By now you should have at least heard about Financial Accounting Standards Board Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes. FIN 48 has been superseded by the Accounting Standards Codification (“ASC”) 740-10, but is still referred to as FIN 48. Most calendar year organizations are now subject to the provisions of FIN 48, and most non-profit organizations with a June 30 year-end will be subject to its provisions come this June. Yes, I did say non-profit organizations. FIN 48 applies to all entities that prepare financial statements under generally accepted accounting principles (“GAAP”), and it affects the year of implementation, and all years under the statute of limitations for each applicable taxing authority. So, what are the requirements?
The first step in the process is to identify any potential uncertain tax positions. For tax exempt organizations, management should ask themselves the following: 1) Compare the organization’s current activity with the tax exempt purpose indicated on its 1023 application. Is it the same? If not, have the articles of incorporation been amended, and a copy provided to the IRS, or is the organization’s tax exempt status now in jeopardy, and any net income subject to tax? 2) Review sources of revenue, and determine if they are related to the organization’s exempt purpose. If not, has a 990-T been filed to report unrelated income, and are expenses allocated to offset this income reasonable and allowable? For small businesses, management should ask themselves the following: 1) Are expenses reasonable and allowable? 2) Are we reporting a capital gain properly, or should it be an ordinary gain? 3) If the company is an “S” corporation, is the “S” election in jeopardy of revocation, which subjects income to taxation at the corporate level? 4) If the company has activity in another state, have appropriate state returns been filed in those states?
Once uncertain tax positions are identified, it is time to recognize and measure them. Under FIN 48, a tax benefit related to an uncertain tax position cannot be recorded in an entity’s financial statements, unless it is “more-likely-than-not” (more than 50% chance) that the tax position will be sustained by the taxing authority. You must assume the taxing authority will examine the tax return, and has full knowledge of all the facts and circumstances regarding the tax position. If it is determined that a tax position will not be sustained, recognition has occurred, and it is time to measure, or calculate an amount that will reduce the tax benefit recorded related to the uncertain tax position. FIN 48 uses the term ‘cumulative probability’ to determine this measurement factor. The amount to record as a tax benefit is the largest cumulative amount that is more-likely-than-not to be sustained by the taxing authority.
Let’s look at a quick example. Let’s assume a C corporation has $100,000 in revenues and $100,000 in expenses, resulting in no taxable income for 2009. In arriving at that figure, the corporation has deducted an expense for $10,000. Management has questioned whether or not the expense is fully deductible in one year. Management decides to fully deduct the expense in 2009, but has determined the following: there is a 40% chance that the entire expense will be allowed by the taxing authority in 2009, a 40% chance that only $8,000 will be allowed, and a 20% chance that only $2,000 will be allowed in 2009. Using ‘cumulative probability’, the largest cumulative amount that is more-likely-than-not (remember, this means over 50%) to be sustained by the taxing authority is $8,000 (40% that the expense is fully deductible + 40% that only $8,000 is deductible). Therefore, a liability needs to be recorded for the $2,000 that may be denied by the taxing authority. Assuming a 40% tax rate, the company would debit current income taxes and credit liability for uncertain tax benefit for $800. Additional disclosures would also be required in the notes to the financial statements.
As you can see, FIN 48 affects all entities preparing GAAP based financial statements. Management needs to thoroughly analyze the organization’s tax positions, current and applicable past years, to determine if any are deemed uncertain, thus requiring adjustment in the organization’s financial statements. This article is a very brief overview of the provisions FIN 48. Each particular organization’s tax situation must be analyzed in order to properly implement FIN 48. If you or your organization has any questions in regards to this article, please do not hesitate to give us a call.
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