On September 8, 2010, the Internal Revenue Service (IRS) issued amended regulations under Section 6012 that will require certain corporation taxpayers to disclose Uncertain Tax Positions (UTP) on a schedule attached to the taxpayer’s return starting with returns filed for calendar-year 2010. Section 6012 requires corporations to file income-tax returns. Historically, the IRS has been granted broad authority to prescribe the form and content of returns. The proposed regulations require certain corporations to disclose UTPs “in accordance with forms, instructions or other appropriate guidance provided by the IRS.”

In view of the language of the regulations, the cliché that the “devil is in the details” is appropriate. In January 2010, the IRS issued for comment a proposed Schedule UTP and related instructions that would apply to certain taxpayers that provide FIN 48 disclosures in their financial statements. It is important to note that according to the current proposals, only corporate taxpayers with total assets of $10 million or more are required to comply with the disclosure regime.

FIN 48 requires a determination of whether a claimed tax benefit may be recognized for financial statement purposes and, if so, in what amount, for purposes of reporting tax liabilities under Generally Accepted Accounting Principles (GAAP) under FAS 109 — Accounting for Income Taxes (ASC Topic 740). The financial statement issuer must believe that any tax benefit claimed meets a “more likely than not” confidence threshold in the event it were to be challenged by a tax authority. Even if it meets that threshold, if there is sufficient uncertainty that the position would be sustained in full, the financial statement issuer must estimate the amount of benefit that would be realized upon settlement with the tax authority.

The proposed Form UTP requires disclosures of the gross amount of the UTP, i.e., before the financial statement estimate of settlement. In addition, the taxpayer must disclose UTPs that are not reflected in the financial statement estimates because the taxpayer believes that the tax treatment — while not in strict compliance with tax law — would not be challenged by IRS because its administrative practice accepts the taxpayer’s treatment. Also, not reported for FIN 48 UTP purposes but required to be disclosed on Form UTP, are financial statement positions with respect to which the taxpayer intends to litigate, if challenged, and believes it would prevail. With regard to the later two types of UTP, representatives of IRS indicate that the Service is considering eliminating the extended reporting obligation. However, to date, the IRS has not withdrawn or replaced those proposals.

Public Companies vs. Private Entities

The impact on private entities is, generally, likely to be quite different from public companies. Public companies have criticized the proposals as intrusive and also asserted that they intensify the ongoing debate over a taxpayer-financial statement issuers’ right to seek attorney-client and work-product privileges to protect disclosure of certain communications pertaining to advice with respect to tax positions they have taken. These privileges, especially work-product privilege claims for information shared with an “independent auditor,” are themselves subject to uncertainty and have recently been the subject of significant litigation. However, the auditor-tax adviser “service model” for public companies most often involves companies that prepare their own tax returns and obtain “filing advice” from tax lawyers. This information is shared with the auditor CPA firm for purposes of evaluating a company’s tax provision. Companies contend that the limited purposes of sharing this information does not constitute a “waiver” of privilege with respect to preventing discovery of a company’s communications with tax counsel.

But the “service model” for CPA firms and private companies is generally very different from the public company service model. Most private companies do not prepare their tax returns internally and most private companies engage the same CPA to perform their audit or review services and to prepare their tax returns and to provide their significant tax advice.

Consequently, the outcome of the ongoing controversy with respect to privilege and work-product privileged communications with CPAs is inapplicable. Information and communications related to tax-return preparation is virtually never subject to privilege claims because it is communicated for the purpose of preparing a tax return — a document that is intended to be provided to the government. While these companies might raise all sorts of objections when the IRS seeks tax and related workpapers created by CPAs, they are not likely to be sustained and the costs of defending against IRS pursuit of the information would likely be prohibitive. So, to a large degree, when it comes to asserting privilege claims, private companies and their CPA firms do not really have “a dog in the fight.” CPAs as advisers to their clients should be aware of and make their clients aware of the limitations on privilege claims.

Conclusion

Private company uncertain tax positions frequently involve timing difference issues and their other uncertain tax positions do not rise to the magnitude of those of large publicly traded companies. Thus, they may well look upon their requirement to succinctly describe their uncertain tax positions and reasons for believing their claimed tax treatment was appropriate as an opportunity to sufficiently present a convincing case to IRS reviewers not to select a return for examination.

Kip Dellinger, CPA, is senior tax partner at Los Angeles, CA-based Kallman And Co. LLP. He is a past-Chair of the AICPA Tax Division’s Tax Practice Responsibilities Committee and is the author of the Practical Guide to Federal Tax Practice Standards (CCH, 2007). He developed and teaches full day courses on Tax Practice Standards, Conduct and Quality Control for California CPAs, FIN 48: Uncertain Tax Positions and Quality Control in a Tax Practice for the Education Foundation of the California Society of CPAs.  He will be a presenter at the AICPA National Tax Conference, held October 25-26, 2010 in Washington, DC.