Uncertainty principles - Accounting for income taxes under FIN 48

Werner Heisenberg forever linked momentum to position with his uncertainty principle, a cornerstone of quantum mechanics.  To anyone familiar with the Internal Revenue Code, uncertainty is frequently linked to positions taken on tax returns.  In many cases, you cannot be certain that a tax position will be accepted by the IRS or the courts.  Now the Financial Accounting Standards Board (FASB) has sought to slow the momentum of these uncertain positions with a quantum leap in financial reporting.

Recently, FASB issued controversial new guidelines on the treatment of uncertain tax positions for financial statement purposes. FASB Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxes, applies to public and private companies that prepare financial statements in accordance with Generally Accepted Accounting Principles (GAAP).  Although public companies have been subject to FIN 48 throughout 2007, in February 2008 FASB delayed implementation for private companies until fiscal years beginning after December 15, 2007.

Affected organizations will now need to review their tax positions, evaluate the level of uncertainty, and reflect that uncertainty in their financial statements.

A two-step process

Evaluating a tax position under FIN 48 involves two steps.  First, determine whether it’s more likely than not that the position would be sustained — based on its technical merits — by the IRS or a state taxing authority (including any appeals or litigation).

If a position fails this test, you can’t recognize any related tax benefits in your financial statements. When you evaluate a position on its merits, you must assume that it will be examined by the taxing authority with full knowledge of all relevant information.

The second step, for positions that meet the more likely than not test, is to determine the portion of the tax benefit to recognize in your financial statements. Under FIN 48, that means “the largest amount of tax benefit that is greater than 50% likely of being realized upon ultimate settlement with a taxing authority.”

It is important to understand that, even though recognition is based strictly on a position’s technical merits, the measurement process takes into account more practical considerations, such as the amount a party would settle for to avoid going to court.

After your initial determination, monitor tax positions and revise your financial statements as needed to reflect changes in the law or your circumstances. You might derecognize a tax benefit in light of an unfavorable court ruling, for example, or identify a previously unrecognized benefit after the statute of limitations period for an audit expires.

A road map for the IRS?

Some taxpayers fear that FIN 48 will provide taxing authorities with a road map to questionable tax positions. FASB dismissed this concern, noting that the guidelines require disclosures of only aggregate amounts, without details about specific tax positions or jurisdictions. Still, even aggregate amounts can raise red flags that may invite further investigation, and the IRS is currently training its agents on how to best develop information from FIN 48 disclosures.

Become familiar with FIN 48

FIN 48 is complex, but if your company — whether it’s public or private — prepares financial statements in accordance with GAAP, consult your tax advisor early to learn how it affects you.

The information contained in this article is provided as general guidance and may be affected by changes in law or regulation. This article is not intended to replace or substitute for accounting or other professional advice. Please consult a CBIZ professional. This information is provided as-is with no warranties of any kind. CBIZ shall not be liable for any damages whatsoever in connection with its use and assumes no obligation to inform the reader of any changes in laws or other factors that could affect the information contained herein.

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