Uncertain tax positions (UTPs) offer taxpayers both opportunities and challenges. We wanted to take a closer look at this important issue, so, of course, we assembled a roundtable of knowledgeable tax professionals, including George Clarke, partner at the Washington, D.C., office of Baker McKenzie; George Hani, member with Miller & Chevalier in Washington, D.C.; and Tom Greenaway, a principal with KPMG in its Washington, D.C., national tax practice, working out of the Boston office. Tax Executive’s senior editor, Michael Levin-Epstein, moderated the discussion in February 2023.
Michael Levin-Epstein: Let’s begin by explaining what “uncertain tax positions” are.
George Clarke: Sure. An uncertain tax position is a position where the taxpayer is not certain of the proper treatments for purposes of putting it on the return but is certain enough of that treatment that they have taken the position on that return. But, for their accounting purposes, they are uncertain if that position will be sustained. That has always existed, but in 2010—I believe it was 2010—the IRS started requiring reporting on a special form, Form UTP, of those positions. So, that’s an uncertain tax position.
George Hani: I would just add that when you file a tax return, you cannot take alternative positions on the return. You have to pick which way you’re going to report a particular transaction or item. Then, for financial reporting purposes, if there is some uncertainty as to whether you should have reported differently, you run through the traps to see if there’s a reserve. If there’s a reserve, and in certain other circumstances, then the item must be reported on Schedule UTP.
Tom Greenaway: Michael, I think George and George explained it well. There are some tax issues for which the answer is clear, but a lot of the tax issues that engage our clients have some gray areas in them. The uncertain tax position question gets at that difference—it gets into the gray areas. If we have a position that, as George [Hani] said, we take on our tax return, but we think we’re probably going to recover less than that full position for financial accounting purposes, GAAP tells us we need to post up a reserve.
Levin-Epstein: Has Schedule UTP changed taxpayers’ behavior?
Hani: I can respond first on that. I do think that there has been an impact on taxpayer behavior. Maybe it’s not as great as the government would have liked, but I do know of taxpayers that have not taken positions simply because it would trigger a UTP reporting. So, they’d rather avoid UTP reporting and file the more conservative position. They may follow that up with an amended return or something, but UTP has changed behavior. How you quantify or get a statistic that shows that is impossible, because there’s no way of finding out when someone made that decision. As far as the revisions go, I don’t think the revisions are meaningfully changing anyone’s calculus.
Clarke: I guess on that second point I’m not sure, because it may be that if the government starts to enforce what it says it’s going to on these revised UTP rules, that taxpayers might change their views as to what is an uncertain tax position and maybe try to tighten that up a little bit as to whether they’re really uncertain or not uncertain. That’s obviously tricky, because you’re dealing with their public auditors as well, but it may be that they do that—the taxpayers take a closer look at whether something is really uncertain or not in this environment coming out of the change in the form.
Greenaway: I guess I have a slightly different view. Maybe I don’t have enough perspective to share—I certainly don’t have enough perspective to share back before 2010. But in my experience practicing in an accounting firm, most taxpayers do not change their behaviors in response to Schedule UTP. I’ll grant George Hani’s point that there are some taxpayers who just won’t take an uncertain tax position, but that’s more because of the financial statement impact rather than the Schedule UTP. Plenty of taxpayers decide that if they can’t book a benefit for a position on their financial statements, they don’t see the point of taking the position on the tax return.
Completing the UTP Form
Levin-Epstein: Let’s talk about the description that is needed when you do file a UTP form. How detailed does it have to be, and is there a penalty or a sanction if that concise description is in fact too concise in the opinion of the IRS?
Hani: I’m happy to take that first, too. My view of Schedule UTP, and in particular the concise description aspect, is that there are two audiences within the IRS. One is an Exam team that happens to have jurisdiction over the particular return. The second, as I understand it, is a centralized group that reviews these schedules to identify emerging issues and then recommends marshaling IRS resources toward those issues. Depending on who reads your concise description, your description could either be meaningful or not. I’ve had experience with a taxpayer that said simply, “Same issues as NOPA [Notice of Proposed Adjustment] 5 in the prior audit.” So, your Exam team knows exactly what you’re talking about—it’s complete transparency as far as that examination is concerned—but completely useless for someone who created a centralized database for emerging issue identification. That particular taxpayer received the nastygram letter that said, “Your concise description was inadequate.” So, what’s the purpose of the Schedule UTP? What are we trying to do with it? That leads to whether your concise description is really adequate or not. It is also worth pointing out that there is no separate penalty, monetary or otherwise, if you have a “bad” description or incomplete description where you fill out the Schedule UTP in some inadequate way. If you’re relying on the form for penalty protection—which you can in coordination with other sets of rules—you may lose that penalty protection, but there is no separate sanction for having a cryptic explanation.
