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New IRS Rulings And Their Possible Unintended Consequences

By Michael B. Nelson, Esq. - Email Editor

Date : February 16, 2010

New IRS Rulings And Their Possible Unintended Consequences

After reading attorney Tim Berry’s flavorful article the other week, I too feel that the alarm bells should be going off to wake up the U.S. taxpayers. The prepared statements made by Commissioner Shulman to the New York State Bar Association Taxation Section Annual Meeting in New York City on January 26, 2010 were made for a very defined purpose! Just as with President Obama, any speech made by a high ranking federal individual has content that is deliberate, well-thought-out, and intended to send a message to the public at large or as in Shulman’s speech a message to lawyers practicing in Federal taxation. Just as in the President’s State of the Union address on January 27, 2010, a day later than Commissioner Shulman’s speech, the two individuals knew of each other’s speech and had their staff working in cooperation to allow for consistency and affirmation as their messages were made to the American public.

The remarks of Commissioner Shulman read to the New York Tax Section in a word-by-word format, from a written text in front of him, were designed to fold into Obama’s address. Shulman’s remarks on transparency are about to become part of the Internal Revenue Manual. The IRM is like a car’s operating manual, it describes the administrative, procedural and policies that guide the I.R.S.

I imagine that corporation returns will fit this definition; however people with $10 million or more of wealth and report a Schedule C, sole proprietorship income, may also soon become an integral part of this definition. Whatever taxpayer is determined to fall under this definition must then retain expensive and competent tax counsel and C.P.A. services to comply with this new level of disclosure and transparency.

What was not disclosed in Commissioner Shulman’s speech was two items:

1. Although the proposal does not require the taxpayer to disclose the taxpayer's risk assessment or tax reserve amounts, the I.R.S. can already simply compel the production of this information through a summons, see United States v. Arthur Young, 465 U.S. 805, 815 (1984); and

2. While the I.R.S. now mentions their future intention of mandating the reporting of uncertain tax positions, this proposal is already part of the IRM as far back in 2002, eight years earlier, see Announcements 2002-63 and 2002-2.

Analysis: Currently, there is a three year Statute of Limitations that the I.R.S. has in which to file an Audit Notification that runs from the date the tax return was filed. Mandating the self reporting of questionable tax positions taken on the tax return will allow the I.R.S. to commence audits well before the Statute limitation. Note also that the I.R.S. is also asking for a six year Statute of Limitations which will ensure any risk of a reported tax position will fall within the audit Statute time limit.

HOW LONG IS A PIECE OF STRING? Publically traded companies are already mandated under the Security and Exchange Commission to have annual independent audits and to identify and quantify uncertain tax positions taken in the tax return for financial accounting purposes. Specifically, large corporate taxpayers are required to identify and quantify for financial accounting purposes a tax position relating to a specific federal tax return for which a taxpayer is required to reserve an amount. This was mandated under the draft Financial Accounting Standards Board ASC 740-10 in year 2006 and applies to the American Institute of Certified Public Accountants, AICPA. Therefore, large businesses are required to report uncertain tax positions in its own books and records and report those positions as well as keep cash reserves in case this position is audited and a liability subsequently follows. This requirement of CPA reporting applies to both domestic and foreign businesses even though U.S. reporting standards do not legally apply to foreign businesses. Note: the International Financial Reporting Standards (IFRS) and country-specific generally accepted accounting standards do require this type of disclosure of many other countries. This was tested in the case of United States v. Arthur Young, 465 U.S.

As we experience every year, as Americans and U.S. companies, our Federal income tax system is self-assessing in which we do all of the accounting, filing out tax returns, filing the return and determine our liabilities. Now, the I.R.S. is adding that we also add to the tax return forms that will openly show our facts upon which we have assessed ourselves a tax, how it was determined and what authority we have relied upon. At the time of my writing, the business tax form is Form 1120, the U.S. Corporation Income Tax Return, but it is being expanded to “other business tax returns” which has yet to be defined by the I.R.S. I suspect that S Corporations, LLC, LP, LLP, and General Partnerships will fall into that citatory of “business taxpayers”. In addition, you will be required to provide:

1. A concise description of each uncertain tax position for which the taxpayer or a related entity has recorded a reserve in its financial statements;

2. The maximum amount of 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;

3. 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; and

4. The schedule will require a concise description of each uncertain tax position in sufficient detail so that the Service can determine the nature of the issue. The sufficiency of a description will depend on the taxpayer’s particular facts and the nature of the underlying transaction. 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:

1. The Tax Code sections potentially implicated by the position;

2. A description of the taxable year or years to which the position relates;

3. A statement that the position involves an item of income, gain, loss, deduction, or credit against tax;

4. A statement that the position involves a permanent inclusion or exclusion of any item, the timing of that item, or both;

5. A statement whether the position involves a determination of the value of any property or right; and

6. A statement whether the position involves a computation of basis.

In addition, the schedule will require a taxpayer to specify for each uncertain tax position the entire amount of United States federal income tax that would be due if the position were disallowed in its entirety on audit. This amount is the maximum tax adjustment for the position reflecting all changes to items of income, gain, loss, deduction or credit if the position is not sustained.

