On September 24, 2010, the Internal Revenue Service released the final version of Schedule UTP regarding “uncertain tax positions.”  The new Schedule finalized the requirement that specified categories of corporate taxpayers include information as to UTPs as part of their tax return.

In announcing the new UTP rules, IRS Commissioner Douglas Shulman hailed “a principled and balanced approach” that will improve tax administration and “will provide significant benefits to taxpayers, including getting them earlier certainty while preserving important taxpayer protections and respecting the important relationships the taxpayer has with its tax advisors and independent auditors.”

Generally speaking, a UTP is any federal income tax position for which a tax reserve has been established in an audited financial statement.  UTPs usually are identified while preparing financial statements under applicable accounting standards, such as Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109 (FIN 48).

Companies affected by the new rules are those corporations filing Form 1120, 1120-F, 1120-L or 1120-PC, which issued audited financial statements and recorded a reserve for one or more U.S. tax positions.

Under the new rules and as described in guidance documents that were released simultaneously:

• Reporting of UTPs will be phased in over five years depending on a companys size:
  

  Corporate Assets	First Year to File Schedule UTP
  $100 million or greater	2010 Tax Year
  $50 million or greater	2012 Tax Year
  $10 million or greater	2014 Tax Year

• The maximum potential exposure related to a UTP does not have to be disclosed.  Instead, the taxpayer must rank its UTPs based on its size of financial accounting reserves.  The taxpayer must also indicate which UTPs are “major”; i.e., when reserves are greater than 10% of the aggregate reported reserves.
• Taxpayers do not have to disclose the rationale and nature of uncertainty in the concise description of the position.  This reconciles UTP disclosures with existing rules (e.g., Form 8275 for disclosure under section 6662).  It also protects attorney-client privilege for any legal advice that taxpayers received in planning for a transaction.
• Taxpayers also do not have to report “Administrative Practice” positions; i.e., those items omitted from tax reserves because “the corporation determined it was the Service’s administrative practice not to raise the issue during an examination.
• Disclosures on Schedule UTP should be made in a manner consistent with the decisions involved in establishing tax reserves for financial accounting, including pertinent certainty and materiality standards.  Under applicable accounting standards, however, taxpayers must disclose positions for which it did not establish a reserve because of an intention to litigate, if challenged.

In addition to the above-described Schedule UTP guidance, the IRS also issued Announcement 2010-76, which expands the Services “policy of restraint.”  The IRS stated that it will not assert any waiver of attorney-client privilege (or the tax advice privilege of section 7525 or the work-product doctrine) in most cases in which a corporation turns over documents to an independent auditor as part of a formal audit program.

Contemporaneously, in a Directive to the Field, the agency instructed tax examiners to apply regular examination tools “without bias in favor of the government or the taxpayer” and to “apply the law as it currently exists, not how we would like it to be.”  According to the Directive, “This is the key to meeting our mission of fair and balanced tax administration[.]”

With the announcement of Schedule UTP, corporations will now require greater attention to “ and legal advice on “ the proper disclosures on tax positions to be made, how to quantify positions for the required rank ordering, and what information should be provided (with an eye toward maintaining privilege). 

The economic substance doctrine was codified on March 30, 2010 in IRC § 7701(o) providing that transactions shall be treated as having economic substance only if the transaction changes the taxpayers economic position in a meaningful way and the taxpayer has a substantial purpose for entering into the transaction.

IRC § 7701(o)(5)(C) further states that the doctrine only applies to a transaction entered into in connection with a trade or business or activity engaged in for income. IRC § 7701(o)(5)(D) provides that the term “transaction” includes a series of transactions.

As it relates to transactions with a potential for profit, IRC § 7701(o)(2)(A) provides that the economic substance doctrine is applied only if the present value of the reasonably expected pre-tax profits is substantial in relation to the present value of the claimed net tax benefit.

