On January 26, 2010, IRS Commissioner Douglas Shulman addressed the New York State Bar Association Tax Section, delivering a 3,000-word speech. The first 60 percent of this speech was devoted to IRS initiatives to manage its responsibilities given the complexity of the present era. Commissioner Shulman described how his agency is tackling:

1. Global high-wealth individuals;
2. Offshore tax evasion;
3. Transfer pricing;
4. Oversight of tax return preparers; and
5. Involvement of boards of directors.

But the commissioner reserved the final 1,200 words of his speech to reveal what will probably become the most memorable aspect of his legacy as IRS Commissioner: the mandatory disclosure of uncertain tax positions (UTPs) by businesses with more than $10,000,000 in assets. (Announcement 2010-30 clarified that businesses with assets equal to or exceeding $10,000,000 must disclose their UTPs.)

The scope and application of this proposal caught most of the business community off guard. Anticipating this reaction, the IRS kept its most senior executives busy for several months by having them attend taxpayer conferences and insisting that what was being requested was in fact still less than what the IRS could demand if it so chose. The IRS invited comments, and their wish was our command.

Taxpayers and their advisors responded with a flood of some 40 comment letters by the June 1, 2010, deadline. Some questioned the purpose of the IRS proposal. Others questioned whether the IRS had the authority to require taxpayers to disclose information that seemed to tread close to issues of privilege. Finally, other questioned the wisdom of the requirement, arguing that such a dramatic departure from past practices will have numerous unintended and deleterious consequences.

Clearly, taxpayers believed that these proposals would cause a significant increase in taxpayer compliance costs. Many felt that fewer issues will get resolved at the exam level while cases moving to appeals will mushroom.

IRS Proposes Regulations Explicitly Requiring Disclosure
As we await the final requirements and details for the mandatory disclosure of uncertain tax positions, the IRS must have decided that it just might be a good thing to explicitly require such a disclosure in a regulation. Accordingly, on September 7, 2010, it proposed the following amendment to Section 1.6012-2:

(a)(4) Disclosure of uncertain tax positions. A corporation required to make a return under this section shall attach Schedule UTP, Uncertain Tax Position Statement, or any successor form, to such return, in accordance with forms, instructions, or other appropriate guidance provided by the IRS.

A public hearing is scheduled for October 15, 2010, and this regulation is expected to be finalized and applicable to returns filed for tax years beginning after December 15, 2009. The IRS noted that it is working through all of the comments it has already received with regard to Announcement 2010-09 when it commented, “A substantial number of public comments have been received regarding the draft schedule. The IRS and Treasury Department are currently reviewing the comments and anticipate publishing a final Schedule UTP in sufficient time to allow taxpayers to comply with the proposed effective date of these regulations.”

Use Q4 to Prepare for the Eventual Disclosure Requirement
Now that the 2009 calendar year compliance season is nearly over, it is time to turn your attention to the inevitable. It is not too early to begin planning for the eventual disclosures that will be made on the 2010 tax return. Now is the time to consider whether a new or incremental addition to an existing UTP will materialize for 2010. Once an item is booked to the FIN 48 (Financial Accounting Standards Board Interpretation No. 48) account, you may have no alternative but to disclose. Also refer to an earlier edition of , where we comment on the benefits of implementing tax accounting method changes, especially if these items will now be required to be disclosed.

Have you found that in the past, when your financial auditor has proposed that an item be recognized as uncertain in your FIN 48 liability, that you have offered no rebuttal? Many have said there were times when they believed that with additional fact-finding, they might have been able to persuade the auditor that a reserve was unnecessary. But with time being in short supply, too often it may have been expedient to allow for the booking of a reserve for some items. Those days may be over. We expect taxpayers will be more likely to argue with their financial auditors that an item is not uncertain, or not material to the financial statements. Our surveys on this point indicate that as many as 70 percent of respondents expect to “push back harder” on their financial auditors and argue against the propriety of a reserve for a possible UTP.

