presents

Reporting Uncertain Tax Positions: Implications of the New IRS Return Schedule

presents

Preparing for New Transparency Demands and Managing Disclosure Risks

A Live 110-Minute Teleconference/Webinar with Interactive Q&AToday's panel features:

Robin Greenhouse, Tax Partner, McDermott Will & Emery, Washington, D.C.Todd Simmens, Partner and National Director, Tax Controversy and Procedure, BDO Seidman, Washington, D.C.

A Live 110-Minute Teleconference/Webinar with Interactive Q&A

Ronald Kerridge, Partner, K&L Gates, DallasAdam Tejeda, Attorney, K&L Gates, New York

Thursday, May 6, 2010

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Reporting Uncertain Tax Positions: Implications of thePositions: Implications of the

New IRS Return Schedule W biWebinar

May 6, 2010

Robin Greenhouse, McDermott Will & Emeryrgreenhouse@mwe.com

Todd Simmens, BDO, LLPtsimmens@bdo.com

Ronald Kerridge, K&L Gates Adam Tejeda, K&L Gatesron.kerridge@klgates.com adam.tejeda@klgates.comg @ g j @ g

Today’s ProgramToday s Program

Relevant Background (Robin Greenhouse) Slides 6-17

Key Terms Of IRS Announcement 2010-9 Slides 18-31

(Todd Simmens and Robin Greenhouse)

Potential Implications Of New Policy Slides 32-68

(Ronald Kerridge and Adam Tejeda)(Ronald Kerridge and Adam Tejeda)

5

Relevant Background g

Robin Greenhouse, McDermottRobin Greenhouse, McDermott Will & Emery

Introduction

• What prompted the Service to issue Announcement 2010-9?

• Evolution of IRS policy of restraint re: tax accrual work papers• Evolution of IRS policy of restraint re: tax accrual work papers

• Public remarks by IRS commissioner, chief counsel and LMSB i icommissioner

• Existing disclosure requirements

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Roadmap - The Tax Gap

• Tax gapThe tax gap is the annual difference between tax liability and taxes– The tax gap is the annual difference between tax liability and taxes paid under the current federal law.

– The net tax gap is the amount remaining after the collection of enforced and late paymentsenforced and late payments.

– $290 billion estimated net tax gap cited in July 2009 Treasury Department report

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Presidential Task Force

• March 2009, the Administration announced the formation of a task force to propose ways to simplify the tax code, reduce evasion, closeforce to propose ways to simplify the tax code, reduce evasion, close loopholes and make changes in corporate tax breaks.

• A major focus for the task force is identified as reducing the net tax• A major focus for the task force is identified as reducing the net tax gap.

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Legislative Influences

• Legislative pressure to collect additional revenue without raising taxes

• Senate Permanent Sub-Committee on Investigations– Fall 2007: PSI issued letters to large corporate taxpayers asking for

t ititax reserve positions.

10

Policy Of Restraint

• The backdrop: U.S. v. Arthur Young, 465 U.S. 805 (1984)

• Announcement 84 46 (policy of restraint)• Announcement 84-46 (policy of restraint)

– Historically, extensive requirements for agents to follow prior to even seeking to obtain tax accrual work papers

• The policy began to erode in 2002, as IRS focused on the proliferation of tax shelters and on the perceived need to obtain this information.

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Modified Policy Of Restraint

• Exceptions to the policy of restraint, i.e., documents may be requested

IRM 4 10 20 3(2) ( l i )– IRM 4.10.20.3(2) (unusual circumstances)

– Announcement 2002-63 (listed transactions)

After examination e g litigation– After examination, e.g., litigation

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IRS Explanation For New Policy

• IRS Commissioner Douglas Shulman announced the new schedule.

“T d d 25 f i i l– “Today, we spend up to 25 percent of our time in large corporate audits searching for issues rather than having a straightforward discussion with the taxpayer about the g p yissues.”

– “It would be more efficient to the process if we had access to more complete information earlier in theaccess to more complete information earlier in the process regarding the nature and materiality of a taxpayer’s uncertain tax position.”

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p

Can’t Find The Issues?

• Current disclosure requirements are robust.

• Federal return includes M-3 Schedule reconciling book to tax gdifferences.

• Federal return discloses “reportable transactions.”

• Sect. 6662 disclosures are made on the return or, for large taxpayers, in separate pre-audit statement.

• FIN 48 disclosures

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“Issues Are There For The Asking”

• IRS Chief Counsel William Wilkins:• IRS Chief Counsel William Wilkins:– “Why would the IRS choose to spend time finding these issues or

risk not finding them when the issues are there for the asking and not protected by any privilege?”not protected by any privilege?

