In Announcement 2010-9, the IRS proposes to require taxpayers subject to FIN 48 to completely disclose their uncertain tax positions and to tell the IRS the maximum amount of exposure they face if the position is completely disallowed. More specifically, the IRS is planning to require that certain filers must provide:
- A concise description of each uncertain tax position for which the taxpayer or a related entity has recorded a reserve in its financial statements and ;
- The maximum amount of the potential federal tax liability attributable to each uncertain tax position determined without regard to the taxpayer’s risk analysis regarding its likelihood of prevailing on the merits.
This is the typical “guilty until proven innocent” methodology that IRS agents have been trying to impose on taxpayers for the past few years and if enacted as proposed, will lead to even more “sloppy” auditing.
Currently, the IRS has a very serious problem auditing taxpayers because the agents that are paid to enforce the law, generally do not understand the law. This occurs because the tax law has become so complicated, that the agency simply cannot provide the agents with sufficient training to go out and do their jobs in an efficient manner. Moreover, IRS agents are not closely supervised so they will sometimes allow their personal bias to encroach upon what should be professional judgments. After a series of embarrassing instances where IRS attorneys were not following published guidance from the IRS, the Office of Chief Counsel had to “remind” IRS personnel they needed to follow the law.
See CC-2003-014. A recent email obtained under the Freedom of Information Act has a seemingly frustrated IRS attorney requesting training for agents in understanding a new provision included in the law (that they apparently had misunderstood or misapplied).
See CCA 200944043.
The following experience further demonstrates that the enforcement problem does not result from the lack of information about the taxpayer, but because of inadequate training of the IRS agents. Until 2004, corporate book to tax adjustments were reported on Schedule M-1. However, in 2004, the IRS began requiring that corporations with assets of $10 million or more file a more detailed reconciliation on a new Schedule M-3. The IRS justified this imposition on taxpayers saying this information was needed to properly enforce the tax law (sound familiar?). Recently, we had an IRS agent who was auditing one of our corporate clients ask us to prepare a Schedule M-1 for the client. We responded that we had prepared a Schedule M-3 because that is what was required since the client’s total assets exceeded $10 million. The IRS agent responded, “Yes, I know….but I don’t understand the M-3.”
To compensate for the fact that the IRS is failing to do its job correctly, the current Commissioner of Internal Revenue, Doug Shulman now wants most business taxpayers to provide the IRS with a roadmap to their POTENTIAL tax deficiencies. According to Mr. Shulman, this is necessary because currently the IRS “…spend(s) up to 25 percent of our time in a large corporate audit searching for issues rather than having a straightforward discussion with the taxpayer about the issues.” Unfortunately, no empirical evidence was provided to back up this claim. My view is that when an IRS opens an audit, the agents generally spend most of their time going through the IRS checklists trying to learn the law on the fly. The approach is recipe book 101. My view is that if IRS agents came in the door with a full and complete understanding of the law, they would not have any trouble identifying the key issues that should be audited. For example, we recently had an IRS agent challenge a client’s research credit; to provide support for the IRS’ position the taxpayer was not entitled to the credit, the agent sent the taxpayers (and us) an outdated copy of the regulations. Opps…...
The Announcement is confusing and inconsistent in what positions must be highlighted on the roadmap for the IRS. For example, it starts out defining an “uncertain tax position” as one in which a taxpayer has “recorded a reserve in its financial statements” but then goes on to say:
In addition to those positions for which a tax reserve must be established under FIN 48 or other accounting standards, uncertain tax positions will include any position related to the determination of any United States federal income tax liability for which a taxpayer or a related entity has not recorded a tax reserve because (i) the taxpayer expects to litigate the position, or (ii) the taxpayer has determined that the Service has a general administrative practice not to examine the position. For this purpose, a related entity is any entity that is related to the taxpayer under sections 267(b), 318(a), or 707(b).
This second statement indicates that the IRS apparently does not understand how FIN 48 is applied. A literal reading of paragraph quoted above would likely cause all of the taxpayer’s positions to be considered uncertain!
