Who Needs to Fight Textron Type Litigation Summons Cases for Tax Acrrual Workpaper and FIN 48 Workpaper The Government Effectively Asks? Just Make Disclosure of Uncertain Tax Positions Part of the Return. IRS Annoucement 2010-9, 2010-7 IRB 408. 2010-7
The IRS recently startled the corporate tax community, which community stills is struggling to effectively deal with, i.e., successfully block, Textron type summonses for the production of tax accrual workpapers and FIN 48 workpapers, by announcing in Annoucement 2010-9, a proposal which would require, for the first time, “large corporations” to report uncertain tax positions on a new schedule to be filed with their annual tax returns. I
In Textron v. United States, an en banc decision of the First Circuit Court of Appeals, held that the work-product privilege was not implicated with regard to the taxpayer's tax accrual workpapers, because it found that the workpapers were not prepared “for” litigation and were required to be produced pursuant to an IRS administrative summons. 104 AFTR 2d 2009-5719 , 577 F3d 21 , 2009-2 USTC ¶50574 (CA-1, 2009), vacating and remanding 100 AFTR 2d 2007-5848 , 2007-2 USTC ¶50605 , 507 F Supp 2d 138 (DC R.I., 2007), aff'd in part and remanded in part 103 AFTR 2d 2009-509 , 553 F3d 87 , 2009-1 USTC ¶50167 (CA-1, 2009), vac'd by 560 F.3d 513 , 103 AFTR2d 2009-1436 (CA-1, 2009). Compare, the Fifth Circuit's decision in El Paso Co., 50 AFTR 2d 82-5530 , 682 F2d 530 , 82-2 USTC ¶9534 (CA-5, 1982) (primary purpose test) with various circuits applying the broader “because of ... in anticipation of litigation” or “but for ... in anticipation of litigation” tests used in describing work product. See, e.g., Roxworthy, 98 AFTR 2d 2006-5964 , 457 F3d 590 , 2006-2 USTC ¶50458 (CA-6, 2006); Adlman, 76 AFTR 2d 95-7188 , 68 F3d 1495 , 95-2 USTC ¶50579 (CA-2, 1995) (memorandum containing opinion work product relating to potential tax litigation arising out of a proposed merger may be protected); Binks Mfg. Co. v. Nat'l Presto Indus., Inc., 709 F2d 1109 (CA-7, 1983); Senate of Puerto Rico, 823 F2d 574 (DC D.C., 1987); In re Sealed Case, 146 F3d 881 (DC D.C., 1998); In re Grand Jury Proceedings, 604 F2d 798 (CA-3, 1979); Simon v. G.D. Searle & Co., 816 F2d 397 (CA-8, 1987); In re Grand Jury Subpoena, 357 F3d 900 (CA-9, 2004); National Union Fire Insurance Co. v. Murray Sheet Metal Co., Inc., 967 F2d 980 (CA-4, 1992). See, in general, August & Grimes, “The Discovery Status of Tax Accrual Workpapers After Textron”, Business Entities (WG&L), Jan/Feb 2010. See also August and Grimes, “Ability of IRS to Discover Tax Accrual and FIN 48 Workpapers”, 10 BET 6 (November/December 2008); August “Attorney-Client Privilege and Work-Product Doctrine in Federal Tax Matters,” 10 BET 4 (July/August 2008); and August, “Understanding Fin 48: Accounting for Uncertainty in Income Taxes,” 10 BET 30 (May/June 2008).
Inviting comments from the tax professional community, which deadline recently passed at the end of March and the tenor of which can be expected to be particularly critical of the proposed measure, the IRS should be expected to require such reporting. Why? Because it bypasses litigation over summonses enforcement actions under §§7602 or 7609 (third party recordkeeper). It’s the economical way to get to the taxpayer’s innermost thoughts and anxieties over which items on the return may not survive “sunshine” and challenge from the IRS and if challenged what is the “worst case” economic impact from the positions disclosed. Because the prospect that the form request may in effect ask clients to waiver privileged information communicated with its outside or in-house tax or general counsel, federal tax practitioner or the work product , particularly mental impressions of its tax and financial advisers on the same subject, litigation with respect to the form should be anticipated. Yet, since the form initiative, if passed, would be required to constitute a return, the non-complying large business taxpayer may fail to disclose at the risk of an extended or no statute of limitations for such year and face the prospects of penalties. Tax return preparers who fail to make the required disclosure face the prospect of preparer penalties and possible charges for violation of Circular 230.
While the Service could yank its proposal over the overwhelming criticisms it will undoubtedly hear, its litigation position on required return information may pose to bid a formidable obstacle to challenge successfully. See, e.g., litigation arising under §6050I. Yet, in its Annoucement the Service was undoubtedly concerned about its “image” in this effort and therefore backs off slightly, at least from an appearance standpoint, by stating at the same time that it otherwise plans to continue its policy of restraint for requesting tax accrual workpapers during an examination. The schedule will require the annual disclosure of uncertain tax positions in the form of a concise description of those positions and information about their magnitude.
Let’s get more specific about what Annoucement 2010-9 would, in its present proposed form, require be filed by corporations that have more than $10 million in assets and one or more uncertain tax positions to disclose those positions to the IRS. The businesses would file a IRS form schedule with the corporate income tax return or other business tax return, i.e., if an unincorporated entity has one or more large corporations as partners or members.
The schedule would require (1) a concise description of each uncertain position for which the taxpayer or a related entity has recorded a reserve in its financial statement and (2) the maximum amount of potential federal tax liability attributable to each uncertain position -- determined without regard to the taxpayer's risk analysis of its likelihood of prevailing on the merits. Uncertain tax positions also would include any position related to the determination of any U.S. tax liability for which a taxpayer or related entity has not recorded a tax reserve because the taxpayer (1) expects to litigate the position or (2) has determined that the IRS has a general administrative practice not to examine the position. A related entity is any entity related to the taxpayer under §§ 267(b), 318(a), or 707(b).
The proposal does not require the taxpayer to disclose the taxpayer's risk assessment or tax reserve amounts, even though the Service can compel the production of this information through a summons. United States v. Arthur Young, 465 U.S. 805, 815 (1984). While the Service, again, intends to require the reporting of uncertain tax positions, the Service is proposing to otherwise retain its existing policy of restraint as described in Announcement 2002-63, 2002-2 C.B. 72, and IRM 4.10.20.
