By Scott L. Semer, Esq.
Davies Ward Phillips & Vineberg LLP, New York, NY
If anything explodes the fiction that the IRS and the taxpayer – particularly the corporate taxpayer – are in a constructive partnership or friendly "customer" relationship to ensure only that the "correct" amount of tax is collected, it is the recent bombshell by the IRS contained in Announcement 2010-9. In fact, the Announcement makes it clear that, even if the IRS likes to refer to taxpayers euphemistically as its "customers", the two sides are, in fact, in direct opposition to each other. Most importantly, it would appear that the IRS actually wants to keep it that way.
In Announcement 2010-9, the IRS proposed requiring certain corporate taxpayers to include a new schedule in their return to report their "uncertain tax positions" and their total potential tax exposure for these positions. The significance of this proposal is demonstrated by its announcement by the IRS Commissioner at the annual meeting of the Tax Section of the New York State Bar Association, one of the largest gatherings of tax lawyers in the United States.
If enacted under its current form, the requirement to file the proposed schedule would apply to corporations that have in excess of $10 million of assets and that prepare financial statements that are subject to FASB Interpretation No. 48 or a similar industry or country specific generally accepted accounting standard requiring them to disclose "uncertain tax positions." The information required would include a brief description of the position and the maximum potential amount of taxes that would be paid if the taxpayer's position is not sustained. The taxpayer would not be required to disclose its argument for or against the position, however, or the strength of its belief in the merits of their position. Additionally, the taxpayer would not be required to disclose the amount of any reserves taken with respect to each position on its financial statement.
Essentially, the proposal is designed to give the IRS the benefit of particular knowledge about a) the uncertain positions corporations are reporting on their financial statements, and b) how much money is at stake, so that the IRS can determine if the issues might be worth pursuing.
What is most important to note is that almost nothing about the corporate tax is "certain." For starters, the concept of horizontal equity – that similar taxpayers should face a similar tax burden – is virtually nonexistent in the corporate tax system. Even in the same industry, effective tax rates vary widely depending on a large variety of factors, not least of which is the great deal of uncertainty about the enormously complex tax code and the almost infinite variety of ways that a corporation can conduct its affairs to achieve what its employees and advisors view as the best tax result.
My old tax law professor, who wrote a famous little book about the tax system (famous among those who spend their lives thinking about the tax system that is), used to complain about having to spend his days as a student listening to endless debates about whether money found lying in the street constitutes taxable income. Fortunately, he pointed out, certainty has long since been established with respect to that less than interesting question. (It IS taxable income for whomever finds it – though whether it is regularly reported as such is another matter.)
For many, indeed even the vast majority, of the hundreds of tax issues that need to be resolved even to file the simplest corporate tax return, no such certainty exists. This is the case even when taxpayers plead with the IRS for guidance – any guidance, even if it is unfavorable to the taxpayer, so long as there is certainty. For example, taxpayers have been asking for over two decades for guidance on when lending by non-U.S. entities to U.S. borrowers creates a U.S. trade or business for tax purposes. Yet the IRS has steadfastly refused to provide any definitive guidance. Indeed, once the proposal contained in Announcement 2010-9 is implemented, why should the IRS ever create certainty? The more uncertainty there is, the more will be disclosed and the more the IRS will be able to pursue on audit and ultimately collect – thus, the more political capital and appropriations the IRS can obtain for itself on Capital Hill after it pats itself on the back for the great job it is doing "servicing" its "customers".
And all of this in pursuit of what goal? While it once was a significant revenue source, the corporate income tax represents a mere drop in the bucket of federal revenue – less than 10% for most of the past decade. And it is an extremely inefficient and cumbersome means to collect even the little revenue it does collect. As demonstrated in a recent study by Ernst & Young, the number of Fortune 500 companies headquartered in the United States has been undergoing a steady and probably irreversible decline over the past decade. One important part of the reason why is the extremely high corporate tax burden faced by U.S. corporations compared to corporations formed in almost any other country in the world.
My corporate tax professor was fond of telling us that the Tax Reform Act of 1986, which did away with the notorious General Utilities rule, was a huge improvement to the integrity of the corporate tax system, which was stripped of one of its most absurd and inefficient features. The best way to improve the corporate tax further, he would say wistfully, would be to eliminate it altogether.
Instead, however, the Obama Administration's just released Budget proposes to add several additional layers of burdensome complexity to the corporate tax, particularly in the international arena. Why? Perhaps because it is easy to tax "corporations" rather than people, and to pretend that it just isn't true that "corporations" don't pay taxes – people do.
Unfortunately, there doesn't seem to be time any more to stop and think about what we are doing, and why. The name of the game is drumming up revenue in any way possible – or more precisely, being able to show that your proposal will collect revenue in the short run, regardless of the long-term costs, including, ultimately, less revenue. There is one business lesson, however, that the IRS and the Congressional tax-writing committees might be well-advised to heed – treat your "customers" as though they are your adversaries, and eventually they just may not be your customers anymore.
For more information, in the Tax Management Portfolios, see Paravano and Reynolds, 798 T.M., Tax Shelters, and in Tax Practice Series, see ¶3850, Examination: Audits, Assessments, Appeals.
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