TAX INSIGHT
Right on Schedule
Changes to business income tax return reporting could mean a roadmap for IRS audit examinations.
INSIGHT columnist Harvey Coustan, CPA is an Ernst & Young retired partner who currently consults on substantive technical and professional standards issues. He has also served as an expert witness in a number of cases.
IRS Announcement 2010-9 (the Announcement), issued on January 26, proposes a separate disclosure schedule to be filed with business income tax returns whose total assets exceed $10 million. The disclosure schedule will require information regarding “uncertain tax positions”—specifically, a concise description that will allow the IRS to determine the nature of the issue (including the rationale for the position) and a concise general statement of the reasons the position is uncertain.
The description must contain:
“The Internal Revenue 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 will require the maximum amount of potential federal tax liability attributable to each uncertain tax position.
The Announcement indicates that disclosure will be required for each position for which a reserve has been established either under FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109 (FIN 48), or pursuant to other Generally Accepted Accounting Principles (GAAP), such as International Financial Accounting Standards (IFRS) and country-specific generally accepted accounting standards. In addition, disclosure will be required for uncertain positions in certain situations where reserves have not been established, such as where the taxpayer has determined that the IRS has a general administrative practice not to examine the issue.
Although the IRS cites United States v. Arthur Young (465 U.S. 805, 815 [1984]) as support for compelling the taxpayer’s risk assessments and reserve amounts, the Announcement indicates that the schedule will not require those items. It also indicates that the IRS is proposing to otherwise retain its existing policy of restraint described in a 2002 announcement, as well as its Internal Revenue Manual, which describes the situations in which the IRS will ask for “tax accrual workpapers” (generally where a taxpayer has entered “listed” transactions).
The Announcement invites comments on the proposal with particular interest in:
“How the maximum tax adjustment should be reflected on the schedule so that it provides the Service with an objective and quantifiable measure of each reported tax position (e.g. specific dollar amount or by appropriate dollar ranges).”
“What alternative methods of disclosure of the amount at issue would allow the Service to identify the relative importance of the uncertain tax positions.”
“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.”
“How the related entity rules should be applied.”
“Whether the scope of the Announcement should be modified regarding the uncertain tax positions for which information is required to be reported (e.g. positions for which no tax reserve has been established because the taxpayer determined the Service has a general administrative practice not to examine the position).”
“Whether transition rules should be used or criteria modified to either include or exclude certain business taxpayers (e.g. the proposed threshold of $10 million total assets).”
“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.”
“Whether the list of information proposed to be included should be modified, including whether certain information should be requested in some circumstances upon examination rather than with tax return.“
It’s easy to see how the use of this schedule can dramatically change the relationship between taxpayers and the IRS, and, alarmingly, between taxpayers and tax preparers. Implementation of FIN 48 has already caused concern among businesses whose financial statements are subject to that FASB Interpretation. Disclosure to auditors has long been problematic for clients who are worried about the loss of attorney-client privilege in instances where auditors request third-party opinions written to discuss the tax aspects of transactions. In the Textron case, which may end up in the Supreme Court, the First Circuit Court of Appeals supported work-product protection for tax-reserve analysis workpapers shown to auditors, but then withdrew its opinion and issued an opinion that went the other way.
As far as the schedule that Announcement 2010-9 eventually might require, privilege or work-product protection are not issues. This information will be disclosed with the return.
According to a report of a comment made by Heather Maloy, commissioner of the Large and Midsize Business Division of the IRS, last February, the IRS needs this information in order to cut down on the audit time necessary to identify issues—estimated at 25 percent. Ms. Maloy stated that the new schedule is anticipated to first apply to 2010 returns filed in 2011. She also mentioned, according to the report, that although corporate taxpayers are the primary focus, the Announcement was not clear on its effect on other entities meeting the criteria. She believed that the most likely penalty for non-compliance would be the penalty for filing an incomplete schedule. Interaction with preparer penalties also is being looked at. The close of the period for comments was originally set for March 29, but in February, the AICPA asked for a 60-day extension.
I believe that a schedule providing more detail regarding uncertain tax positions ultimately will be required. If that’s the case, it will result in a number of things. Some taxpayers will not be as candid with their tax return preparers. Others will resist challenging the IRS on various positions. And it seems likely that identifying issues won’t be a significant part of the IRS’ examination of reporting taxpayers. Hopefully, it will apply a realistic approach to issues whose potential for additional tax assessment is immaterial.
More later.