By William Prue, Director of Accounting and Auditing  

In 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48 - Accounting for Uncertainty in Income Taxes. FIN 48 requires U.S. companies to recognize and measure tax positions they have taken or expect to take.  FIN 48’s effective date for privately-owned entities was deferred but the standard now covers all entities – public, privately-owned, and not-for-profit, including pass-through entities - for years beginning after December 15, 2008 (generally, calendar 2009). Its impact is significant and requires additional tracking and documentation from every entity and location.

What is a tax position?

A tax position is a position in a previously filed tax return or a position to be taken in a future tax return that is reflected in measuring current or deferred income tax assets and liabilities in an entity’s financial statements. This analysis requires a review of an entity's tax positions taken on all of its income tax returns. If a position is uncertain, a related liability (if material) is recorded for the potential tax, plus penalties and interest. The term "tax position" also encompasses, but is not limited to:

1. A decision not to file a tax return
2. Allocation of income between jurisdictions
3. A decision to classify a transaction, entity, or other position in a tax return as tax exempt
4. An entity’s status, including its status as a pass-through entity (S-Corp, LLC, etc.) or a tax exempt not-for-profit entity 

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. Newly issued standards establish uniform accounting for uncertain tax positions. 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 tax-exempt, and taking a tax deduction.

Entities that prepare their financial statements according to Generally Accepted Accounting Principles (GAAP) must review all of their federal and state tax positions — including decisions not to file in a particular state — and to determine whether the positions would "more likely than not" withstand a challenge by the IRS or a state tax authority. More likely than not means that there is a more than 50% possibility that the position would be sustained upon examination by taxing authorities.

If a position fails the more-likely-than-not test, the corresponding tax benefit isn’t recognized in the company’s financial statements. Entities must establish reserves for the portion of the tax benefit that isn’t recognized (or if applicable, record a liability) and make financial statement disclosures about uncertain tax positions.

Private companies would be required to disclose the following:

• The total amount of interest and penalties recognized in the financial statements.
• The nature of uncertainties that could significantly change within 12 months.
• A description of tax years that remain subject to examination by major jurisdictions.

IRS Proposes FIN 48 Disclosure in Tax Returns

On January 26, 2010, the IRS issued Announcement 2010-9, Uncertain Tax Positions. In a speech on that day, Commissioner Douglas Schulman said this proposal would apply to businesses with assets over $10 million that prepare financial statements under FIN 48. These companies will have to file a new schedule, currently under development, with their tax returns. The form will require a brief description of all uncertain tax positions taken by the taxpayer, along with the maximum dollar amount of tax exposure for the issue. It will not require the taxpayer to reveal its risk assessment or tax reserve amount (which the IRS can still seek by summons). No effective date for the new filing requirement has been determined, but Mr. Schulman told reporters it will not be in effect for the current tax season. He also mentioned penalties if, upon audit, it is found that a company did not file the required information.