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Newsletter - Summer 2007
Tax Positions at Risk
David Brooks, Principal, Assurance Services |
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What happens when the IRS, SEC and the
Financial Accounting Standards Board
(FASB) share a common vision about how
uncertain income tax positions should be
disclosed in financial statements? For one,
tax directors of large public companies begin
evaluating whether they have properly accounted
for and disclosed tax positions in their income
tax returns and financial statements.
A new accounting pronouncement, known
as FIN 48, Accounting for Uncertainty in Income
Taxes, is requiring companies to evaluate
income tax related "gray" areas-tax rules and
regulations subject to interpretation or judgment.
If a company determines that an examination
would more likely than not result in an unfavorable
outcome, it must quantify the amount of exposure
and recognize additional expense and liability in
its financial statements.
Designed to provide information to financial
statement users, FIN 48 has created significant
controversy and uncertainty. The new reporting
standard is far reaching and applies to privately
held companies and not-for-profit entities that
prepare financial statements in accordance with
Generally Accepted Accounting Principles (GAAP).
FIN 48 is generally applicable to audited, reviewed
or compiled financial statements for years
beginning after December 15, 2006.
While not without controversy,
one benefit of FIN 48 is that it should provide
non-tax executives of a private company with
a clear picture of the company's overall tax
exposure. With a clear understanding of exposure,
executives should be better able to
monitor and reduce exposure areas.
For example, if a tax position is
dependent on transactions being
handled and documented in a
certain manner, the FIN 48 analysis
could help improve the internal
policies and procedures needed
to help support the tax treatment.
In adopting FIN 48, privately
held companies need to review
positions they have taken or plan
to take in federal, state and local income tax filings, including decisions not to
file returns in certain jurisdictions and other tax
issues related to foreign jurisdictions. They should
identify any positions that, based on technical
merit, would more likely than not result in an
unfavorable outcome.
Not-for-profit companies will have to assess
their tax positions as well, determining if there
is any exposure to unrelated business income,
or whether there are any events that could
potentially jeopardize their tax-exempt status.
Incorrect or unduly aggressive tax
positions that are not likely to withstand IRS
scrutiny require the company to reduce its
current net income by the taxes, interest and
penalties associated with the uncertain tax
position. Tax positions that are more likely
than not to withstand an IRS audit, but
nevertheless represent some degree of
uncertainty, may result in a partial charge
to the company's income.
The charge to net income may not
necessarily be a concern to a privately held
company, but what should be of concern is
how the IRS or other taxing authority will
approach and use the information associated
with the tax analysis. The IRS is not tipping its
hand on its approach to FIN 48 documentation,
however, the IRS has formally stated that it is
training its agents on FIN 48 and accounting
for income taxes.
In adopting FIN 48, a company will have
to analyze the income tax returns
for all jurisdictions in which
the statute of limitations
remains open. The company
will also have to document
the tax position related to
significant acquisitions and
dispositions for open tax years.
Other areas that require analysis
include results of prior tax examinations,
timing differences between
reporting of book and tax items,
prior year financial statements and
trial balances and the company's prior
period accounting for income taxes.
Without question, FIN 48 will significantly
change the manner in which companies account
for uncertainty in income taxes. In many instances,
these requirements will result in these uncertainties
being highlighted in the financial statement in the
form of additional disclosure and recognition.
The evaluation and implementation of
all provisions of FIN 48 will require significant
involvement by various tax and accounting
professionals. Early attention to FIN 48 is
essential for the timely and efficient completion
of financial statements. And, it could provide the
added benefit of reversing a potentially uncertain
tax position.
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