Uncertain Tax Positions

IRS Proposes New Tax Return Disclosure of Uncertain Tax Position Starting 2010 Centered Around Financial Statement Tax Reserves and Separately Wins Battle Over Right to Summons Tax Workpapers in Textron.

In January 2010, the Internal Revenue Service ("IRS") announced a new tax return disclosure requirement for "uncertain tax return positions" ("UTPs") that are reflected by tax reserves for U.S. Federal income tax liability recorded for financial statement purposes. The IRS' objective in requiring UTP disclosure is to gain greater visibility of tax return positions that represent potential underreporting of tax.

UTP reporting on new Schedule UTP, released by the IRS on April 20th in draft form, generally applies starting 2010 to business entities that both report Federal income tax reserves in an audited financial statement and have assets in excess of $10 million. Initially, only certain corporate return filers are subject to the new disclosure rule in the 2010 tax year, although the IRS expects that after 2010 pass-through entities, REITs, RICs, and tax-exempt organizations will also be subject to UTP reporting. UTP disclosure will affect privately-held businesses, including portfolio companies of private equity and venture capital funds, publicly-traded corporations, U.S. subsidiaries of foreign corporations and foreign corporations doing business in the U.S.

UTP disclosure requires a concise summary of each UTP that is part of a taxpayer's tax reserve computation for financial statement purposes. The UTP disclosure rules thus effectively piggyback onto new, complex financial statement disclosure rules under US Generally Accepted Accounting Principles ("GAAP") for reporting tax contingencies -- FASB Interpretation No. 48 ("FIN 48") -- applicable to public companies since 2007 and non-public companies since 2009, as well as other accounting standards used to calculate tax reserves including International Financial Reporting Standards ("IFRS").

The IRS maintains that the UTP disclosure rule will not alter its long-standing policy of restraint in requesting tax accrual workpapers requiring first a known issue as to which additional facts are needed and satisfaction of other conditions. The inevitable effect of UTP disclosure will be greater intrusion into the tax reserve determination process. The April release of new Schedule UTP also comes on the wave of IRS litigation success in Textron Inc. v. United States, in which the First Circuit Court of Appeals rejected a work product defense to an IRS summons for tax accrual workpapers on the rationale that the workpapers were prepared for GAAP reporting purposes rather than in anticipation of tax litigation. On May 24, 2010, the Supreme Court declined to review the First Circuit decision arguably giving the IRS further momentum in seeking tax accrual information through the...