IRS's policy updates on FIN 48: The eye of the beholder; Stein - Is the United States facing the inevitable?

Recently, the IRS positions – LMSB-04-0507-044; LMSB-04-0507-045; and CC-2007-015 - have been made public. See 2007 TNT 125-9, 2007 TNT 125-10 and 2007 TNT-12.

The IRS says it will continue to maintain a policy of restraint on FIN 48 workpapers, as it has with tax accrual workpapers Yet in the same breath, the IRS is training its agents on “FIN 48 information and disclosures” and has created a tax accrual workpaper (TAW) cadre to assist with the review of documents received in response to TAW’s IDR’s.

So the question is what is the IRS up to as to FIN 48? The answer lies in the details of its interpretation of FIN 48.

In LMSB-04-05017-045, the IRS set forth its interpretation of FIN 48 and then set forth 10 questions with 10 responses. Of interest to were the following Q&A’s:

Question #1: Are FIN 48 Disclosures a Roadmap for the IRS?

Answer #1: . . . Revenue Agents should not be reluctant to pursue matters mentioned in FIN 48 disclosures, but should be mindful of our policy of restraint on Tax Accrual Workpapers (TAW) and not cross over the boundaries contained there. If for example, there is discussion in the tax footnotes about a contingent tax liability being reversed because the statute of limitations related to the transfer of an intangible asset has expired, even though the statute may have run on that particular issue, this provides insight into how the taxpayer may be treating other intangible assets in other years where the statute of limitations is still open. In this example, this is public information that can be used without violating the TAW's policy. (Italicized for Emphasis).

Question #2: What is the impact of FIN 48 on the Service's tax accrual workpaper ("TAW") policy?

Answer #2: The Service's TAW policy may be found at IRM 4.10.20. Since FIN 48 is new, we will have to experience and study FIN 48 disclosures as they are published. However, FIN 48 workpapers are tax accrual workpapers, and they are subject to the policy of restraint covering TAW.

On the other hand, FIN 48 Disclosures reported in quarterly and/or annual financial statements, and any other public documents, are not subject to the policy of restraint, and should be considered by examiners and others when conducting risk assessments. These FIN 48 disclosures might lead into discussions with appropriate taxpayer personnel during an examination, a CAP engagement, a PFA process or other taxpayer interaction. (Italicized for Emphasis)

Question #3: Is it permissible to sign restricted consents to extend the statute of limitations?

Answer #3: After setting forth its policy, the IRS set the following factors as to when a restricted consent will be accepted: (a) what our working relationship has been like; (b) the nature of the issues involved; (c) whether the taxpayer has been forthcoming in identifying its uncertain tax positions; (d) where we are in the audit plan timeline; (e) how many issues are left to examine; whether Notices of Proposed Adjustments are signed when they are agreed to or left to linger until the end of the exam.

Observation: In CC-2007-015, Effective Tax Rate Reconciliation Workpapers, the IRS concluded that that effective tax rate reconciliation workpapers are neither tax accrual workpapers nor audit workpapers under the intended definitions of those categories and the Service's longstanding policy of restraint. “They are not prepared for the purpose of determining the proper amount of the reserve for contingent tax liabilities. These workpapers are not audit workpapers in the sense of workpapers retained by the auditor to document the performance of the audit. They are prepared by the taxpayer, not the auditor.”

In discussing FIN 48, the IRS stated that as to Disclosure of Reserve for Uncertain Tax Positions:

The disclosure provisions of FIN 48 provide more information about the uncertainty in income tax assets and liabilities. Besides requiring an enterprise to accrue interest and penalties (where warranted) in the financial statements with respect to unrecognized tax benefits the following disclosures are required:

(a) A tabular reconciliation of the total amounts of unrecognized tax benefits at the beginning and end of the period, which shall include at a minimum:

1. The gross amounts of the increases and decreases in unrecognized tax benefits as a result of tax positions taken during a prior period.
2. The gross amounts of increases and decreases in unrecognized tax benefits as a result of tax positions taken during the current period
3. The amounts of decreases in the unrecognized tax benefits relating to settlements with taxing authorities
4. Reductions to unrecognized tax benefits as a result of a lapse of the applicable statute of limitations

(b) The total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate;
(c) The total amounts of interest and penalties recognized in the statement of operations and the total amounts of interest and penalties recognized in the statement of financial position;

(d) For positions for which it is reasonably possible that the total amounts of unrecognized tax benefits will significantly increase or decrease within 12 months of the reporting date:

1. The nature of the uncertainty;
2. The nature of the event that could occur in the next 12 months that would cause the change;
3. An estimate of the range of the reasonably possible change or a statement that an estimate of the range cannot be made;
(e) A description of tax years that remain subject to examination by major tax jurisdictions 

Query: When does the table cease to be treated as part of FIN 48 and when does it become an effective tax rate reconciliation workpapers? How does a revenue agent explore the issues set forth in the table without obtaining/discussing the underlying documents which created the table? Who defines cooperation/forth coming? In addition, what if the effective tax reconciliation table arose out of discussions between the company’s in-house-counsel, its auditors and outside counsel, i.e. Textron, what is privileged and what is not? See U.S. v. Frederick, 182 F.3d 496, 501 (7th Cir. 1999) wherein the Court stated:

We also reject the government's argument that numerical information can never fall within the attorney-client or work-product privilege. Cf. United States v. Schwimmer, 892 F.2d 237, 242 (2d Cir.1989); United States v. Davis, supra, 636 F.2d at 1043; In re Grand Jury Proceedings, 601 F.2d 162, 171-72 (5th Cir.1979). Such cases are rare, but they can be imagined. Suppose a lawyer prepared an estimate of his client's damages; the estimate would be numerical, but insofar as it reflected the lawyer's professional assessment of what to ask the jury for it would be attorney work product. Similarly, if the lawyer asked his client how much he had obtained in the theft for which he was being prosecuted and the client answered, “$10,000,” the answer would be protected by the attorney-client privilege.

It is thus apparent that the issues surrounding FIN 48 and the disclosure of the underlying documents and workpapers has only been temporally “resolved” by the IRS’s policy of restraint. In the coming years, it can and should be expected that the IRS will seek to obtain information that the taxpayer will view as being in the auspices of Tax Accrual Workpapers and then privilege information which the IRS will seek to obtain. The questions for taxpayers facing compliance with FIN 48  becomes when does legitimate tax planning cease to be the practice of law and when does it become part of the public domain and therefore accessible to the IRS? Personally, if I were subject to FIN 48, I would not rely on the IRS’s policy of restraint but rather ensure that policies are in existence which protects my legitimate tax plans. As they say that is easier said than done. For an interesting discussion as to the problems that FIN 48 is creating see also Uncertainty All Around: Fin 48 Highlights From the NTA Spring Symposium, Weiner 2007 TNT 113-10 and sources citted therein.

 In Stein, The Justice Department has filed a motion in a U.S. district court in which it stated: “based on the Government's analysis of the Court's prior ruling and on extensive legal research, we have concluded that the defendants are correct in their assertion that the only remedy that directly addresses the Constitutional violations found by the Court is dismissal of the Indictment.” The Government however maintained that the Court’s prior ruling was incorrect and that not all of the defendant’s case should be dismissed. It is apparent that the largest criminal tax case in the history of the United States, is at least to some of the defendants, coming to an end an inglorious end as far as the government is concerned. In light of the numerous constitutional violations, it was the government that tied the Court’s hands not vice-verse.

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