxpayer has made a risk assessment that such issue is more likely than not to be sustained by the taxing authority, but is not sufficiently strong, i.e., at a “should level,” so that no reserve would be reported. Thus, while the tax reserve amounts are not required to be disclosed, the Announcement clearly requires the taxpayer to indirectly disclose its risk assessment and accordingly, raises questions about the application of the work product privilege.
The Announcement, however, goes further by defining “uncertain tax positions” to include any position related to the determination of any U.S. federal income tax liability for which a taxpayer or a related entity has not recorded a tax reserve because the taxpayer has determined that it expects to litigate the position. This disclosure would appear to require a taxpayer to disclose a tax position for which the taxpayer has taken the full tax benefit and has not established a FIN 48 reserve, because the taxpayer has determined that the tax benefits “should” or “will” be sustained by the taxing authority. These would include a tax position for which a taxpayer has obtained a “should level” opinion from a tax advisor.
The Announcement recognizes the difficulty the IRS faces in implementing this proposal. As discussed above, FIN 48 includes an ongoing obligation to evaluate a change in circumstances, and thus a tax position may be added or removed from the FIN 48 reserves in subsequent years. Accordingly, the Announcement seeks comments on “How the new schedule should address taxpayers that initially did not record a reserve for an issue, but in later years do record a reserve.” Another example of the complexity of the implementation is the method for calculating the maximum tax adjustment. The Announcement specifically requests comments on “Whether the calculation of the maximum tax adjustment should relate solely to the tax period for which the return is filed or to all tax periods to which the position relates, and whether net operating losses or excess credits should be taken into account in determining the maximum tax adjustment.”
This is clearly a game changing announcement for taxpayers. Significant reaction from the taxpayer community can be expected.