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IRS Response To Criticism

• IRS Commissioner Shulman:The new IRS schedule for reporting uncertain tax positions is not– The new IRS schedule for reporting uncertain tax positions is not intended as a list of issues for which deficiencies will always be established. There are issues on that list for which the correct examination outcome is “no change.” (Tax Executive Institute,examination outcome is no change. (Tax Executive Institute, April 12, 2010)

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“Fears Are Unfounded”

• LMSB Commissioner Heather Malloy:Fears are unfounded that auditors would use the new schedule as– Fears are unfounded that auditors would use the new schedule as the basis for sending a Form 5701 (Notice of Proposed Adjustment) or use the maximum tax adjustments reported as the starting point for discussion of amounts at issue. (Tax Executivesstarting point for discussion of amounts at issue. (Tax Executives Institute, April 13, 2010)

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Key Terms Of IRS A t 2010 9Announcement 2010-9

Todd Simmens, BDO, LLPTodd Simmens, BDO, LLPRobin Greenhouse, McDermott Will & Emery

IRS Announcement 2010-9

• Goals of Announcement 2010-9

• Uncertain tax positions• Uncertain tax positions– FIN 48

• Required reporting

• Policy of restraint– Impact of Announcement 2010-9

• Comment period

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• Comment period

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IRS Announcement 2010-9 (Cont.)

• Taxpayers with total assets in excess of $10 million must attach a new schedule to federal return.

Th h d l t i l d “ i d i ti f h t i t• The schedule must include “a concise description of each uncertain tax position for which the taxpayer or a related entity has recorded a reserve on its financial statements.”

• Schedule must include a statement of the “maximum amount of potential federal tax liability attributable to each uncertain tax position (without regard to the taxpayer’s risk regarding its likelihood of prevailing on the merits).”p eva g o e e s).

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What Is An Uncertain Tax Position?

• An uncertain tax position includes any position for which a reserve must be established under FIN 48 or other accounting standards.

“[U] t i t iti i l d iti l t d t th• “[U]ncertain tax positions include any position related to the determination of any U.S. federal income tax liability for which a taxpayer or related entity has not recorded a tax reserve because (i) the taxpayer expects to litigate the position, or (ii) the taxpayer has d t i d th t th S i h l d i i t ti ti t tdetermined that the Service has a general administrative practice not to examine the position.”

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Requirements For Description

“[T]his concise description will include the rationale for the position and a concise general statement of the reasons for determining that the position is an uncertain tax position.”

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Specific Description Requirements• A list of the Code sections potentially implicated by the positionA list of the Code sections potentially implicated by the position

• A description of the taxable year or years to which the position relates

• A statement of whether the position involves an item of income, gain, loss, deduction or credit against tax

A t t t f h th th iti i l t i l i• A statement of whether the position involves a permanent inclusion or exclusion of any item, the timing of that item, or both

• A statement of whether the position involves a determination of theA statement of whether the position involves a determination of the value of any property or right, and

• A statement of whether the position involves a computation of basis

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Effective Date

• The schedule will be required for 2010 federal returns.

• Proposed regulations will be issued to provide that certain businesses i d t k t (i l di ti i d t krequired to make a return (including corporations required to make a

return under section 6012) also will be required to file a form or schedule relating to the disclosure of uncertain tax positions.

• Draft schedule was released in April 2010.

• Comments due June 1, 2010

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Enforcement

• The IRS is evaluating options for penalties or sanctions to be imposed when a taxpayer fails to make adequate disclosure of the required informationinformation.

• One option being considered is to seek legislation imposing a penalty for failure to file the schedule or to make adequate disclosure.

• May use existing penalties for failure to file a return

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Draft Schedule UTP• Draft issued April 19, 2010

C• Contents– UTP number

• Schedule UTP as drafted would require a whole number toSchedule UTP as drafted would require a whole number to identify each tax position, which would then correspond to the description required in Part III.

Primary code sections– Primary code sections• Up to three of the primary code sections would be required for

each tax position.

– Timing: Temporary, permanent, both• Classification must be consistent with the accounting standards

used to prepare the financial statements

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Draft Schedule UTP (Cont.)( )• Contents (Cont.)

– Pass-through entity numberPass through entity number• If the reported tax position relates to a tax position of a pass-

through entity, the pass-through entity’s EIN is to be reported. For foreign entities with no EIN an F is enteredFor foreign entities with no EIN, an F is entered

– Administrative practice• Indicate here whether the position would not be challenged

based on IRS administrative practice

– Maximum tax adjustment• The maximum tax adjustment amount for each tax positionThe maximum tax adjustment amount for each tax position

(that is not a valuation tax position or transfer pricing tax position) is entered here. For valuation positions, a “V” is entered; for transfer pricing positions, a “TP” is entered; both

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in order of magnitude.

