What is an uncertain tax position?
All companies seek to legitimately reduce their overall tax burden and minimize or delay cash outflows for taxes. Positions taken in tax returns may be well-grounded and in good faith, but with the complexities and varying interpretations of the tax law, these positions may not ultimately prevail. Complexity creates uncertainty regarding the actual benefit a company will receive from a position taken on its tax return. FIN 48 establishes a uniform process for determining whether the tax benefit resulting from a position taken on a tax return should be recognized in the financial statements of an entity.
Common examples of uncertain tax positions include characterizing gains or losses as capital gains or losses, claiming a tax credit, allocating income between jurisdictions (or not filing a return when a company believes it does not have nexus in a state or country), excluding income the company believes is taxexempt and taking a tax deduction.
Compliance deadline is fast approaching—or may already be here.
For midsized companies without a large in-house tax department or the ability to dedicate multiple staff members to a special project, complying with this interpretation could prove daunting, especially for those that file in multiple states and countries.
FIN 48’s aggressive timeline magnifies the problem. For calendar-year-end companies, FIN 48 is effective for 2007. Calendar- year companies that only issue year-end annual financial statements are not required to adopt FIN 48 until they issue their financial statements at the end of 2007.
However, companies that issue GAAP financial statements more frequently, such as monthly or quarterly as required by their bank or by Securities and Exchange Commission (SEC) rules, must comply with FIN 48 for their interim statements as well. For these companies, the compliance deadline is fast approaching—or may already be here.
The FIN 48 approach
FIN 48 utilizes a two-step approach for evaluating tax positions. It addresses the recognition and measurement of income tax positions using a “more-likely-than-not” (MLTN) threshold. More-likely-than-not is defined as being more than 50 percent probable.
Step One: Recognition. Under FIN 48, the FASB may not recognize a benefit related to an uncertain tax position in the financial statements unless it is MLTN (more than 50 percent probable) the position will be sustained based solely on its technical merits.
Step Two: Measurement. The tax benefit of a qualifying position is measured as the largest amount of tax benefit that is more than 50 percent likely to be realized upon ultimate settlement with a taxing authority. This poses significant challenges in evaluating tax positions in various state, local and foreign jurisdictions.
Consider the example of “Company A.” Company A takes a $100 research-and-development credit on its federal income tax return and reduces its taxes paid for the year by $100. Management believes its research-and-development expenditures meet all the criteria to qualify for the entire credit. However, based on past history of similar tax credits, the company’s tax officials believe there’s just a 40 percent likelihood that, if the company was audited, the IRS would allow the entire credit. They believe there is at least a 51 percent likelihood the IRS would allow $80 of that credit. FIN 48 would allow the company to recognize that $80 tax benefit in its financial statements. The remaining $20 would appear as a liability in the company’s financial statements.
Prior to FIN 48, Company A officials might have arrived at their $80 prediction (or some other amount) using various thresholds of probability they deemed appropriate. Likewise, they might have reported the $20 liability in various ways within the company’s financial statements. FIN 48 establishes a uniform approach.
FIN 48 does not require companies to restate previously issued financial statements for liability adjustments required because of its adoption. Instead, the cumulative effect of the change may be presented as an adjustment to the company’s beginning retained earnings in the year of adoption.
Choosing a partner
While some midsized companies will have the time and internal resources to comply with FIN 48, others will need to seek outside assistance. Publicly traded companies needing outside help must be aware of SEC independence rules limiting the assistance the company’s independent auditors can provide.
- If you choose to select an external partner to help you meet FIN 48 requirements, experts offer the following tips:
- Start your search as early as possible. Many other companies will be seeking similar help to meet the same tight deadlines.
- Ensure your partner is well-versed in GAAP as well as in the tax laws and tax case history of each state and country where your company does business.
Select a partner who can facilitate communication between your auditors, tax professionals and other external parties. As with any new ruling, it will likely take some time to determine all the documentation requirements and ensure best practices. The more all the players communicate up front, the less likelihood there is of unpleasant surprises down the line.
FIN 48 is applicable to all entities whether they are privately owned, publicly traded or not-for-profit organizations. Can your organization comply with this far-reaching interpretation? IBI