What’s UP with UTP?
Here’s what’s new with Schedule UTP:
The asset threshold for filing Schedule UTP drops from $100 to $50 million beginning with the 2012 tax year and to $10 million in 2014. Many more Daszkal Bolton clients will now be impacted going forward.
Who Must File?
Corporate taxpayers who file:
- 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 Tax Return
- Form 1120-PC U.S. Property and Casualty Insurance Company Income Tax Return
What is the Phased Effective Date?
- Calendar year 2012 for corporate taxpayers with total assets equal to or greater than $50 Million
- Calendar year 2014 for corporate taxpayers with total assets equal to or greater than $10 Million
What are the Key Elements of Reporting?
- Disclosure on Schedule UTP is required if two criteria are met:
1. Corporation has taken a tax position on its U.S. Federal income tax return for the current tax year or a prior tax year; and
2. Either the corporation or a related party has recorded a reserve with respect to that tax position for U.S. Federal income tax in audited financial statements or did not record a reserve for that tax position because the corporation or related party ―expects to litigate the position.
- The initial recording of a reserve will trigger reporting of a tax position taken on a return. However, subsequent reserve increases or decreases with respect to the tax position will not.
- Transition Rule – A corporation is not required to report a UTP for a tax position taken in a tax year beginning before January 1, 2010
- Taxpayers must provide a concise description for each tax position listed on Schedule UTP, including:
1. A description of the relevant facts affecting the tax treatment of the position; and
2. Information that can reasonably be expected to apprise the IRS of the identity and nature of the tax position.
- The concise description should not include:
1. Assessment of the hazards of a tax position;
2. Analysis of the support for or against the tax position; or
3. Any privileged information.
Key Point: Schedule UTP was created and is required as part of an IRS strategy to improve compliance through greater transparency. The initiative requires a taxpayer to identify to the IRS certain potential “soft spots” in the taxpayer’s tax return when the taxpayer files the return. In prior years, the taxpayer’s obligation was to file an accurate return and then the IRS had to find any potential soft spots. In summary, a corporation must file a UTP form when it records a “reserve” for a tax position in its audited financial statements. Schedule UTP requires the corporation to make a “concise description” of such a tax position. In addition, disclosure on Schedule UTP is also required when a reserve is not recorded in the audited financial statements but in arriving at such a conclusion there was an assumption there is a greater than 50 percent probability the tax position will be litigated.
What is the Impact on Companies?
There is no question that UTP filing has increased costs for large companies, although probably not catastrophically; smaller companies facing UTP obligations in 2013 and going forward will feel the pain more.
For multinational corporations, transfer pricing issues are virtually bread and butter.
The research credit is fraught with ambiguity and there is no shortage of dispute between taxpayers and the IRS about its scope. Trade or business expenses presumably point to the myriad issues and uncertainty regarding whether expenses are properly deductible or must be capitalized and amortized.
Large corporations that have every return audited reported an average of 3.2 positions, while for the rest of the current filing population the average was 1.8 positions.
- The top three Code sections listed as underlying all disclosed UTPs were Secs:
- 41 (credit for increasing research activities),
- 482 (allocation of income and deductions among taxpayers), and
- 162 (trade or business expenses);
- 25% of all UTPs were international issues;
- 21% of all UTPs disclosed were transfer-pricing issues (Sec. 482);
The American Institute of Certified Public Accountants (AICPA) has been trying to convince the IRS to eliminate Schedule M-3, which duplicates some of the information now reported on Schedule UTP, and eliminate UTP reporting for companies that voluntarily participate in the IRS’s Compliance Assurance Process (CAP) program. The CAP program allows taxpayers to work collaboratively with an IRS team to identify and resolve potential tax issues before tax returns are filed.
FIN 48, now referred to as Accounting Standards Codification (ASC) 740-10, requires substantial disclosure surrounding businesses’ UTPs, and is essentially meeting its goal of increasing the relevance and comparability in reporting information about income tax uncertainties. But it has some shortcomings and FASB may decide to make some changes in FIN 48. Any decision by FASB to rewrite portions of FIN 48 — as in requiring either fuller or more detailed disclosures — might embolden the IRS to do the same with Schedule UTP. There is a concern that Schedule UTP could lead to adverse audit and settlement consequences. The last update for 2012 Form 1120 was issued late August. Daszkal Bolton will make every effort to keep clients updated on further developments.
Will the“Tax Gap” Affect IRS UTP Guidance?
Underreporting by individuals and corporations constitutes the lion’s share of the tax gap, and the corporate underreporting rate grew much more quickly. The IRS, therefore, may view auditing of UTP schedules as one way of slowing the tax gap expansion. But does confusion surrounding the complexities of our tax code lead to noncompliance?