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Draft Instructions To Schedule UTP• Tax positions to be reported• Tax positions to be reported

– Those for which taxpayer has recorded a reserve in an audited financial statement or for which there is an IRS administrative

ti hi h th t t t liti tpractice or which the taxpayer expects to litigate

• 60-day rule– Report tax positions for which a decision to record the reserve for p p

the current or prior year was made within at least 60 days before the filing of the relevant tax return

• Current and prior year positionsCurrent and prior year positions– A taxpayer need not report a tax position taken in a prior position

if the taxpayer reported the position on a schedule UTP filed with a prior year return

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prior year return.

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Draft Instructions To Schedule UTPDraft Instructions To Schedule UTP (Cont.)

• Required filers– The corporation files Form 1120 (U.S. Corporation Income Tax Return),

Form 1120 F (U.S. Income Tax Return of a Foreign Corporation), FormForm 1120 F (U.S. Income Tax Return of a Foreign Corporation), Form 1120 L (U.S. Life Insurance Company Income Tax Return) or Form 1120 PC (U.S. Property and Casualty Insurance Company Income Tax Return)

– The corporation has assets equal to or exceeding $10 million– The corporation or a related party issued an audited financial statement,

which covers all or a portion of the corporation’s operations for all or a portion of the corporation’s tax year; andTh ti h t iti th t t b t d– The corporation has one or more tax positions that must be reported on Schedule UTP

2929

Announcement 2010-30

• Covered taxpayers– Corporations required to file Form 1120

Insurance companies required to file Form 1120 L– Insurance companies required to file Form 1120-L– Life insurance companies required to file Form 1120-PC– Foreign corporations required to file Form 1120-F

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Quid Pro Quo

• IRS should make concessions in return for disclosure of uncertain tax positions.– IRS should grant a taxpayer’s request for a TAM on a disclosed

uncertain tax position.– IRS should meet MLTN threshold in order to issue a 5701 on a

disclosed uncertain tax position.IRS h ld S 6662 d l f– IRS should not assess Sect. 6662 understatement penalty for disclosed uncertain tax position.

– IRS should not redact “case evaluation” or “hazards” from chief counsel advice on tier and industry issuescounsel advice on tier and industry issues.

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Potential Implications Of N P liNew Policy

Ronald Kerridge and Adam Tejeda, K&L GatesRonald Kerridge and Adam Tejeda, K&L Gates

Possible Ties To Textron AndPolicy Of Restraint

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Policy Of RestraintIRS longstanding policy of restraintIRS longstanding policy of restraint

Supreme Court confirmed the IRS’ right to obtain auditor’s tax accrual workpapers under its summons authority. United States v. Arthur Young & Co., 465 U.S. 805 (1984)

As currently interpreted, since tax accrual workpapers are not generated in connection with seeking legal or tax advice, but are developed to evaluate a taxpayer’s deferred or contingent tax liabilities in connection with its disclosure to third parties of itsliabilities in connection with its disclosure to third parties of its financial condition, tax accrual workpapers are not privileged communications. Neither the attorney-client privilege nor the tax practitioner privilege provided under Sect. 7525 of the Internal Revenue Code of 1986, as amended (the “Code”) (which is based

b t i li it d th th tt li t i il ) t tupon, but is more limited than, the attorney-client privilege), protects tax accrual workpapers from production upon proper request by an authorized examining agent.

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Policy Of Restraint (Cont.)Despite the broad scope of authority recognized by the Supreme Court,Despite the broad scope of authority recognized by the Supreme Court, the Service has historically acted with restraint, declining to request tax accrual workpapers as a standard examination technique.

Announcement 2002-63: The IRS indicated that it will seek tax accrualAnnouncement 2002 63: The IRS indicated that it will seek tax accrual workpapers if it has reason to believe that a particular company has engaged in one or more specified types of tax-avoidance strategies, i.e., “listed transactions.”

The IRS announced that it would continue its longstanding policy to not routinely seek to obtain tax accrual workpapers through its summons power in situations in which a listed transaction is not at issue.

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Policy Of Restraint (Cont.)AICPA and FASB: Recognizing that the IRS possesses (though it rarely e ercises) the a thorit to obtain ta accr al orkpapers the AICPA and FASBexercises) the authority to obtain tax accrual workpapers, the AICPA and FASB have long advised that such workpapers are indispensable to a public-company audit, even though the IRS could legally obtain them. AICPA, Practice Guide on Accounting for Uncertain Tax Positions Under FIN 48, at 12 (2006)

A public company’s failure to provide its auditors with sufficient information regarding the company’s tax accrual could negatively affect the auditor’s ability to certify the financial statements.

