Uncertain Tax Positions
What exactly are “uncertain tax positions?”
For many reasons, large and sophisticated taxpayers take aggressive positions on their tax returns and report taxes due to the IRS which are significantly less than the amount of tax they ultimately pay.
An “uncertain tax position” is an accounting term that relates to an earnings recognition provision for an issue. FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109 (“FIN 48”), states that in order to recognize income with respect to an issue, a taxpayer must determine if the weight of available evidence indicates it is more likely than not, based on the technical merits, that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. In the simplest terms, if a taxpayer thinks that the IRS has a better position than they do on the merits, it is an uncertain tax position. Even though they cannot take the benefit of such positions for financial reporting purposes because they think they will lose if challenged by the IRS, businesses choose to take uncertain tax positions on their income tax returns in order to potentially recognize tax benefits in the future if the IRS does not identify and ultimately prevail on the issue. In addition, the company saves money on their current taxes by reporting a lower amount of tax due on their return.
For financial statement purposes, a taxpayer must go through the following steps to decide how much tax benefit, if any, they can recognize in their financials for each uncertain tax position:
For purposes of Schedule UTP, the schedule required to be filed by certain corporations to disclose uncertain tax positions to the IRS, an “uncertain tax position” is a position taken on a current or prior United States federal income tax return and either the corporation or a related party has recorded a reserve with respect to that tax position for United States federal income tax in audited financial statements, or the corporation or related party did not record a reserve for that tax position because the corporation expects to litigate that position. Currently, there is no technical definition of when a “reserve is recorded.” Ronald Schultz, Senior Advisor to the Deputy Commissioner for Services and Enforcement, said at a November, 2010 District of Columbia Bar luncheon that the IRS is following the financial accounting definition of recording a reserve, meaning that the IRS is currently relying on accounting practices under FIN 48 or other accounting standards.
Reporting requirements for uncertain tax positions
Corporations are required to disclose uncertain tax positions taken on a return filed for tax years beginning on or after January 1, 2010, under Treasury Regulation section 1.6012-2(a)(4) and (5). The IRS is believes that the disclosure of uncertain tax positions makes audits more efficient. In remarks to the New York State Bar Association Tax Section annual meeting, former IRS Commissioner Doug Shulman said, “Today, we spend up to 25% of our time in a large corporate audit searching for issues rather than having a straightforward discussion with the taxpayer about the issues.” According to Announcement 2010-75, the IRS requires corporations to rank all of the reported tax positions based on United States federal tax reserves recorded for the position taken, and designate those tax positions for which the reserve exceeds 10 percent of the aggregate amount of the reserves for all tax positions on the schedule. The IRS is also asking that corporations identify and rank tax positions that no reserve was established for based on an expectation to litigate the position; however, the IRS does not ask the corporation to determine the amount of the potential adjustment and these positions may be assigned any rank by the corporation.
Under the current disclosure rules, only corporations already required to reserve and report uncertain tax positions under FIN 48 or other accounting rules, and that have assets in excess of $10 million, are required to report their uncertain tax positions to the IRS. For purpose of the disclosure rules, uncertain tax positions are those required to be reserved for under FIN 48 or other accounting rules and any position related to the determination of any United States federal income tax liability for which a taxpayer or a related entity has not recorded a tax reserve because (i) the taxpayer expects to litigate the position, or (ii) the taxpayer has determined that the Service has a general administrative practice not to examine the position.
The current disclosure requirements do not require corporations report all of the relevant information about the uncertain tax position, such as the amount of the reserve, the taxpayer’s rationale in taking the position, the nature of the uncertainty, or the taxpayer’s risk calculation. This leaves ample opportunity for persons with information about a corporation’s uncertain position to come forward under and provide the IRS with additional information about the uncertain tax position, including hazards of the tax position and analysis of the support against the tax position.