Congress believes the tax gap is more than $300 billion that we simply can’t afford to waste. So it is entirely possible that Congress may lean on the IRS to clarify or even tighten the instruction language in Schedule UTP. Daszkal Bolton work with clients to make their disclosures compliant without disclosing privileged material, which is imperative even with the expansion of the ‘policy of restraint’ to the schedule. Recent guidance suggests that agents not ask taxpayers why a position is uncertain and emphasizes that the mere inclusion of a Schedule UTP with a return does not automatically indicate that an audit is appropriate or that the taxpayer’s position is either incorrect or aggressive.
What is the IRS Guidance for Schedule UTP Concise Descriptions?
Schedule UTP instructs a taxpayer to draft a concise description as follows:
Provide a concise description of the tax position, including a description of the relevant facts affecting the tax treatment of the position and information that reasonably can be expected to apprise the IRS of the identity of the tax position and the nature of the issue. In most cases, the description should not exceed a few sentences. Stating that a concise description is “Available upon Request” is not an adequate description.
The new IRS guidance offers five examples of hypothetical concise descriptions that rather clearly do not meet the requirements of the instructions. One such example is:
“This is an issue for which we have recorded of reserve because the appropriate tax treatment of this position is unsettled and we are awaiting published guidance and we are awaiting the outcome of pending litigation.”
The other examples of clearly insufficient descriptions note “the issue is under audit” or “that the item is subject to IRS scrutiny”. The IRS notes that descriptions like this are inadequate because they do not provide relevant facts affecting the tax treatment the item nor do they identify the tax position and the nature of the issue.
The second set of examples compare specific hypothetical concise descriptions for the same tax position, one of which is insufficient and one of which is sufficient.
An insufficient concise description:
“This is a research credit issue”.
The guidance suggests the following is a better description of a potential research credit issue:
“The taxpayer incurred support department costs that were allocated to various research projects based upon the methodology the taxpayer considers reasonable. The issue is whether the taxpayer’s method of allocating these costs is acceptable by the IRS”.
Another example starts with the following insufficient description:
“The taxpayer claimed a domestic production activities deduction. The domestic production activities deduction is highly factual and subject to review by the IRS”.
The guidance indicates that a sufficient concise description for a domestic production activities deduction would read as follows:
“The taxpayer claimed the domestic production activities deduction on certain production activities income for 2010. The issue is whether costs incurred for product aging processes that occur in designated areas located at the taxpayer’s distribution facility are considered manufacturing or production costs of the tangible personal property, and therefore, a component of Qualified Production Activities Income”.
How to Plan for Schedule UTP?
The IRS expects that many more corporate taxpayers will “learn” that they are required to file a Schedule UTP, and that many more of their tax issues are uncertain and are required to be reported on Schedule UTP. Currently, there is no specific penalty for failing to file a required Schedule UTP. The IRS does, however, have the ability to assert the accuracy-related penalties under Internal Revenue Code Section 6662, as well as other penalties that might be applicable for “negligence” or “disregard of the rules and regulations”. The IRS appears to be asserting penalties more frequently, and Agents are likely to assert penalties against a corporate taxpayer that has failed to disclose a position as being uncertain when the IRS proposes a substantial audit adjustment with respect to the tax issue. The IRS is, in many respects, relying on accounting firms to help it police this area, and is concerned about the low number of uncertain tax positions being reported by large corporations.
Since the inception of Schedule UTP, much has been spoken and written about it. This tax filing season, and next, many more of our clients face important decisions with regard to uncertain tax positions so it is not just large corporations anymore that must start divining IRS instructions. Daszkal Bolton can be of assistance and suggests the following:
- Develop an effective and efficient UTP reporting process beginning with the initial calendar tax year of reporting
-Identify positions to be reported given changes in reserves
-Develop or modify existing processes and operational controls to capture necessary information to comply with reporting requirements
- Strategically address IRS examination issues
- Reduce or eliminate uncertainty prior to the release of the year-end financial statements and/or prior to the filing of the initial Schedule UTP
Contact Us: Should you have questions regarding this or any other complex corporate tax issue, please contact Sandy Smith, CPA, Partner, at 561-367-1040 or firstname.lastname@example.org. His area of corporate expertise consists of tax planning and compliance, resolving complex tax issues relating to domestic transactions and investment activities, as well as state and local tax compliance. Sandy also assists clients in conflict resolution with state and federal taxing authorities. He has represented several clients during IRS Audits.