FASB has rejected complaints by public companies about financialFASB has rejected complaints by public companies about financial accounting rules that require them to create documents that could assist the IRS. In doing so, FASB has emphasized that accounting rules appropriately “provide a roadmap for taxing authorities,” noting that the taxing authorities are “acting in the broader public interest in regulating compliance with self-reporting income tax laws ” FASB Interpretation No 48 Accounting forreporting income tax laws. FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, App. B: Background Information and Basis for Conclusions P B64 (2006) (FIN 48)

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TextronIRS PositionIRS Position

IRS Chief Counsel William Wilkins on March 5 said that the requirement that certain companies disclose their uncertain tax positions and the respective maximum federal income tax exposure for them on a new schedule attached to their returns isn’t an outgrowth of Textron.

Wilkins has stated that “I have heard and read some references that make it seem as if this is an outgrowth of the Textron case – litigation over the application of work product doctrine to various kinds of tax documents … That’s a little bit off the mark. I think the more important development as b k d i h f h i l di ibackground is the fact that accounting rules surrounding uncertain tax positions change and it evolved in a way that made it necessary for the IRS to come to grips with this set of issues.”

Effectively according to Wilkins accounting rules require certain corporationsEffectively, according to Wilkins, accounting rules require certain corporations to track and record uncertain tax positions, which are then reviewed and certified by independent auditors. “Why would the IRS choose to spend time finding these issues or risk not finding them when the issues are there for the asking and not protected by a privilege?”

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Textron (Cont.)Textron and privilege: Evaluation of Wilkins’ position

T i bli l d d D i i di fTextron is a publicly traded company. During its audit of Textron’s 2001 tax return, the IRS learned that Textron had engaged in a listed transaction (i.e., a SILO transaction) that the IRS had previously determined was abusive. IRS

di l i d t T t ki it taccordingly issued a summons to Textron seeking its tax accrual workpapers for the audit of its 2001 financial statements, as well as the tax accrual workpapers generated by Textron’s independent auditor for that year.

Textron’s workpapers (pretty standard for such a taxpayer) consisted of (i) a spreadsheet listing every material item in its tax return that if challenged by the IRS could result intax return that, if challenged by the IRS, could result in additional taxes being assessed; and (ii) documents supporting the reserve calculation on the spreadsheet.

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Textron (Cont.) General notes regarding Textron’s tax accrual workpapersGeneral notes regarding Textron s tax accrual workpapers

Reserve amount was calculated for each uncertain tax position

Workpapers included items that Textron intended to concede, such as items that had been resolved in prior audits

Textron’s employees testified that the workpapers had beenTextron s employees testified that the workpapers had been created in order to establish a GAAP-compliant tax reserve on the company’s financial statements and to demonstrate the accuracy of those statements to its auditor (as securities laws and auditing standards required).

Textron refused the IRS summons and asserted that the workpapers were protected as attorney work product.

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Textron (Cont.)General procedural history

District court held that the tax accrual workpapers were protected as work product. The determination of work product protection in the First Circuit is whether the documents were created “because of the prospects of litigation” (a broader standard than the primary purposeprospects of litigation (a broader standard than the primary purpose standard, i.e., whether the “primary purpose” of creating the documents was to aid in litigation).

District court determined that the tax accrual workpapers wereDistrict court determined that the tax accrual workpapers were work product, notwithstanding their regulatory purpose, because they “would not have been prepared at all but for the facts that [Textron] anticipated the possibility of litigation.”

Appellate Review – Part 1: Majority concluded that workpapers were work product because they were “dual purpose documents” generated both to “assist in litigation” and “to comply with securities requirements.” Explaining further that “the anticipation of litigation

l d ith iti d ti i t ff ti l f d

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coupled with securities and reporting requirements effectively forced [Textron] to operate under the hypothetical belief that litigation would occur” over each disputable tax position

Textron (Cont.)Appellate Review – Part 2: After remand to the district court to determine certain factual issues, the government sought rehearing, dete e ce ta actua ssues, t e go e e t soug t e ea g,which was granted. On rehearing, the court held that Textron’s tax accrual workpapers were not protected as attorney work product because they “were prepared in the ordinary course of business” and “were independently required by statutory and audit requirements.”

Only purpose of the tax accrual workpapers was to permit Textron to comply with certain statutory and audit requirements

Workpapers had no dual purpose for use in litigation as well as financial reporting purposes. The court explained that the district court had not found “that the workpapers were prepared for use in possible litigation – only that the reserves would cover liabilities th t i ht b d t i d i liti ti ”that might be determined in litigation.”

No chilling effect on the audit process: The court rejected Textron’s argument that producing tax accrual workpapers to the IRS would hill th i ti i th f t ti th t bli i

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chill their creation in the future, noting that public companies were legally obligated to create those workpapers “to comply with the securities laws and accounting principles.”