The two key steps in the FIN 48 analysis of any uncertain tax position are recognition and measurement. First, in the recognition step, each tax position is evaluated to determine whether it is more likely than not (MLTN) that the position will be sustained upon examination by the taxing authorities. The company must assume that it will be audited, and that the taxing authority will evaluate the technical merits of each tax position. Second, a tax position that meets the MLTN standard then is measured to the largest amount of the tax benefit that is greater than 50 percent likely of being realized upon ultimate settlement with the tax authority. The company must consider the possible estimated outcomes using the facts, circumstances, and information available at the reporting date. Unlike the recognition test, where a company should assume resolution in the court of last resort, the measurement should consider what the company would ultimately accept on settlement with the tax authorities. Given this application of the FIN 48 rules, I have no idea what the IRS is getting at when it states that uncertain positions can exist outside of FIN 48. How is that possible?
Despite this confusing second statement (which seems to open the door to virtually everyone), the SCOPE section of the Announcement seems to limit the requirement to business taxpayers who are subject to FIN 48 or IFARS with total assets in excess of $10 million. In
Mr. Shulman’s speech he appears to agree with this interpretation in that he says “[r]eporting uncertain tax position would be required at the time a return is filed by certain business taxpayers: those who have both a financial statement prepared under FIN 48 or other similar accounting standards reflecting uncertain tax positions and assets over $10 million.”
In the ultimate display of its inability to understand and apply the English language, the Announcement defines a “concise” description:
As currently contemplated, this concise description will include the rationale for the position and a concise general statement of the reasons for determining that the position is an uncertain tax position. To be sufficient, the description must contain:
- The Code sections potentially implicated by the position;
- A description of the taxable year or years to which the position relates;
- A statement that the position involves an item of income, gain, loss, deduction, or credit against tax;
- A statement that the position involves a permanent inclusion or exclusion of any item, the timing of that item, or both;
- A statement whether the position involves a determination of the value of any property or right; and
- A statement whether the position involves a computation of basis.
According to the Office Edition of The American Heritage Dictionary (3rd Edition which is dog- eared on my desk) “concise” is defined as “Expressing much in few words; clear and succinct.” From the listing of items that must be included, it is clear the description will be anything but “concise” as that term is commonly used.
The IRS ends the Announcement by saying it intends to “retain the existing policy of restraint for requesting tax accrual workpapers during the course of examinations…” That statement really roils for two reasons: First, the IRS has not been following that announced policy of restraint since IRS agents routinely ask for such workpapers at the start of an audit (this happened within the last three months to me). Second, why would the IRS need the detailed workpapers when they are given a roadmap along with the MAXIMUM potential liability?
FIN 48 was criticized for providing the IRS with a roadmap to potential issues. The criticism was blunted somewhat when the disclosures required under FIN 48 were scaled back (in particular for private companies) and when the IRS claimed it was exercising restraint in requiring the disclosure of tax accrual workpaper. However, now the real intentions of the IRS are clear and they include the production of a “road map.” This is certainly not the “balanced” proposal that Doug Shulman indicated was on the horizon in his
October 26, 2009 speech to the AICPA.
Announcement 2010-9 requests comments and it is uncertain whether it will be adopted in the fashion outlined; nevertheless, over the past five years a clear pattern has emerged where the IRS is blaming taxpayers and their advisors for their inability to carry out their jobs. The complaining has reached a fevered pitch because the IRS continues to flounder. The only way to fix this problem is to simplify the tax law; but that isn’t going to happen when each year there are over 300 tax law changes.
Expect the IRS to continue to demonize tax return preparers as it continues to look for ways to explain and justify its actions. Mr. Shulman’s goal is to make CPAs and other tax preparers quasi-IRS employees responsible for enforcing the tax law. This will be done by forcing CPAs and other tax prepares to do what the IRS wants, or face disciplinary action. Sound familiar? Just ask GM, Bank of America, and AIG.