Clarke: Just to chime in on that, I agree with everything that George said. I think the question, really, about these revisions to UTP is that the government is unhappy with the level of concision that some people have incorporated into the practices associated with the UTP, and they want a more fulsome description. That’s point one. Point two, on the penalty, there is a possibility that the government will say that your return is not complete for purposes of the statute of limitations on assessment starting to run. That would be the only penalty—there’s no monetary penalty—although that could be a big one depending on how it impacts you.
Greenaway: One of the more theoretical questions, I suppose, is whether or not the return is complete for the purposes of the Beard v. Commissioner test: whether a complete return has actually been filed. I think most of us, when we engage with that question, conclude that even a bad or blank Schedule UTP is not going to invalidate the whole return for purposes of the Beard test.
Work Product and Privilege
Levin-Epstein: Let’s talk about how taxpayers can best protect their work product and privilege in answering the questions on the form. What’s your advice there?
Clarke: I guess I’ll start with that. Obviously, there’s a big problem today in the application of attorney-client privilege to public companies in the taxpayer space. Because usually when a taxpayer has advice that would otherwise be attorney-client privilege advice, with respect to “a tax position” writ large, they need to disclose that information in some fashion to their accounting firm in order to get the benefit. That of course waives privilege. So, there’s a big problem with that well beyond UTP. However, there are certain circumstances in which taxpayers take the position that that advice is work product and the disclosure to the accounting firm for purposes of, among other things, evaluating GAAP reporting doesn’t waive that work product. It’s in those contexts that I think people would have something to say on the UTP that could incorporate work product. In those circumstances, the way we would advise clients is, “Don’t disclose the substance of that work product on the UTP.” I would imagine that most people to the extent that they continue the practice that they’ve had in having a relatively concise explanation on the Form UTP probably are not going to do that. And one way to deal with work product if, for whatever reason, you need to mention it in order to fill out the UTP properly, you can just say, “Look, in order for me to properly answer this question, it would require me to disclose work product,” and I am not going to do that. You could certainly take that position. I think those circumstances will probably not come up very often.
Hani: I agree with all of that. The one thing I would add is that when doing your description, focus on the item and not the uncertainty. So, I do a lot of work related to tax accounting method, and when you do a [Form] 3115, you describe the item and then the current and proposed methods. Think of the concise description in the same way, that you’re describing just what is on the return and not what caused you angst about the amount that you put on the return.
Levin-Epstein: Tom? Any comment?
Greenaway: No, I think George and George said it well.
Levin-Epstein: Some taxpayers put up partial reserves on issues like research credit. Not because of the technical uncertainty of their positions, but because in their judgment it is difficult to reach an agreement with the IRS on a technical basis. In those circumstances, what role does Schedule UTP play in this dynamic?
Greenaway: Let me start with that one. This is, from my perspective, one of the frustrating things about Schedule UTP. The situation you just described, Michael, is a common one. Just to recap, a taxpayer must put up a reserve for a position even if the taxpayer believes it’s more likely than not to be sustained if the taxpayer would settle that position at less than a full concession by the government. Of course, with issues like research credit, unless the taxpayer is willing to commit to potentially years of controversy and litigation, it’s likely that a taxpayer will compromise to some degree or another to reach an agreement. With that as background, we have a lot of taxpayers that put up relatively modest reserves on issues like research credit. Not because they’re concerned about the technical accuracy of their position, but they predict that they may be working with an IRS team that, from a taxpayer’s perspective, may potentially be taking an unreasonable position on the same issue. Just by way of example, there are large technology companies whose research credit may be disallowed 100 percent by the IRS at the Exam level. Now, that’s obviously not right, but in order to obtain 100 percent of the claimed benefit, the taxpayer would have to litigate to judgment on the merits. And most taxpayers are not interested in doing that. So, big picture, some of the signals that the Schedule UTP is throwing off are actually signals that the government itself is creating by taking uncertain tax positions in Exam.
Levin-Epstein: Anybody else want to weigh in here?
Clarke: I totally agree with what Tom just said. I think he summarized it very well.
Hani: Yes, same.
Levin-Epstein: Anything else you want to add?
Clarke: There was this debate in the context of the rules about what’s a contrary position, and I think the government did back up a little bit off what it had said initially with respect to what’s a contrary position, so I think people should obviously look through the rules as finalized and think about whether they actually have a contrary position for purposes of reporting on the form.
Hani: As a final thought, every audit is a human experience. When you’re interacting with your Exam team, you often want to create a relationship of trust and respect. So, I always focus on that audience as opposed to the centralized, emerging-issue kind of group. If you have included a Schedule UTP with your return and you get selected for an examination, talk to them about the items on your return, and maybe you’ll find out if they think your description is too cryptic. You then have an opportunity to elaborate. A lot of what’s requested on Schedule UTP, an examining agent can get with a relatively simple [information document request]. So, have a discussion with them and not worry so much about whether it’s on Schedule UTP or not. Just try to resolve the issue.
Greenaway: I’d just build on that comment to say that a large part of our work is storytelling. And your first chance potentially to tell your story is on that Schedule UTP. Of course, it doesn’t have to be a long story—it can be a couple sentences. But framing the issue and framing the item are critically important.