Textron (Cont.)Court gave IRS ammunition for its current position regarding uncertain taxCourt gave IRS ammunition for its current position regarding uncertain tax positions. The court emphasized that the IRS faces “practical problems in discovering underreporting of corporate taxes” given the length and complexity of corporate tax returns, and that permitting the IRS to obtain tax accrual workpapers “serves the legitimate, and important, function of p p g pdetecting and disallowing abusive tax shelters.”

Theme mentioned immediately above reflected in statement made by Commissioner Shulman. In his prepared remarks given upon the p p g pissuance of Announcement 2010-9, Commissioner Shulman stated that the goals of the proposal are “to cut down the time it takes to find issues and complete an audit … ensure that both the IRS and taxpayer spend time discussing the law as it applies to their facts, rather than looking for information and to help [the IRS] prioritizerather than looking for information … and to help [the IRS] prioritize selection of issues and taxpayers for examination.”

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UTP Disclosure An Outgrowth Of Textron?

The answer may depend on one’s interpretation of “outgrowth.”

Accounting and securities rules forced certain taxpayers to produce the information; Textron told the IRS that it’s available if requested.

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Timing And Wording Of Disclosures: On April 19, 2010, the IRS released aOn April 19, 2010, the IRS released a

draft schedule (“Schedule UTP”) and instructions that further

l i th IRS itiexplain the IRS position regarding uncertain tax positions

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positions.

Who Must File? A corporation must file Schedule UTP with its income tax return if:A corporation must file Schedule UTP with its income tax return if:

The corporation files 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 TaxCorporation), Form 1120 L (U.S. Life Insurance Company Income Tax Return) or Form 1120 PC (U.S. Property and Casualty Insurance Company Income Tax Return)

The corporation has assets equal to or exceeding $10 millionThe corporation has assets equal to or exceeding $10 million

The corporation or a related party issued an audited financial statement, which covers all or a portion of the corporation's operations for all or a portion of the corporation's tax year; andfor all or a portion of the corporation s tax year; and

A related party is any entity that is related to the corporation under Code sections 267(b), 318(a), or 707(b), or any entity that is included in a consolidated audited financial statement in which the

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included in a consolidated audited financial statement in which the corporation is also included.

Who Must File? (Cont.)The corporation has one or more tax positions that must be reported onThe corporation has one or more tax positions that must be reported on Schedule UTP

Note regarding other corporate taxpayers and non-corporate taxpayers: Th d ft h d l d i t ti l id th t f 2010 t thThe draft schedule and instructions also provide that, for 2010 tax years, theIRS will not require a Schedule UTP from Form 1120 series-filers other than those identified previously (such as real estate investment trusts or

regulated investment companies), pass-through entities, or tax-exempt i ti Th IRS ill d t i th ti i f th i t t filorganizations. The IRS will determine the timing of the requirement to file

Schedule UTP for these entities after comments have been received and considered.

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Tax Positions To Be ReportedSchedule UTP requires the reporting of a corporation's federal income tax positions for which the corporation or a related party has recorded a reserve in an audited financial statement. p p y

Audited financial statements - Standards: A tax position must be reported regardless of whether the audited financial statement is prepared based on U.S. Generally Accepted Accounting Principles (GAAP), International Financial Reporting Standards (IFRS), or other country-specific accounting standards, including a modified version of

f th b (f l difi d GAAP) th t i t t dany of the above (for example, modified GAAP) that requires a taxpayer to record a reserve for federal income tax positions.

Record a reserve: In general, a corporation or a related party records a reserve with respect to a tax position taken by the corporation when any of the following occurs in an audited financial statement of the corporation or a related party:audited financial statement of the corporation or a related party:

An increase in a liability for income taxes payable or a reduction of an income tax refund receivable with respect to the tax position,

A d ti i d f d t t i i d f d t li bilit ithA reduction in a deferred tax asset or an increase in a deferred tax liability with respect to the tax position, or

Both of the above.

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Tax Positions To Be Reported (Cont.)Tax position taken in a tax return A tax position taken in a tax return means aTax position taken in a tax return. A tax position taken in a tax return means a tax position that would result in an adjustment to a line item on that tax return (or would be included in a Code Sect. 481(a) adjustment) if the position is not sustained.

E l 6 ( t diff ) A ti i dit i itExample 6 (permanent differences). A corporation incurs an expenditure in its 2010 tax year and takes the position that the expenditure may be amortized over five years, beginning in its 2010 tax return. The corporation determines it is uncertain whether any current deduction or amortization of this expenditure is allowable. The corporation has taken a tax position in each of the five tax

b i h ' t t th ld b dj t t tyears, because in each year's tax return, there would be an adjustment to a line item on that return if the position taken in that year is not sustained.

