FIN 48 and Tax Return Disclosure

Financial Accounting Standards Board (FASB) Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxes, potentially forces disclosure of uncertain tax positions in GAAP-based financial statements. Its implementation has resulted in increased analysis by public auditors, often with the assistance of members of the firm’s tax staff and client personnel. However, of equal interest are the IRS’s recently announced plans to require disclosure of such uncertain tax positions in corporate tax returns. This item provides a brief overview of the FIN 48 requirements, an update on the IRS plans, and some observations on the dynamics created among an engagement’s auditors, tax preparers, and client personnel resulting from these new rules.

FIN 48 Overview

FIN 48 amends and interprets Statement of Financial Accounting Standards (FAS) No. 109, Accounting for Income Taxes. It creates the need to identify and measure uncertain tax positions for potential accrual and disclosure in a company’s financial statements. The evaluation is a two-step process. First, the company must determine whether it is more likely than not that the position taken or to be taken on a tax return will be sustained under examination (including appeals and potential litigation). This determination must assume that the issue will be examined by a competent authority who has complete knowledge of all information relevant to the position and that the authority’s conclusion will be based solely on the technical merits of the position. If a position meets these criteria (and the audit’s materiality threshold), the financial statements must be adjusted to reflect the impact, including interest and penalties, and certain disclosures are required. FIN 48 became effective several years ago, but for most nonpublic entities its impact was first felt on financials for calendar year 2009.

Implementation Issues

In practice, these requirements created a very interesting dynamic among the parties involved in the analysis. For years, tax professionals in public accounting firms have been accustomed to practicing in a manner consistent with the Sec. 6694 paid preparer penalty provisions. Those requirements bear similarities to FIN 48. However, Sec. 6694 requires disclosure (Form 8275, Disclosure Statement, or 8275-R, Regulation Disclosure Statement) only in cases where a potential problem is identified. With the implementation of FIN 48, CPA audit teams understandably are seeking assurance from their tax counterparts that clients’ financial statements have not understated tax liabilities due to subjective positions. New audit procedures are in place, often requiring tax personnel to provide memos or other documentation to their audit counterparts.

This added step raises a few issues that accounting firms may not have addressed in the past. First, tax service providers may find themselves noticing a different comfort level between determining that Form 8275 is not required and providing written affirmation that no issues are present. The latter may require digging deeper into client and CPA records—and on whose time budget? For example, a relatively new client potentially may have had nexus in states in which no returns were filed for years, perhaps prior to becoming a client of its present service provider. Because the statute of limitation never began to run, a potential issue exists that warrants some analysis. Should the client pay for this? If not, which department absorbs the time overrun—audit or tax? There may be more to the FIN 48 analysis than meets the eye, and consideration of these issues and communication among tax and audit personnel (and the client) are recommended.

IRS Disclosure Initiative

The IRS stated in Announcement 2010-9 that it is planning a new form to report uncertain positions, Schedule UTP, Uncertain Tax Position Statement (discussed in more detail in the next item, Awdeh and Oneschuk, “Transparency and Compliance in Light of the New Schedule UTP”):

• Schedule UTP will be required to accompany Form 1120, U.S. Corporation Income Tax Return, and three other returns in the 1120 series, but only for entities with assets greater than $10 million;
• Concise descriptions of each uncertain position and presentation of the maximum amount of related federal tax liability attributable to each uncertain position will be required; and
• Disclosure will be required not only for items for which reserves are created under FIN 48, but for some positions for which no reserve was created due to factors such as taxpayer plans to litigate.

Conclusion

FIN 48 and proposed Schedule UTP have created the need for some analysis to be undertaken with a little more formality than in the past, even for competent practitioners with good intentions. As with many other aspects of business, practitioners should be sure to communicate well with the parties involved. Tax and audit personnel should discuss the division of duties, and the cost of a more comprehensive analysis and potential for additional (and unwelcome) disclosure should be discussed with clients. They should also consider the need for potential corrective action, such as amended returns, changes in accounting methods, and participation in state tax amnesty programs if appropriate. The first filing period for which Schedule UTP will apply is 2010, and taking appropriate corrective measures right away could avoid the need to file the form.

Editor: Anthony S. Bakale, CPA, M. Tax.

EditorNotes

Anthony Bakale is with Cohen & Company, Ltd., Baker Tilly International, Cleveland, OH.

For additional information about these items, contact Mr. Bakale at (216) 579-1040 or tbakale@cohencpa.com.

Unless otherwise noted, contributors are members of or associated with Baker Tilly International.