Analysis: Where will this end? Currently we are requiring this disclosure of large multi-national public traded companies. As you can see, the bar is being lowered to capture smaller businesses within the now proposed rules of disclosure of uncertain tax positions on tax returns where even the SEC is not making such a disclosure requirement. A limit of assets more than $10,000,000 can apply to very small businesses, especially businesses with one commercial building can fall well within this new definition!

COMPELLING ENFORCEMENT:

The IRS is also considering penalties or sanctions to be imposed when a taxpayer fails to make adequate disclosure of the required information regarding its uncertain tax positions. One option being considered is to seek legislation imposing a penalty for failure to file the schedule or to make adequate disclosure.

At this time, the IRS’s intention is to apply this disclosure requirement on business taxpayers with assets totaling more than $10 million if the taxpayer has one or more uncertain tax positions of the type required to be reported on the new schedule. This includes a taxpayer who prepares financial statements, or is included in the financial statements of a related entity that prepares financial statements, if that taxpayer or related entity determines its United States federal income tax reserves accounting standards relating to uncertain tax positions involving United States federal income tax.

PUBLIC COMMENT:

Now for the good part, if there is one, this modification to the 2002 legislation is not law yet. The IRS has asked for public comment to be submitted by March 29, 2010. However, it seems that the IRS not only needs our help in transparency and pointing out our well-researched tax positions on tax returns, but these public comments are now asked with specific guidelines:

1. How the maximum tax adjustment should be reflected on the schedule so that it provides the Service with an objective and quantifiable measure of each reported tax position (e.g., specific dollar amount or by appropriate dollar ranges);

2. What alternative methods of disclosure of the amount at issue would allow the Service to identify the relative importance of the uncertain tax positions;

3. Whether the calculation of the maximum tax adjustment should relate solely to the tax period for which the return is filed or to all tax periods to which the position relates, and whether net operating losses or excess credits should be taken into account in determining the maximum tax adjustment;

4. How the related entity rules should be applied;

5. Whether the scope of the Announcement should be modified regarding the uncertain tax positions for which information is required to be reported (e.g., positions for which no tax reserve has been established because the taxpayer determined the Service has a general administrative practice not to examine the position);

6. Whether transition rules should be used or criteria modified to either include or exclude certain businesses taxpayers (e.g., the proposed threshold of $10 million total assets);

7. How the new schedule should address taxpayers that initially did not record a reserve for an issue, but in later years do record a reserve; and

8. Whether the list of information proposed to be included should be modified, including whether certain information should be requested in some circumstances upon examination rather than with tax return.

If you chose to participate, your comments are to be submitted to: Internal Revenue Service, CC:PA:LPD:PR (Announcement 2010-9), Room 5203, P.O. Box 7604, Ben Franklin Station, N.W., Washington, D.C. 20044. Alternatively, comments may be hand delivered between the hours of 8:00 a.m. and 4:00 p.m., Monday through Friday, to CC:PA:LPD:PR (Announcement 2010-9), Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue, N.W., Washington, D.C. Comments may also be transmitted electronically via the following e-mail address: announcement.Comments@irscounsel.treas.gov. Include "Announcement 2010-9" in the subject line of any electronic communications. The IRS will make all comments will be available for public inspection and copying.

CONLCUSION:

What is certain from all of this is that doing business in the United States is about to become very burdensome financially, with huge losses of business privacy, and massive increases in a business’s legal budget. This, in my opinion, is an opening of the floodgates for large case audits, auditing of wealthy companies and their individual shareholders, the creation of an even larger case backlog of taxpayer Appeals and Petitions into the United States Tax Court. However, from the Government's prospective, they will be adding to their legions of unpaid governments employees by mandating tax counsel and C.P.A.s perform services for the benefit of the U.S. government in researching tax positions claimed on the tax return that then becomes the tax research utilized by the government. I think this type of legislation may well produce additional revenue, but it will not attract foreign businesses to our shores nor will it bring about rapid growth of U.S. businesses that are the backbone and foundation for “jobs creation” as mentioned numerous times in the State of the Union address.

Feel free to email us at info@trustmakers.com or call to discuss your options.

Taking Action If you have a company, foundation or trust outside the US borders and want to know if you have correctly set it up for structural and/or tax purposes our advisors are now handling these cases. Please reply to info@trustmakers.com.

By Michael B. Nelson, Esq.
TrustMakers.com

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