The need to file Schedule UTP, Uncertain Tax Position Statement, may have taken many corporate taxpayers by surprise in 2014, since the asset threshold for compliance was lowered from $50 million to $10 million.
In addition, the final UTP regulations issued in December 2010 (Regs. Sec. 1.6012-2(a)(4), T.D. 9510) fell short of resolving the concerns of many commentators that filing a Schedule UTP causes a waiver of the attorney-client privilege, the Sec. 7525 tax adviser privilege, or the work product doctrine. Provisions relating to the assertion of privilege were not included in the regulation.
Schedule UTP trends
Surprisingly, the number of Schedule UTP filers and number of reported positions were both lower in tax year 2013 compared with the three previous years (see IRS UTP Filing Statistics). Not surprisingly, the most typical UTPs in all years have to do with the Sec. 41 research and development credit and Sec. 482 transfer pricing, with Sec. 263 (capitalization) and Sec. 199 (domestic production activities) tied for third place in terms of the substantive areas being reported. Many UTPs in the past four years also involved Sec. 162 (business expenses) issues.
When the initial draft Schedule UTP was released in 2010, passthrough and tax-exempt entities were excused from filing. However, the IRS has not modified its position that it will consider expanding the filing requirement to include passthrough entities (see Announcement 2010-75).
Schedule UTP disclosure mechanics
Now that the phase-in period under the UTP regulations has ended and the UTP reporting threshold has dropped, tax practitioners are struggling more than ever with the mechanics of filing Schedule UTP while preserving the privileged status of workpapers and tax positions. Until Congress acts or the courts resolve these issues, it is unclear whether filing a Schedule UTP will cause the waiver of a privilege. Consequently, tax practitioners considering whether to file a Schedule UTP should make sure they thoroughly understand the reporting requirements under the UTP regulations and file only if absolutely necessary and only in the required form and content of disclosure.
UTP reporting is required of all corporations that prepare or issue audited financial statements, that have assets equal to or exceeding $10 million, that have taken a tax position on their U.S. federal income tax return for the current or a prior tax year, and either:
- Recorded a reserve with respect to the tax position for U.S. federal income tax, interest, or penalty; or
- Did not record a reserve for a tax position for which litigation is anticipated.
A corporation expects to litigate a position if it determines that the probability of settling with the IRS is less than 50% and that under applicable accounting standards (GAAP, IFRS, etc.), no reserve was recorded because the corporation determines it is more likely than not to prevail on the merits in litigation (see also “Schedule UTP: The Early Returns Are In,” JofA, Nov. 2012, page 54).
If it is determined that the corporation is required to file a Schedule UTP, the tax practitioner should pay particular attention to Part III, which requires a concise description of all UTPs identified in Parts I and II of the schedule. It is 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. It does not require the corporate taxpayer to disclose the rationale and nature of the uncertainty.
Taxpayers must remain vigilant when drafting the description of UTPs in Part III to avoid inadvertently disclosing any opinions, analyses, or evaluations that are protected by the attorney-client, federal tax advice, or work product privileges. The description should be limited to the information required by the instructions to Part III of Schedule UTP. On the one hand, professional practice rules would have the preparer disclosing very little about the transaction so as to not waive privileges. On the other hand, IRS guidance focuses on ensuring that descriptions (in addition to identifying a tax issue) provide sufficient relevant facts affecting the tax treatment of the item and sufficiently describe the nature of the issue. This presents the preparer with a Catch-22: to overdisclose and possibly waive privilege, or to underdisclose and face the consequences of improper disclosure, which arguably could trigger a variety of penalties. The IRS’s guidance is available at tinyurl.com/8mgwke9.
Sec. 6662 requires a taxpayer to disclose tax return positions for which the taxpayer does not have substantial authority or face potential penalties. In Announcement 2010-9, the IRS said it was considering seeking legislation to impose a failure-to-file penalty if Schedule UTP was omitted or did not provide adequate disclosure. Following the logic of the announcement, the IRS would have to conclude that a defective or missing Schedule UTP would rise to the level of a Sec. 6651(a) penalty for a complete failure to file a required return. Many commentators believe that the IRS’s position exceeds the bounds set by Congress, and to date, no such legislation has been introduced.
To be cautious, tax return preparers should, at a minimum, perform two layers of due diligence. First, they should reasonably inquire whether any tax positions may rise to the level of disclosure. If so, they should craft a disclosure that provides sufficient information to consider the return complete while ensuring the disclosure does not inadvertently waive privileges or other evidentiary protection held by taxpayers.
More due diligence needed
As a road map to potential audit issues, Schedule UTP has drawn much attention over the past few years. However, many taxpayers and preparers have failed to focus on it, due to the high threshold of applicability. Now, since the asset threshold for filing has lowered, many more tax return preparers will need to take the following actions, requiring more due diligence:
- Determine whether a Schedule UTP is required.
- If a Schedule UTP is required, then determine how the preparer will comply with the disclosure rules while avoiding inadvertent waiver of various taxpayer legal protections.
- Determine how to communicate with clients regarding the possibility of various penalties associated with nonfiling or inadequate disclosure.
By Robert A. Mathers, CPA/PFS/ABV, J.D., shareholder, and Mark Kmiecik, J.D., LL.M., senior attorney, both with Davis & Kuelthau SC in Wisconsin. Mathers also is a member of the AICPA Tax Practice Responsibilities Committee.
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