Example 7 (temporary difference). A corporation incurs an expenditure in its 2010 tax year and claims a deduction for the entire amount on its 2010 tax2010 tax year and claims a deduction for the entire amount on its 2010 tax return. The corporation determines it is uncertain whether the deduction is allowable in the 2010 tax year or the amount instead is amortizable over five years. The corporation has taken a tax position in each of the five years, even though it claimed a deduction in a single year, because in each year’s tax return there would be an adjustment to a line item on that return if the position

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return there would be an adjustment to a line item on that return if the position taken in that year is not sustained.

Tax Positions To Be Reported (Cont.)Schedule UTP also requires the reporting of tax positions taken by theSchedule UTP also requires the reporting of tax positions taken by the corporation in a tax return for which a reserve has not been recorded by the corporation or a related party based on an expectation to litigate or an IRS administrative practice.

Reserve not recorded based on administrative practice. A tax position required to be reported on Schedule UTP includes a tax position for which a reserve would have been recorded in the audited financial statement but for a determination that, based upon past , p padministrative practices and precedents of the IRS in dealing with the tax position of the taxpayer or similar taxpayers, the IRS has a practice of not challenging the tax position during an examination.

Reserve not recorded based on expectation to litigate. A tax position required to be reported on Schedule UTP includes a tax position for which a reserve was not recorded in the audited financial statement after the taxpayer or a related party determines that, if the IRS had full knowledge of the tax position it is unlikely a settlement

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IRS had full knowledge of the tax position, it is unlikely a settlement could be reached. For this purpose, a settlement is unlikely if the probability of settlement is less than 50%.

Tax Positions To Be Reported (Cont.)Timing: A tax position is required to be reported on a Schedule UTP attached to aTiming: A tax position is required to be reported on a Schedule UTP attached to a particular tax year's return if (a) at least 60 days before filing the tax return a reserve has been recorded with respect to that tax position, or at least 60 days before filing the tax return a decision was made not to record a reserve based on an expectation to litigate or an IRS administrative practice, and (b) the tax position has been taken by the corporation in a tax return for the current tax year or a priorhas been taken by the corporation in a tax return for the current tax year or a prior tax year.

The initial recording of a reserve will trigger reporting of a tax position, but subsequent reserve increases or decreases with respect to a tax position t k i t t ill ttaken in a tax return will not.

Example 2 (reserve increase). A corporation took a tax position in its 2010 tax return and recorded a reserve for the tax position on Sept. 30, 2010. On Dec 31 2012 the corporation increased its reserve with respect to the taxDec. 31, 2012, the corporation increased its reserve with respect to the tax position taken in its 2010 tax return. Because the corporation recorded a reserve with respect to its 2010 tax position more than 60 days before filing its 2010 tax return, it must report the 2010 tax position on the Schedule UTP filed with its 2010 tax return. The taxpayer is not required to report the 2010 tax position again on its 2012 tax return as a result of the reserve increase in

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tax position again on its 2012 tax return as a result of the reserve increase in 2012.

Tax Positions To Be Reported (Cont.)Reporting current year and prior year tax positionsReporting current year and prior year tax positions

Tax positions taken by the corporation in the current year’s tax return for which the decision whether to record the reserve was made at least 60 days before filing the tax return are reported on Part I of Schedule UTP.

Tax positions taken by the corporation in a prior year’s taxTax positions taken by the corporation in a prior year s taxreturn for which the decision whether to record the reserve was made at least 60 days before filing the tax return are reported on Part II of Schedule UTP.

Exception: A corporation is not required to report a tax position it has taken in a prior tax year if the corporation reported that tax position on a Schedule UTP filed with a prior year tax return.

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pos t o o a Sc edu e U ed t a p o yea ta etu

Concise Description Of Tax PositionA corporation that reports a tax position on Schedule UTP is required to provide aA corporation that reports a tax position on Schedule UTP is required to provide a concise description of each tax position.

The concise description should include information that reasonably can be expected to apprise the IRS of the identity of the tax position and the

t f th t i t I ti l th d i ti t i l dnature of the uncertainty. In particular, the description must include:

A statement that the position involves an item of income, gain, loss, deduction or credit against tax;

A statement whether the position involves a determination of the value of any property or right or a computation of basis; and

The rationale for the position and the reasons for determining theThe rationale for the position and the reasons for determining the position is uncertain. In most cases, the description should not exceed a few sentences.

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Concise Description Of Tax Position (Cont.)In addition to requiring the reporting corporation to include a concise description ofIn addition to requiring the reporting corporation to include a concise description of the tax position, the Schedule UTP requires (a) the corporation to provide a brief summary of Code sections (up to three), (b) the corporation to indicate whether the tax position results in a temporary difference, a permanent difference, or both, and (c) if the tax position taken by the corporation relates to a tax position of a pass-through entity the corporation is required to provide the EIN of the pass-pass through entity, the corporation is required to provide the EIN of the passthrough entity to which the tax position relates.

Examples of acceptable concise descriptions, as provided in the draft instructions, are included below.

