Schedule UTP: IRS mandates disclosure of uncertain tax positions.

• Author: Hennig, Cherie J.

The historic framework of the U.S. income tax has been one of voluntary compliance in which taxpayers self-report their income, deductions, and resulting tax liability. This self-assessment system is based on the assumption that taxpayers will act honestly and in good faith in meeting their tax obligations. The IRS is charged with monitoring taxpayer compliance and collecting taxes rightfully due the government.

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Under the leadership of Commissioner Douglas Shulman, the IRS's emphasis in dealing with large corporate taxpayers has become one of voluntary disclosure requiring greater transparency and increased information flow, with the stated goals of identifying and resolving audit issues more quickly. (1) In January 2010, the IRS announced a proposal to require large corporations to report uncertain tax positions on the new Schedule UTP, Uncertain Tax Position Statement, to be filed with their annual tax returns. (2) In Announcement 2010-9, the IRS stated that "to discharge its obligation to fairly and uniformly administer the tax laws, the Service must be able to identify quickly and efficiently significant issues (including uncertain tax positions) underlying the tax return." (3) Shulman commented that Schedule UTP is intended "to move us away from protracted trench warfare ... to earlier and speedier issue resolution and greater efficiency and certainty." (4) In a speech before the American Bar Association, (5) Shulman announced the following goals of the new schedule:

* Create certainty regarding a taxpayer's obligations sooner rather than later;

* Cut down on the time it takes to find issues and complete an audit;

* Provide consistent treatment across taxpayers;

* Make efficient use of government and taxpayer resources by focusing on issues and taxpayers that pose the greatest risk of tax noncompliance;

* Ensure that both the IRS and the taxpayer spend more time discussing the law as it applies to the facts and less time looking for information;

* Help the IRS prioritize taxpayers for examination;

* Help the IRS identify issues where there is uncertainty and where further guidance is needed;

* Help the IRS prioritize selection of issues during an audit; and

* Obtain key information regarding uncertain tax positions without getting into the heads of the taxpayers, or their advisers, as it relates to quantifying risk.

This article explores the requirements of Schedule UTP and provides examples of the types of tax positions that taxpayers must disclose on that schedule. Modifications to the IRS's policy of restraint pertaining to tax reconciliation workpapers, made contemporaneously with the release of the final Schedule UTP, are discussed. Suggestions are made on how to avoid the inadvertent waiver of the work-product privilege for documents relating to uncertain tax positions. The conclusion recommends that the IRS consider integrating the desired UTP disclosures into the Schedule M-3 to eliminate redundant reporting of uncertain positions.

Who Must File a Schedule UTP?

Types of Corporations Covered

Corporations that file a Form 1120, U.S. Corporation Income Tax Return; Form 1120-F, U.S. Income Tax Return of a Foreign Corporation; Form 1120-L, U.S. Life Insurance Company Income Tax Return; and Form 1120-PC, U.S. Property and Casualty Insurance Company, with total assets of $100 million or more must file a Schedule UTP starting with the 2010 tax year. (6) The schedule must be attached to a calendar-year 2010 tax return or to a fiscal year-end return that begins in 2010 and ends in 2011. A Schedule UTP need not be attached to a return for a short tax year ending in 2010. The IRS has announced that it will consider whether to extend all or a portion of Schedule UTP reporting to noncorporate taxpayers, such as passthrough entities and tax-exempt entities, starting in 2011 or later years.

Total Asset Threshold

The IRS initially proposed that corporate taxpayers having $10 million in total assets file the Schedule UTP. (7) In response to public comments requesting that the threshold be increased, the IRS adopted a five-year phase-in of the reporting requirement based on asset size. The initial reporting threshold of $100 million of total assets for 2010 will be reduced to $50 million starting with the 2012 tax year and to $10 million for the 2014 tax year. (8)

Audited Financial Statement Requirement

Only a corporate taxpayer or related party that has issued audited financial statements covering all or a portion of the corporation's tax year is required to file a Schedule UTP. (9) The schedule's instructions define the term "audited financial statements" to mean financial statements on which an independent auditor has expressed an opinion under GAAP, IFRS, or other country-specific accounting standard. Compiled or reviewed financial statements are not audited financial statements.

