Income tax accounting for uncertainties -FIN48, ASC 740-10

1. Accounting for Income Tax
Uncertainties & Common Pitfalls
Katherine D. Morris, CPA
August 2010
www.smith-howard.com

2. Uncertainty in Income Taxes –
Agenda
• Guidance
• Reviewing UTP’s
• Documentation
• Reporting & Disclosures
• Proposed IRS R
P d Reporting
ti
• Potential Issues
• Common Pitfalls in ASC 740

3. Solitary facts…
Accounting for
Income Tax
I T
Uncertainties

4. ASC 450 (FAS 5)
Historical G id
Hi t i l Guidance
• Evaluate likelihood of future events
– Probable
- Likely to occur
– Reasonably possible
- More than remote but less than
p
probable
– Remote
- Slight
• Guidance does not quantify thresholds
• ASC 450 (fka FAS 5) continues to be
applicable for the evaluation of non-
income tax reserves

5. Accounting for Income Tax
Uncertainties: What is required?
U i i Wh i i d?
• Requires all material income
tax positions for all open tax
years to be reviewed

6. How: 2 Step Process
2-Step
• Step 1: Recognition:
–A tax position must be More likely than not?
“more likely than not”
(MLTN) of being sustained
in an audit to record the
benefit of the position
–Assume you will be audited
Assume
–If MLTN standard is not
met, the item is an
“uncertain tax position
uncertain position”

7. How: 2 Step Process
2-Step
• Step 2: Measurement:
–If a position is recognizable, the amount recognized must be the
largest amount of tax benefit that is greater than 50% likely of
being realized
g
What probable outcome > 50%?
Possible Outcome
P ibl O t Cumulative
C l ti
Probability
$
$ 100 5%
%
$ 60 55%
$ 20 95%

8. Scope – What is a
Tax P iti ?
T Position?
• Tax benefit on return filed or expected to be filed
p
• Decision not to file a return
• Allocation or shift income
• Characterization of income
C f
• Decision to exclude income

9. Recognition Threshold:
“More Likely Than Not”
More Not
• Greater than 50%
– Matter of judgment
–BBased on f t and circumstances
d facts d i t
– Consider all available evidence

10. Recognition Threshold:
“More Likely Than Not”
“M Lik l Th N t”
• Technical merits of a tax position are
derived from sources of authority
– Legislation & statutes
– Legislative intent
– Regulations, rulings, case law

11. When?
• Effective for US GAAP financials
– Nonpublic Companies:
p p
• Periods beginning after December
15, 2008
• Effective for 2009 calendar year
companies
– Public Companies:
• Periods beginning after December
15, 2006

12. Uncertain Tax Positions ASC 740-10
Pass Th
P Through Entities
h E titi
• ASU 2009-06 provides:
p
– Guidance for pass-through entities and tax-exempt
not-for-profit entities
– Disclosure modifications for non public entities
non-public
• Clarifies that all entities are subject to ASC 740
– Even if the only tax position in question is the entity s
entity’s
tax status.
• Technical merit required
– Management needs to determine whether the laws
and regulations of the taxing jurisdictions attribute
income taxes to the entity or its owner.

13. Now Applies to
Pass-through E titi
P th h Entities
• Attribution to the entity
– Amounts that may be due are classified as
income taxes and subject to ASC 740 for the
entity.
• Attribution to owners
– Amounts due to or from the taxing jurisdiction
are classified as transactions with owners
owners.

14. Now Applies to Pass-through
Entities
E titi
• Critical issues:
– Is the pass-through treated as a valid
partnership or s-corporation in the jurisdiction
s corporation
for which they must file?
– Would the technical merits of the jurisdiction
indicate that income taxes are attributable to
the owner(s) or the pass-through entity?

15. Now Applies to S corporations
S-corporations
• Considerations
– Does the S-corporation have a valid S-
Corporation election?
– Have the distributions historically been in
proportion with ownership?
– Is the S-corporation properly tracking the disposal
of assets with built in gains?
built-in-gains?
– Is the S-corporation filing in all required states
and paying income taxes that are not passed to
owners? ?
– Have foreign taxes on their investments been
considered?

16. Now Applies to Non profits
Non-profits
• Considerations: Non-Profits
– Did the non-profit have a valid tax exempt
application approved by the IRS?
– Is the non-profit entity meeting the requirements
non profit
of its tax exempt status?
– Have articles been submitted to the IRS for
changes in the business over the years i e is
years—i.e.,
tax-exempt status current?
– Does the non-profit entity have any unrelated
business i
b i income not previously reported?
t i l t d?
– Does the non-profit have partnership or foreign
investments?

17. The bottom line…
Reporting &
Disclosures

18. Reporting: Transition
• Implementation:
p
– Record cumulative effect as an adjustment to the
opening balance of retained earnings
• Include:
– Tax liability upon adoption
– Refund claims not previously recorded
– Interest and penalties on UTPs
• Exclude:
– Items that would not be recognized in earnings
g g
• e.g., business combination adjustments to goodwill
– Timing differences fully offset by changes in DTA &
DTL

19. Reporting: Interest
• Interest
– ASC 740 (FIN 48) requires accrual if position in
tax return is not recognized in financial
statements under ASC 740 (FIN 48)
– When tax law requires interest on underpayment,
start recognizing in 1st period it would begin
accruing under tax law
– Amount is statutory interest rate times difference
between ASC 740 (FIN 48) tax position and
amount taken in tax return