Example 14. The corporation investigated and negotiated several potential business acquisitions during the tax year. One of the transactions was completed during the tax year, but all other negotiations failed and the other potential transactions were abandoned during the tax year The corporation deducted coststransactions were abandoned during the tax year. The corporation deducted costs of investigating and partially negotiating potential business acquisitions that were not completed, and capitalized costs allocable to one business acquisition that was completed. The issue is the allocation of costs between failed acquisitions and the successful acquisition.

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Concise Description Of Tax Position (Cont.)Example 15 The corporation entered into a loan transaction in which itExample 15. The corporation entered into a loan transaction in which it made a general pledge of its assets to its lender. The corporation's assets include stock of FSub, a wholly owned foreign subsidiary. FSub reports no earnings and profits for U.S. federal income tax purposes based on its treatment of an item of income that defers income recognition to a later year. The corporation has taken the position that the pledge of FSub stock did not result in an investment in U.S. property under Code Sect. 956. The issue is whether there was an investment in U.S. property causing a deemed distribution of FSub earnings to the corporation as a result of the treatment of an item of FSub's income thatcorporation as a result of the treatment of an item of FSub s income that defers its recognition.

Example 16. The corporation received a cash distribution from Venture LLC (Venture LLC is treated as a U S partnership for tax purposes) TheLLC (Venture LLC is treated as a U.S. partnership for tax purposes). The corporation claims the distribution is not taxable because it did not exceed the corporation's basis in its interest in Venture LLC. The issue concerns (1) the computation of basis in the Venture LLC interest, and (2) the application of the disguised sale and partnership anti-abuse rules

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( ) pp g p pof Subchapter K and regulations thereunder to recharacterize the transaction as other than a distribution.

Transition Rules

A corporation is not required to report on Schedule UTP a tax position taken in (a) a tax year beginning before Dec. 15, 2009, or p ( ) y g g(b) a tax year beginning on or after Dec. 15, 2009 and ending before Jan. 1, 2010, regardless of whether or when a reserve was recorded with respect to that tax position.

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The Maximum Tax Adjustment (MTA)A corporation that reports a tax position on Schedule UTP is required to provide theA corporation that reports a tax position on Schedule UTP is required to provide the MTA with respect to such position.

General. The MTA for a tax position taken in a tax return is an estimate of the maximum amount of potential U.S. federal income tax liability associated with the tax year for which the tax position was takenwhich the tax position was taken.

The MTA is determined on an annual basis.

For tax positions that relate to items of income, gain, loss and deduction, p , g , ,estimate the total amount in dollars and multiply by 0.35 (35%).

For example, the MTA for a tax position taken in a tax return claiming a $100 deduction is $100 x 0.35 or $35.

For items of credit, estimate the total amount of credit in dollars. Combine the dollar estimates related to all applicable items of income, gain, loss, deduction, and credit to determine the MTA of that tax position.

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For example, the MTA for a tax position taken in a tax return claiming a $50 credit is $50.

How To Calculate Maximum Tax Adjustment

The MTA does not include interest or penalties The effects of aThe MTA does not include interest or penalties. The effects of a tax position on state, local or foreign taxes are disregarded when computing the MTA.

Determination of MTA for valuation and transfer pricing tax positions. A determination of a MTA is not required for valuation or transfer pricing purposes. Instead, the MTA reporting requirement is satisfied by indicating whether the tax position is a q y g pvaluation or a transfer pricing tax position and by providing a ranking of these tax positions based on either the amount recorded as a reserve for U.S. federal income tax for that tax position taken in the tax return, or the estimated adjustment to jU.S. federal income tax that would result if the tax position taken in the tax return is not sustained.

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Coordination With Other Reporting Requirements

A complete and accurate disclosure of a tax position on the appropriate year's Schedule UTP will be treated as if the pp p ycorporation filed a Form 8275 (Disclosure Statement) or Form 8275-R (Regulation Disclosure Statement) regarding the tax position. A separate Form 8275 or Form 8275-R need not be filed to avoid penalties with respect to that tax position.p p p

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Auditors’ Use Of Information

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Auditors’ Use Of InformationIn general it appears that one of the goals of uncertain tax positionIn general, it appears that one of the goals of uncertain tax position reporting is to allow the IRS to look further at risks that taxpayers have identified themselves. The new reporting will clearly affect exam teams and will aid the IRS in audit selection. Even though the IRS has denied that the Schedule UTP will be used as a starting point and an end point g p pfor an audit, it is a possibility and, accordingly, there is the potential for misuse of Schedule UTP.

If a position is uncertain to the taxpayer, it’s likely also uncertain to p p y , ythe IRS. No guarantee that an audit will result.

