The United States has a system of taxation by confession (Hugo Black) and the Financial Accounting Standards Board has moved the confessional from the income tax return to the balance sheet and footnotes. With the implementation of FASB Interpretation 48, “Accounting for Uncertainty in Income Taxes;” an interpretation of FASB Statement No. 109 (FIN 48) comes the most significant interpretation for tax reporting that has been seen in many years and the implementation date is right around the corner for SEC filers.
Smart Business talked to Barbara Catherall, a senior audit manager at Tauber & Balser, P.C., about the importance of the new interpretation.
What was the impetus for FIN 48?
Tax positions represent interpretations of the income tax code. As such, it is easy to understand the validity of recognizing the benefit of a tax position in the financial statements when the degree of certainty that the position can be sustained is high. However, the law is often subject to interpretation and whether a tax position can be sustained can often prove to be difficult to determine. FASB 109 contains no guidance on assessing the degree of confidence of sustaining tax positions. Consequently, a diversity of practice developed and has resulted in non-comparability in financial statements.
FIN 48 clarifies the accounting for uncertain tax positions that have been recognized in the financial statements in accordance with FASB 109, ‘Accounting for Income Taxes,’ by developing a recognition threshold and measurement attribute for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. In addition, FIN 48 provides guidance on derecognition, classification, interest, penalties, accounting in interim periods, disclosure and transition.
How are tax positions evaluated?
First, evaluate the position for recognition. The company should recognize the effects of a tax position in its income statement if the position will more likely than not be sustained on examination by the relevant tax authority. The term ‘more likely than not’ is a likelihood of more than 50 percent which is the same criterion used to evaluate whether a deferred tax asset is realizable. An entity should not recognize any income statement benefit for a tax position if the more-likely-than-not threshold is not met. Entities should base their analysis of the more-likely-than-not threshold only on the technical merits of the tax position. In making this analysis, an enterprise should presume that the tax position will be examined and evaluated by the relevant tax authority with full knowledge of all relevant information. The company must also assess the technical merits of the tax position based on the weight of the relevant tax law authorities at the reporting date. Each tax position must be evaluated individually. FIN 48 prohibits offsetting the positions against each other or aggregating positions.
What provides guidance concerning technical merits?
The authority for tax law can be found in legislation, statutes, legislative intent, regulations, rulings and case law. A company can also consider prior administrative practices and precedents established by the relevant tax authority if they are widely understood. For instance, many tax authorities have indicated by historical administrative practices and precedents that they will not challenge an entity’s capitalization policy of deducting insignificant assets, even though the tax law may not prescribe a capitalization threshold or contain a materiality provision.
What types of issues are included in tax positions?
Tax positions can include the following:
- A decision not to file a tax return in a jurisdiction
- The allocation of income between jurisdictions
- The characterization of income in the tax return
- A decision to exclude taxable income in the tax return
What happens when the tax return basis is different than the result of applying FIN 48?
Any difference arising between the amount that a company recognizes by applying FIN 48 and the amount reported, or expected to be reported, on its tax return results in a liability for unrecognized tax benefits (a FIN 48 liability) that should be classified as current for those amounts expected to be paid within one year. It is not classified as a deferred tax liability.
FIN 48 is effective for fiscal years beginning after December 15, 2006. This means that SEC calendar year filers need to consider FIN 48 when preparing their first quarter 2007 filings.
BARBARA CATHERALL is a senior manager providing service to both the Forensic and Audit departments at Tauber & Balser, P.C. She has more than 20 years of public accounting experience for both publicly and privately-held companies in the professional services, retail, wholesale distribution, manufacturing, health care, real estate, not-for-profit and construction industries. Reach her at email@example.com or (404) 814-4961.