IRS: Show Us Where It Could Hurt

A new proposal from the IRS could force companies to reveal more details about uncertain tax positions.
Marie LeoneJanuary 26, 2010

The Internal Revenue Service is proposing new regulations that would require companies to disclose significantly more information about uncertain tax positions than they are currently revealing in financial statements, including the maximum amount of potential tax liability the companies would have to record if the IRS disallowed a claim. The rule affects all corporations that have assets of more than $10 million and file financial results using U.S. generally accepted accounting principles.

IRS commissioner Doug Shulman announced the proposed rule during a speech given Tuesday at the New York Bar Assn.’s annual meeting. The proposal essentially runs roughshod over the much weaker accounting disclosure rule known as FIN 48, issued by the Financial Accounting Standards Board in 2006. FIN 48 (now known as FASB Topic 740) requires corporations to disclose how much they have kept in reserve to cover the possibility that the IRS or state tax officials might disallow certain tax treatments, such as the companies’ claim for credits and deductions or exclusions of certain revenue from taxable income. But the accounting rule only requires the aggregate reserve amount to be reported on the income statement, without forcing companies to itemize or describe the position.

“It’s going to be like shooting fish in a barrel for the IRS” if the new regulations are adopted, asserts Robert Willens, a tax expert who runs a consultancy in New York. “To my way of thinking, this is a reaction to the poor-quality FIN 48 disclosures.”

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Calculating uncertain tax positions is a thorny issue. Companies must assume their tax positions will be audited, then must try — with the help of attorneys and accountants — to handicap the likelihood that their tax decisions would survive an audit. Prior to FIN 48, companies kept those opinions and estimates related to the reserves under wraps, for fear of tipping off the IRS or plaintiffs’ attorneys. Indeed, companies complained bitterly about FIN 48 when it was first proposed, fearing the disclosures would provide the IRS with clues about what to look for.

It appears that such clues are exactly what Shulman expects from the new rule. The proposed separate schedule that would have to be filed with corporate tax returns will provide the IRS with a road map to weak tax positions. “Companies will have to literally provide a list of tax positions ranked according to the potential liability,” adds Willens.

In his speech, Shulman pointed out that IRS audits of corporate tax returns are not particularly efficient because auditors spend too much time ferreting through documents trying to identify poorly defended tax deductions — tax assumptions that could be overturned and thus yield revenue for Uncle Sam. What’s more, the commissioner emphasized a company will not be required to disclose its risk assessment of a position — that is, how strong or weak a company and its lawyers think the position is — although the agency can compel the company to reveal that information.

“This is almost expected, because the FIN 48 disclosures were so nondescript. I am sure the IRS had high hopes for FIN 48 originally, but the disclosures turned out to be just horrendous,” posits Willens.

The proposed rule is out for public comment until March 29.

An earlier version of this story misspelled Commissioner Shulman’s name. CFO regrets the error.