Note that a corporate taxpayer without audited financial statements is still required to file a Schedule UTP if it meets the related-party definition described in the instructions. A related party is any entity that has a relationship described in Sec. 267(b), Sec. 318(a), or Sec. 707(b) or that is included in the consolidated audited financial statements in which a corporation with audited financial statements is also included.

Example 1: A Corp. has $160 million in assets. B Corp. is a foreign corporation not doing business in the United States but is a related party to A. The corporations issue separate audited financial statements. A takes a tax position on its tax return, and B records a reserve with respect to the tax position. The position must be reported on a Schedule UTP attached to A's tax return. No disclosure is required by B since it is not required to file a U.S. income tax return.

Example 2: C Corp. has $160 million in assets and issues consolidated audited financial statements with D Corp. but does not file a consolidated tax return. Even though C and D do not have a relationship that is described in Secs. 267(b), 318(a), or 707(b), both are sub ject to the Schedule UTP reporting requirements.

What Tax Positions Must Be Reported on Schedule UTP?

U.S. Federal Income Tax Positions

An applicable corporation must report tax positions taken on a U.S. federal income tax return on Schedule UTP if:

* The corporation has taken a tax position on its U.S. federal income tax return for the current year or for a prior tax year; and

* The corporation or a related party has either:

1. Recorded a reserve with respect to all or part of that tax position in audited financial statements; (10) or

2. Not recorded a reserve for a tax position because the corporation expects to litigate the position. (A tax position meeting the requirements of (1) or (2) is sometimes referred to in this article as a "UTP disclosure position.")

Tax Position Taken on a Tax Return Defined

A tax position taken on a tax return is defined as one that would result in an adjustment to a line item on the tax return or that would be included in a Sec. 481(a) adjustment (changes in method of accounting) if the position were not sustained upon an IRS audit.

Example 3: E Corp. has a $100 net operating loss carryforward that will expire if E does not use it in 2010. E reports $100 of income in 2010 that the loss carryforward will offset but is uncertain whether the income should be reported in 2010 or 2011. The corporation has taken a tax position on both the 2010 and 2011 tax returns because there would be an adjustment to a line item on both returns if the position taken in that year were not sustained.

If multiple tax positions affect a single line item on the tax return, each tax position is treated as a separate tax position. A tax position is based on the unit of account used to prepare the audited financial statements in which a reserve has been recorded. The unit of account must be the same unit of account used by the taxpayer for GAAP or modified GAAP statements. The taxpayer may not use a unit of account that is based upon the entire tax year. The corporation must instead identify a unit of account that will apprise the IRS of the identity and nature of the issue underlying the tax position taken on the tax return. (11)

Example 4: F and G Corps. issue consolidated audited financial statements and file a consolidated tax return. F bases its research and development credit on costs accumulated for each individual research project, while G uses its functional expenditures. The unit of account for F is each project, while the unit of account for G is its functional expenditures.

Financial Statement Reserves

Whether a reserve has been recorded and must be disclosed on the Schedule UTP is determined by reference to the reserve decisions made by the corporation or a related party for audited financial statement purposes. (12) If, under the applicable accounting standards, no reserve was required for a tax position taken on a tax return, either because the amount was immaterial for audited financial statement purposes or there is sufficient certainty regarding the tax position, (13) the tax position need not be reported on the Schedule UTP. The IRS has not provided a definition of materiality, so presumably it is left up to the corporate taxpayer to determine when a position is material.

In Announcement 2010-75, the IRS assured corporate taxpayers that "the schedule seeks the reporting of tax positions consistent with the reserve decisions made for audited financial statement purposes." The rationale for this approach is to rely on existing documents and analysis for the Schedule UTP disclosures. Kathryn A. Zuba, special counsel with the IRS Office of Associate Chief Counsel, has stated that "one core rationale underlying the final UTP regime is to create consistency with financial reporting standards because taxpayers are already reporting information using such standards." (14)

The initial recording of a reserve will trigger...