On October 5, 2010, IRS Associate Chief Counsel, William D. Alexander, speaking at a panel discussion sponsored by the Boston Bar Association, said that the newly codified economic substance doctrine does not constitute a change in substantive law. Mr. Alexander instead said that the codification affects issues of proof and stressed that when planning a transaction one cannot plan the transaction around issues of proof. Mr. Alexander explained that when planning a transaction, the transaction should be based on the assumption that all facts will become known and entered into the record and thereafter appropriately appreciated by the finder of fact and determiner of law. Thus, practitioners who have been structuring transactions based on the reality of the transactions will not be affected by the codification of the economic substance doctrine.

Taxpayers have requested published guidance on the doctrine since its codification on March 30, 2010. In response, the IRS issued a notice, Notice 2010-62, describing how the IRS plans to administer the doctrine moving forward. The notice also explains guidance on penalties and foreign taxes. The IRS, however, does not intend to issue guidance on specific transactions that would or would not pass muster under the doctrine or so-called Angel List transactions.

During his discussion, Mr. Alexander noted that the doctrine is rooted in common law and because common law is evolving, the IRS may “take a run on an existing authority which it might think . . . was wrongly decided.”

Our professionals at Fuerst Ittleman PL are knowledgeable in the newly codified economic substance doctrine. If you believe you have been affected by the new law please contact our professionals at contact@fidjlaw.com.

On September 9, 2010, the United States Court of Appeals for the 3rd Circuit held that the use of a “willful blindness” jury instruction satisfies the willfulness element of a criminal tax offense. In finding the jury instruction appropriate, the court concluded that, where warranted by the trial evidence, a willful blindness instruction “properly appl[ies] to a defendants knowledge of his legal duties.”

The 3rd Circuit upheld the conviction of Richard Stadtmauer, an account and executive vice president of Kushner Companies, for conspiracy to defraud the United States and for willfully aiding in the filing of materially false or fraudulent tax returns. The charges against Stadtmauer grew out of an investigation of Charles Kushner, chairman of Kushner Companies. Prior to Stadtmauers charging and conviction, Charles Kushner pled guilty to assisting in the filing of false returns. While Kushner was under investigation Stadtmauer was charged with conspiracy to take $6 million in improper deductions for limited partnerships owned by Kushner.

Mr. Stadtmauers appeal centered on the District Courts instructions to the jury regarding Stadtmauers knowledge of the falsity of his companys tax returns. For the government to establish that Stadtmauer willfully aided in preparing false returns, it was required to prove that Stadtmauer intentionally violated a known legal duty. In his instructions to the jury, U.S. District Court Judge Jose Linares told the jury it could convict if it found that Stadtmauer knew about applicable IRS requirements or if Stadtmauer “deliberately closed hiseyes to what hehad every reason to believe.”

Stadtmauer argued on appeal that the jury instruction did not satisfy the requirement that the government establish that the law imposed a duty on the defendant and that the defendant knew of this duty. Stadtmauer relied heavily on Cheek v. United States, 498 U.S. 192 (1991), a 1991 U.S. Supreme Court case, which Stadtmauer argued prevented the use of willful blindness to satisfy the willfulness element in tax fraud cases. The 3rd Circuit rejected this argument finding that Stadtmauers case was clearly distinguishable stating “Stadtmauers attempt to equate a person who deliberately avoids learning of a legal duty with a personwho is ignorant of that duty by virtue of a good-faith belief or misunderstanding is not persuasive.” The decision of the 3rd Circuit falls in line with decisions of the 1st, 5th, 7th, and 11th Circuits which have also held that Cheek does not prevent a willful blindness instruction in tax fraud cases.

The appeals court also rejected arguments by Stadtmauer that willful blindness improperly applied to intent and that the government was required to provide direct evidence of conscious avoidance to satisfy a willful blindness instruction. A copy of the 3rd Circuits opinion can be read here: U.S. v. Stadtmauer.

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