Tax ethical and penalty issues in the UTP context: a review after five years of experience.

• Author: Purcell, Thomas J., III
• Position: Uncertain tax position

Virtually all difficult tax practitioner ethical problems arise from conflicts between a practitioner's responsibilities to clients, to the tax system, and to a practitioner's own interest in remaining an ethical person while earning a satisfactory living. These ethical problems come to the fore in the context of Schedule UTP, Uncertain Tax Position Statement, a form introduced six years ago, and now generally applicable to all corporations having year-end assets of at least $10 million per Schedule L of Form 1120, U.S. Corporation Income Tax Return. To understand the ethical problems in the context of Schedule UTP, this column first reviews the advent of Schedule UTP and its purpose and design. It then considers the applicable ethical rules and concludes with some best practice tips and other considerations for practitioners.

Purpose of Schedule UTP in the Framework of the U.S. Tax System

The U.S. tax system depends on voluntary compliance--taxpayers, and not the government, fill out their own returns. Inherent in this self-assessment system--its foundation--is the presumption that a taxpayer will prepare a transparent and forthcoming tax return. Prior to the issuance of Schedule UTP, there was no requirement to disclose uncertain tax positions (i.e., tax return positions taken on the return for which the ultimate outcome is uncertain) if the position was supported by substantial authority, was not a reportable transaction, and was not a tax shelter. As a result, to identify uncertain tax positions, the IRS needed to select a return for examination and expend a substantial amount of effort through its field agents to determine whether a return contained any underlying uncertain tax positions (preamble to REG-119046-10).

To improve tax administration concerning the largest and most complex taxpayers, the IRS released Schedule UTP in 2010, touting it as a principled and balanced approach that would provide earlier certainty for uncertain tax positions, while preserving important taxpayer protections and taxpayers' relationships with their tax advisers and independent auditors (see IR-2010-98, "Prepared Remarks of IRS Commissioner Doug Shulman to the American Bar Association" (9/24/10)). The IRS thus created a tool it could use a priori in selecting returns for examination (with the hope of making field agents' work much more efficient).

What Information Is and Is Not Disclosed on Schedule UTP

Schedule UTP disclosures were intended to be drawn from information used for financial reporting purposes under FASB Interpretation No. (FIN) 48, Accounting for Uncertainty in Income Taxes (now incorporated into FASB Accounting Standards Codification (ASC) Subtopic 740-10) (see IR-2010-13, "Prepared Remarks of IRS Commissioner Doug Shulman to the American Bar Association" (1/26/10)). That financial reporting rule was instituted to address the concern that a diversity of practice had developed with respect to financial statement reporting of tax exposures related to identical uncertain tax positions taken on corporate tax returns.

In fine with this financial reporting link-up, a Schedule UTP is filed only when either a reserve is recorded with respect to a U.S. income tax position in a corporations (or related party's) audited financial statements, or the corporation (or related party) did not record a reserve for that tax position because the corporation expects to litigate the position. Schedule UTP also requires the taxpayer to rank its uncertain tax positions from highest to lowest based on the size of the position, using the federal income tax reserve amounts, which themselves are not disclosed on Schedule UTP. (Uncertain tax positions in the expected-to-be-litigated bucket, which do not have reserve amounts, can be given any rank.) This ranking is designed to make Schedule UTP a more effective examination selection tool.

The IRS pointed out that it purposely chose less disclosure than it might have (under the empowering Sec. 6011 regulations), in choosing not to require a taxpayer to disclose its assessment of the strength of its uncertain tax positions, the amounts it reserved on its books, and its risk assessment analysis or process (see IR-2010-13). Rather, Schedule UTP requires taxpayers to disclose a concise description of each uncertain tax position and the ranking mentioned above. The description must provide sufficient information to identify the issue and the relevant facts and, as noted above, does not require information related to the corporation's assessment of the hazards of a tax position or an analysis of the support for or against the tax position. See the exhibit above for a comparison of a sufficiently concise description to one that is considered insufficient.

IRS Restraints Regarding Schedule UTP

The IRS (T.D. 9510) stated further that Schedule UTP...