Identifying What Must Be Disclosed
Generally, only new UTPs need to be disclosed. Most of the accumulated history of your UTPs is beyond the scope of what is currently contemplated as disclosable under the transition rules for Schedule UTP. This includes all of the existing UTPs reported on tax returns (original or amended) for years beginning before December 15, 2009. Generally only a UTP that you will be taking in the 2010 (or later) tax return needs to be considered for disclosure. But this does not mean that a 2010 reserve increase that stems from a re-determination of the FIN 48 “measurement” for a prior year’s UTP needs to be disclosed. ()

You might also be grappling with the need to possibly record penalties for UTPs in light of the recent Canal Corporation and Subsidiaries tax court case. Have you asked yourself whether the need to record a penalty itself constitutes a UTP? While interest is generally a mechanical exercise, accuracy-related penalties on the other hand can be potentially avoided based on an analysis of the underlying facts, circumstances and principles articulated in Section 1.6664. Such an analysis appears to be the very essence of uncertain tax positions. But the Announcement indicates that a tax position taken in a return means “a tax position that would result in an adjustment to a line item on that tax return.”

There is no specific line for accuracy-related penalties, unless somehow Schedule J, line 9 could be argued to be the relevant line item. Or perhaps you can you rely on the statement in Announcement 2010-30, which provides that for purposes of calculating the maximum tax adjustment (MTA), interest and penalties need not be included. But the larger point here is that now is probably the time to address these issues, not in the spring and summer of 2011 when the 2010 tax return is being prepared. It will be too late then to do anything about the existence of a tax reserve that was increased in 2010.

As you might also be aware, in addition to the requirement to disclose UTPs for which a reserve was booked, taxpayers will also be required to disclose any UTP (even if there is no reserve booked) for items that the taxpayer intends to litigate if necessary, and items for which the taxpayer believes the IRS will not propose an audit adjustment because it believes the IRS follows an administrative position not to disturb the taxpayer’s treatment. It may take substantial time to determine the size of the issue related to this “administration position” issue.

Again, our surveys indicate that close to 40 percent of all respondents have indicated that one or both of these conditions exist in their company. We understand how difficult it will be to determine the size of the issue in order to adequately report this. For example, a common belief is that an “administrative practice” exists for the expense treatment of many small asset additions. Knowing that you have a policy to deduct small asset additions below a stated dollar value is not the same as knowing how many dollars were expensed in 2010. You may be well advised to begin now to determine how best to efficiently gather and analyze the data for these disclosure items.

Communicating with the CFO
Finally, we still find it interesting that many tax professionals have indicated that they have not briefed their CFO on this new disclosure requirement. Close to half of all tax executives that we survey indicate they have not discussed this with their CFO. Maybe these executives believe this is a “tax only” concern. But we again refer you to the survey response that the majority of tax respondents expect to “push back harder” on their financial auditors on recording reserves this year.

These two survey data points appear at odds. On the one hand, tax executives possibly intend to change their approach or behavior with their financial audit firm, and yet many have not yet explained to their CFO the reason for this change. Perhaps many of the tax executives who have not yet briefed the CFO were waiting to see if and how this disclosure mandate played out.

Now that the IRS has taken the formal steps to provide us with a regulation making this disclosure an explicit requirement, we suggest that the time for talking to the CFO is now. He or she may already know about the looming change, as the New York Times ran a “Business Day” article on this on August 24, 2010 — not a good way for a CFO to hear about coming tax regulations.

Alvarez & Marsal Taxand Says:
Use the fourth quarter of 2010 to plan for the eventual disclosures that the IRS promised us back in January. Explain to your CFO that the rules of tax reporting are changing. Develop a knowledge of issues that are or will be reported in the 2010 tax return. Work now to determine if these positions will require any FIN 48 reserve. Build the technical support for those positions in order to eliminate as many as possible from any requirement to disclose.

Disclaimer
As provided in Treasury Department Circular 230, this publication is not intended or written by Alvarez & Marsal Taxand, LLC, (or any Taxand member firm) to be used, and cannot be used, by a client or any other person or entity for the purpose of avoiding tax penalties that may be imposed on any taxpayer.

The information contained herein is of a general nature and based on authorities that are subject to change. Readers are reminded that they should not consider this publication to be a recommendation to undertake any tax position, nor consider the information contained herein to be complete. Before any item or treatment is reported or excluded from reporting on tax returns, financial statements or any other document, for any reason, readers should thoroughly evaluate their specific facts and circumstances, and obtain the advice and assistance of qualified tax advisors. The information reported in this publication may not continue to apply to a reader's situation as a result of changing laws and associated authoritative literature, and readers are reminded to consult with their tax or other professional advisors before determining if any information contained herein remains applicable to their facts and circumstances.

About Alvarez & Marsal Taxand
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