Taxpayers with cost sharing arrangements ("CSAs") can again expect close audit scrutiny-and potential adjustments-related to their treatment of stock-based compensation ("SBC") costs. On June 22, the Supreme Court denied certiorari in Altera, letting stand the decision of the U.S. Court of Appeals for the Ninth Circuit upholding the validity of the IRS regulation requiring the sharing of SBC costs under a CSA. The IRS had suspended audit adjustments based on the regulation while the case was pending, but since the Supreme Court declined review, it has announced its intent to audit and adjust taxpayers with Altera issues, i.e., those that have not been sharing SBC costs under their CSAs, in all Circuits, not just the Ninth.
IRS LB&I Commissioner Doug O'Donnell has cast Altera as an important win for the IRS that can be used as leverage at IRS Appeals and in any future litigation outside the Ninth Circuit, and as an encouragement to develop strong transfer pricing issues on audit-putting CSA taxpayers on notice. This Alert describes the menu of options available to a CSA taxpayer with an Altera issue and outlines key technical, procedural, and state tax considerations that a taxpayer should take into account in developing and implementing a strategy.
Exploring the Options
For CSA taxpayers with Altera issues, the Supreme Court's decision presents questions for filed and future years. For filed years, three options are now on the table: proactively prepare for audit, take the hit and amend open years and/or volunteer adjustments, or wait and see.
Preparing and mounting a robust audit defense is likely a meaningful option only for taxpayers outside the Ninth Circuit, where Altera is generally the law of the land. In other Circuits, the full panoply of technical arguments raised in the Altera litigation, discussed further below, remain viable. In addition to honing the substantive support for their positions, taxpayers should marshal the facts, preserving critical data on SBC costs and intangible development costs ("IDCs") for relevant years in anticipation of IDRs. Audit preparation should take into account not only the likelihood of an IRS audit but also the possibility that certain states may view the Altera decision as authorizing them to make transfer pricing adjustments at will.
Taxpayers lacking an appetite for controversy may consider acting unilaterally to resolve their Altera issues by amending filed returns for years open to adjustment and/or volunteering affirmative adjustments during the audit cycle-again, at both the Federal and state levels. A taxpayer has no duty to amend a return position taken in good faith, but especially for Ninth Circuit taxpayers, volunteering adjustments and any additional tax may mitigate the overall exposure. State Departments of Revenue ("Departments") have long supported voluntary resolution through disclosure programs whereby a taxpayer can negotiate a favorable settlement of past liabilities with the added benefits of limited lookback periods and waivers of penalties. Certain states like North Carolina have already announced voluntary corporate transfer pricing resolution initiatives in the wake of Altera.
Terms in the CSA providing for specific actions in the event of an IRS win in Altera may heavily influence whether to implement adjustments unilaterally, and if so, how. For Federal income tax purposes, taxpayers are generally "bound by their form" and thus expected to comply with the terms of their contracts. As discussed further below, compliance with form may entail making a current-year adjustment to the IDC allocation to account for SBCs not shared in specified earlier years. Although the adjustment may flow through current-year financials and cash, we question whether the...
