Tricky tax positions

Expect to spend more time analyzing
your tax positions and providing disclosures to the IRS now that FIN 48 is in effect for all businesses that prepare financial
statements in accordance with generally
accepted accounting principles (GAAP).

Whether you carry forward a net operating
loss, record R&D credits, institute tax strategies to increase or reduce income, or perform any other transaction that results in differences between book and taxable income,
you’ve got work to do.

“The best action to take immediately is to
learn about and discuss FIN 48 with your
accountant,” says Ed Decker, CPA, an associate director in the tax department at SS&G
Financial Services, Inc.

Smart Business spoke with Decker about
what you need to know about FIN 48 and
how it will affect your business.

What exactly is FIN 48?

FIN 48 requires companies to evaluate all
material tax positions that apply to FAS 109.
A tax position is defined as any position
taken in a previously filed tax return or a
position that is expected to be taken that
could result in a current or deferred income
tax asset or liability reported in the financial
statements. A tax position can result in a permanent reduction of income taxes payable or
a deferral of income taxes to future years.
Also, a position may result in a change to the
expected realizability of deferred tax assets.
Essentially, FIN 48 takes FAS 109 and financial statement reporting to the next level by
imposing a recognition threshold for each
tax position and clarifying any uncertainties
in income taxes reported in financial statements. Tax positions must be analyzed. A
company may only recognize an income tax
benefit if the position has a ‘more likely than
not’ (more than 50 percent) chance of being
sustained on the technical merits in the first
tax period. However, a tax benefit may be
recorded later if the ‘more likely than not’
threshold is met in a later period, the matter
is resolved, or the statute of limitations has
expired. Then, businesses must determine
whether or not the benefit will be realized
and accordingly record a valuation allowance. For example, let’s assume a company
takes a tax position in the current year that results in a tax benefit for future years. The
company concludes that the position meets
the ‘more likely than not’ threshold and
records a deferred tax asset. Now, the company must determine how much of the benefit will be realized and record a valuation
allowance for the remainder. It’s important to
note that FIN 48 applies to tax positions
taken in the current year, positions for periods that remain open under applicable
statute of limitations and tax positions a company will take in the future. FIN 48 is effective
for public companies for fiscal years beginning after Dec. 15, 2006, and became effective
for nonpublic companies for periods beginning after Dec. 15, 2007.

How will FIN 48 affect all businesses?

FIN 48 applies to all income taxes, including state and municipal. Every business issuing GAAP financial statements will face
issues concerning these tax returns as they
determine specific filing requirements.
Consider the cities and states where you do
business or even have a connection (nexus).
For example, a business has nexus in
Michigan if it leaves a footprint in the state;
other states require nexus only when products are recorded as bought and/or sold in
the state. This will require evaluating tax law
in every taxing jurisdiction in which you do
business and taking a position on whether
you will file or not. There are different ways
to apportion your income between states and
cities (single factor, two factor or three factor,
or other weighted average methods), and
your position may be challenged by a particular taxing jurisdiction. Shifting of income
between jurisdictions is also considered a tax
position and transfer-pricing policies may be
subject to FIN 48. Complying with FIN 48 will
be more difficult as there is less authoritative
guidance available from the state and little, if
any, from municipalities. Navigating state
and municipal tax requirements may become
a bigger headache for some companies than
dealing with federal returns.

What will be the cost for compliance?

That is difficult to say, but undoubtedly,
businesses will face a cost increase associated with FIN 48’s documentation requirements and demand for more reporting. As far
as the professional/moral cost of upholding
the regulation, accountants are questioning
their ability to remain independent in light of
FIN 48 reporting. It appears that there will
not be an independence issue as long as the
client understands the reason why a specific
tax position does or does not meet the ‘more
likely than not’ threshold and the basis for
determining the amount of tax benefits.

Can businesses expect more IRS audits pertaining to FIN 48?

The IRS has trained its agents on FIN 48
and issues associated with it, but this does
not mean the IRS will audit more businesses.
With regard to tax accrual work papers, IRS
agents do not generally request them, except
in cases where the taxpayer has entered into
a ‘listed transaction’ (an aggressive tax position). It’s not known if IRS procedures will
change or if FIN 48 will require any other
kind of reporting. The best prevention is to
understand FIN 48 and act accordingly under
the direction of a trusted adviser.

ED DECKER, CPA, is an associate director in the tax department at SS&G Financial Services, Inc. (www.SSandG.com). Reach him at
(330) 668-9696 or [email protected].