Stated purpose

Issue identification: According to IRS Chief Counsel William Wilkins, issue identification is a central objective of the proposal. Further, he has indicated that examinations stemming from the information provided on the schedule will not materially differ

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p yfrom today’s audits.

Auditors’ Use Of Information (Cont.)Efficiency: The IRS hopes it can conclude audits more rapidly as a result ofEfficiency: The IRS hopes it can conclude audits more rapidly as a result of the information it gathers, with the outcomes based on application of law to the facts of a taxpayer's transactions. Wilkins has reiterated that the IRS will not second-guess a taxpayer's financial statement reporting decisions and acknowledged that there will be an increased demand for pre-filing certainty.

Since the IRS will have greater access to information, auditors will not be forced to spend the same amount of time on issue identification and will not need to request the same information.

Increased efficiency may free some IRS resources and thus, result in more audits.

Wilkins has stated that the purpose of having taxpayers report issues they t t liti t i th t i d 't hid i th t b f i t texpect to litigate is so that companies don't hide issues that may be of interest

to the IRS. If a company is determined to litigate an issue and not settle, the only two possible outcomes are a complete loss or a complete win.

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Auditors’ Use Of Information (Cont.)The requirement to disclose issues not typically reserved because ofThe requirement to disclose issues not typically reserved because of administrative practice is an attempt to ensure there is a consistentunderstanding of administrative practice among industries and the IRS, according to Wilkins. “If administrative practice is in fact well understood within the IRS and documented, that's not an interesting gdisclosure, but there is concern over [a possible] disconnect between what industry might view as administrative practice and what the IRS does.” Further, according to Wilkins, disclosure acts as a check on rogue interpretations within specific industries.

In requiring a concise description of a reported issue, the IRS is merely trying to get enough information to tell if the issue is interesting for purposes of audit or issue selection. The description should provide the necessary facts to do a legal analysisnecessary facts to do a legal analysis.

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Possible State Implicationsp

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Possible State ImplicationsSchedule UTP may encourage states to propose and adopt their own state-Schedule UTP may encourage states to propose and adopt their own statespecific disclosure requirements.

Even though many states’ corporate tax laws mirror the federal corporate tax laws, states often have state-specific items (e.g., add-backs and other

difi ti d ll ti th d l i ) Th if t t t d tmodifications and allocation methodologies). Thus, if states were to adopt their own version of Schedule UTP, such schedules might be substantially different from the federal Schedule UTP or the schedules adopted by other states, increasing a taxpayer’s compliance burden.

Even if states decide not to adopt their own version of Schedule UTP, additional state tax audits may follow.

As permitted under Code Sect. 6103(d), the IRS has entered t ith ll 50 t t d hi h th IRS h f d l tagreements with all 50 states under which the IRS shares federal tax

returns and return information with the states. Thus, the IRS may share any Schedule UTPs that it may collect from taxpayers with the states, or the IRS may merely share identified issues with the states. The receipt of such information may trigger additional state tax audits.

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Implications Under Treaty p yPartner Exchange Of Information Provisions

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Implications Under Treaty Partner Exchange Of Information Provisions

U.S. income tax treaties generally contain an article addressing the exchange of information between contracting states. Under the Exchange of Information article, the competent authorities of the contracting states are generally able to exchange informationthe contracting states are generally able to exchange information among those states as may be necessary for carrying out the provisions of the treaty.

If a competent authority of a contracting state receivesIf a competent authority of a contracting state receives information under an Exchange of Information provision, such information must generally be kept confidential under such contracting state’s domestic laws.

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Implications Under Treaty Partner Exchange Of Information Provisions (Cont.)

F l A ti l 26 f th 1981 M d l U S I T T t t t iFor example, Article 26 of the 1981 Model U.S. Income Tax Treaty states in relevant part:

“The competent authorities of the Contracting States shall exchange such information as is necessary for carrying out the provisions of this Convention or of the domestic laws of the Contracting States concerning g gtaxes covered by the Convention insofar as the taxation thereunder is not contrary to the Convention. The exchange of information is not restricted by Article I (General Scope). Any information received by a Contracting State shall be treated as secret in the same manner as information obtained under the domestic laws of that State and shall be disclosed only to ypersons or authorities (including courts and administrative bodies) involved in the assessment, collection, or administration of, the enforcement or prosecution in respect of, or the determination of appeals in relation to, the taxes covered by the Convention. Such persons or authorities shall use the information only for such purposes. They may disclose the information in y p p y ypublic court proceedings or in judicial decisions.”

Accordingly, it is possible that information provided on the Schedule UTP will be disclosed to competent authorities, under the Exchange of Information provisions of U S income tax treaties

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provisions of U.S. income tax treaties.

Disclaimer:To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax d i t i d h i i tadvice contained herein is not

intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Code oravoiding penalties under the Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed

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transaction or matter addressed herein.