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Uncertain Tax Positions

March 24, 2017

Andrew S. Lattimer, CPA, MST
Partner

Have you ever picked up a pair of financial statements and thought, "Are these prepared in the same manner, especially regarding uncertain tax positions taken by the company?" 

Well, in July 2006, the Financial Accounting Standard Board ("FASB") issued Interpretation No. 48 ("FIN 48") – Accounting for Uncertain Tax Positions – to try and put all companies on the same playing field.  Although FIN 48 initially related solely to publicly held corporations, the interpretation now applies to privately held companies as well.  It should be noted that FIN 48 is now referred to as ASC 740-10 under the new codification of Accounting Standards.  For purposes of this article we will exclusively refer to the interpretation as FIN 48.

The purpose of FIN 48 was to give guidance to companies on how they should account for their uncertain tax positions ("UTP").  The lack of guidance resulted in disparities in how a company would account for their uncertain tax positions under FAS 5.  The FASB felt the interpretation was needed in order to increase comparability in the financial reporting of income taxes.  The scope of FIN 48 only applies to income taxes, as it excludes other taxes such as sales taxes, property taxes, payroll taxes and capital base taxes, to name a few.

Uncertain Tax Positions

An UTP is defined as a position in a previously filed tax return or a position expected to be taken in a future tax return by the company.  Examples of tax positions include but are not limited to:

  • A decision to not file a tax return (i.e. state tax return)
  • An allocation or a shift in income between jurisdictions (i.e. transfer pricing)
  • The characterization of income or a decision to exclude reporting taxable income in a tax return (i.e. deferred revenue)
  • A decision to classify a transaction, entity or other position in a tax return as tax exempt

When it comes to UTPs a company has taken or expects to take on its tax returns, FIN 48 provides guidance on how a company should recognize, measure, present and disclose this in its financial statements.  It also includes positions in which the company did not file a tax return.

The company must now determine how to move forward. First it must identify any tax positions taken or expected to be taken on its tax returns.  Once the company identifies the tax position, it must determine the level at which the tax position will be evaluated (i.e. unit of account).  The evaluation can be either qualitative or quantitative.  The company should take into account the support, documentation and law of the tax position, as well as the position the taxing authority may take upon audit.

Under FIN 48, a company may not take a tax benefit (i.e. an expense) on its financial statements if it does not believe the position would, more likely than not, be allowed by a taxing authority. "More likely than not" is defined as greater than 50 percent and, in evaluating the "more likely than not" position, the company must assume that the taxing authority is aware of all relevant facts.  If the company cannot satisfy this threshold, it is not allowed to take the benefit of the position until is recognized.  Therefore, a FIN 48 liability should be established. 

There is one known exception to the above "relevant facts" issue - reliance on past administrative practices.  For example, if a company typically writes off all fixed assets purchased under $500, and the taxing authority has audited and accepted the company's position, no FIN 48 liability is required, even though there is no specific guidance that allows a company to expense these fixed assets.

If the recognition threshold is met, the tax benefit recognized is measured at the largest amount of the tax benefit that is "more likely than not" to be realized.  For example, say the company takes a research and development tax credit of $100,000 on its 2009 tax return.  The company then determines that the probability it would receive the full $100,000 credit is 35 percent.  The company then accesses the probability that it would receive $75,000 of the credit at 55 percent. Therefore the company can only recognize the tax benefit of the research & development of $75,000, and is required to set up a FIN 48 liability for the remaining $25,000.  The company cannot recognize the tax benefit of the $25,000 until it is recognized, with the recognition event being either the lapsing of the statute of limitations or the acceptance under audit of the position by the taxing authority.

As a result of FIN 48, the Treasury has jumped on board and proposed regulations that would require the company to disclose these uncertain tax positions on its 2010 and forward tax returns.  Stay tuned, as this is a hot topic with much opposition.

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Disclaimer: Any written tax content, comments, or advice contained in this article is limited to the matters specifically set forth herein. Such content, comments, or advice may be based on tax statues, regulations, and administrative and judicial interpretations thereof and we have no obligation to update any content, comments or advice for retroactive or prospective changes to such authorities. This communication is not intended to address the potential application of penalties and interest, for which the taxpayer is responsible, that may be imposed for non-compliance with tax law.

 

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