IRS proposes new disclosure rules, wants to expose risky tax breaks.

By  Scott Sinder, Philip West and Amanda Pedvin Varma

A new IRS initiative would require certain businesses to disclose with their tax returns information regarding “uncertain” (read: risky) tax positions. The proposal significantly expands the information taxpayers have to file with their tax returns about their most sensitive and potentially vulnerable tax positions. It materially tips the playing field in favor of the IRS in its quest for more effective tools to use in tax audits and controversies. It has important implications for business taxpayers—including insurance agencies and brokerage firms.

The proposal requires businesses to report details on tax positions where they must establish reserves for financial statement purposes.

Under Financial Accounting Standards Board Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” a business issuing financial statements under GAAP (Generally Accepted Accounting Principles), is required to evaluate each of its tax positions and ask whether the position has a “more likely than not” chance of being sustained on its technical merits. If a position is not likely to be sustained, the business must record full reserves for that position.

If a position meets the “more likely than not” threshold, the business must determine how much of a reserve to place against those particular tax benefits it is claiming. Determining reserves is made under a complex and judgment-intensive process. The business may record the largest benefit that has a greater than 50% chance of succeeding and it must establish reserves for the balance.

The new IRS initiative (IRS Announcement 2010-9), would apply to any business taxpayer with assets of $10 million or more that has an “uncertain tax position.” That would include a position where a tax reserve must be established, or a position where a reserve has not been recorded because the taxpayer or a related entity expects to litigate the position or because the taxpayer “has determined that the Service has a general administrative practice not to examine the position.”

The IRS is developing a schedule for those affected business taxpayers who would be required to file with their tax returns. The schedule is expected to require a concise description of each uncertain tax position, the rationale for that position, and a general statement of the reasons for determining that the position is uncertain. It would also require the maximum amount of potential federal tax liability attributable to each uncertain position. To be considered sufficient, the description will require: (a) the Internal Revenue Code sections potentially implicated by the position; (b) the taxable year or years to which the position relates; (c) a statement that the position involves an item of income, gain, loss, deduction, or credit against tax; (d) a statement that the position involves a permanent inclusion or exclusion of any item, the timing of that item, or both; (e) a statement whether the position involves a determination of the value of any property or right; and (f) a statement whether the position involves a computation of basis.

Significantly,the IRS has attempted to make clear that, under this new disclosure requirement,businesses would not be required to disclose the perceived strength or weakness of theirtax positions or the amounts that they reserved for each position. Taxpayers have nevertheless expressed concerns that even the information that they will have to provide under this announcementwill sometimes betantamount to forcingthem to waive the protection of the attorney work product doctrine because they will be revealing the advice they have received in taking the tax positions they have taken..

Once it is released, the IRS will require affected taxpayers to submit the new schedule with their tax returns. The IRS is considering options for penalties or sanctions that could be imposed if a taxpayer fails to make adequate disclosure (Announcement 2010-9).

In announcing the new initiative, Commissioner Doug Shulman says the service could have asked tax payers for much more. “…a lot more,” he says. “…We believe we have crafted a proposal that gives us the information we need to do our job without trying to get in the heads of taxpayers as to the strengths or weaknesses of their positions.”

The new policy, says Shulman, does not affect the IRS’s “policy of restraint” in requesting tax accrual work papers. These generally constitute the documentation of a company’s analysis of tax contingencies and reserves reported on financial statements. They include the amount of the risk and the amount of the reserve for that particular item. The IRS’s current policy is to request tax accrual work papers from taxpayers who engage in transactions that are on an IRS list of tax avoidance schemes.

The IRS set a March 29 deadline for public comments on the proposal. If implemented, the new IRS disclosure initiative will require some business taxpayers to devote significant additional resources to evaluating their tax positions and preparing their tax returns.

Sinder, a partner at Steptoe & Johnson, is CIAB General Counsel.
Philip West, is chair of Steptoe's International Tax practice.
Amanda Pedvin Varma is a Steptoe tax associate.