20. Reporting: Penalties
• Penalties
– Recognize when tax position does not meet
minimum statutory threshold to avoid payment
of penalties
– Recognize in period in which company claims
or expects to claim position in tax return

21. Disclosures
• Accounting policy for classification of
interest and penalties
• Public Companies Only:
• Tabular “rollforward”
• Total amount of UTBs that affect the effective tax
rateInterest and penalties
• Description of open tax years

22. Required Disclosures –
Nonpublic Companies
N bli C i
– Total interest & penalties
• ASC Section 740-10-50-15(c)
– 12-month look forward
12 month
• Reasonably possible of occurring in the next 12
months
– ASC Section 740-10-50-15(d)
– Open statutes
– ASC Section 740 10 50 15(e)
740-10-50-15(e)

23. Hindsight: Error versus Change in
E i
Estimate
ASC Master Glossary
• Change in estimate / change in facts / change in
j g
judgment:
– results from “new information”
• Error:
– results from…
“mathematical mistakes, mistakes in the application
of accounting principles, or oversight or misuse of
principles
facts that existed at the time the financial
statements were prepared”
Slide 23
Accounting For Income Taxes July 2010
PricewaterhouseCoopers

24. Hindsight: Error versus Estimate
Considerations in Tax
• New information; or
•RReasonably k
bl knowable i f
bl information
ti
• Ask / document:
– Was it a fact that was known or should have
been known?
Slide 24
Accounting For Income Taxes July 2010
PricewaterhouseCoopers

25. IRS Announcement 2010-9 and
2010 17
2010-17
Proposed Reporting of Uncertain
Tax P iti
T Positions

26. Uncertain Tax Positions:
Proposed IRS Reporting
January 26, 2010 IRS drops
a bomb…
IRS Announcement 2010-9:
• Comment period ended June
1, 2010.
• Proposes UTP reporting,
effective for 2010 tax returns.
Certain Business Taxpayers
will b required t report
ill be i d to t
uncertain tax positions
(UTP) in tax returns.
returns

28. Lost in the
wilderness…
Potential Issues

29. Consider Changes in Accounting
Principle
Pi i l
Guidance:
– Accounting methods or principles may be
changed for book purposes in the financial
statements.
t t t
– The changes may not be considered for tax
reporting purposes because a tax accounting
method change was not requested but must be
considered for the financials.
– A book/tax difference and the expected reversal
b k/t diff d th t d l
of the item must be computed for computing
interest & penalties.
ASC 740 and ASC 740‐10
Page 29

30. Audit S ttl
A dit Settlement
t
• Issue
– When is an uncertain tax position “settled”?
• Application
– FSP FIN 48-1, “Definition of Settlement in
FASB Interpretation No 48 ” issued May 2007
No. 48,

31. Audit S ttl
A dit Settlement
t
• Guidance
– Position must be effectively settled and meet 3
conditions
1.
1 Completion of exam;
2. Company does not intend to appeal/litigate; and
3. Remote likelihood that taxing authority would
examine/re-examine tax position
/
• Take Away
– Even though FIN 48 1 was issued in 2007
48-1 2007,
uncertainty and disputes around “settlement” still
exists; therefore, support tax positions taken

32. “Settlement” is Limited to Examined
Settlement
Return Year(s)
• Issue
– Company completes an exam and agent fails
to identify an uncertain tax position in that
year’s tax return; company settles year under
exam
• Take Away
– Settlement provides no new evidence about
the technical merits of similar tax positions in
other years’ tax returns

33. Valuation Allowance on DTAs Not a
Substitute for Analysis
• Guidance
– DTAs should be established for all deductible
temporary differences, NOLs and Credits
p y ,
– Record DTAs gross; then consider need for VA
– VA may be required on a specific DTA if future
y
realization is in doubt due
• Expiration of a tax attribute (e.g., an NOL, tax credit)
• I
Insufficient future taxable income in a particular
ffi i t f t t bl i i ti l
jurisdiction

34. Uncertain Tax Positions ASC 740-10
Related Entities
• Guidance:
– Consolidated or combined financial statements are to
include all tax positions of each entity within the group that
is subject to income taxes or that has taxable income
assigned to it from a pass-through entity
• Example:
– A must include ASC 740 10 issues
740-10
of B, even though A is a A
Consolidated
pass-through entity 100% Financials
B

35. Gross up Deferred Tax Assets
G D f dT A t
• Guidance
– Gross-up deferreds when have a full VA and
uncertain tax liabilities
• Federal exposures and state benefits
• Transfer pricing exposures and benefits from
p g p
different jurisdictions

36. No Netting of Cross Jurisdictional
Tax Issues
• Guidance
– Multinational companies should not use a
historically based
historically-based blended foreign tax rate
• Required to calculate UTPs based on each
jurisdiction and the rate in existence when benefit
was taken or will be taken
• Example:
– R&D labs may be located in one country; manufacturing
plants in other countries
– Company may file in one jurisdiction but not another:
benefits cannot offset exposures

37. Recognize B
R i Benefits
fit
• Guidance
– ASC 740-10 also applies to refund claims
– Recognize and measure benefits using the
ASC 740-10 (fka FIN 48) criteria, not as a
contingent gain under ASC 450 (fka FAS 5)
• Take Away
– Consider the impact of liabilities and refund
claims separately
l i t l
• Retained earnings at the time of adoption
• Income tax benefit in future periods

38. Consider Tax Law Changes
• Guidance:
– Deferred tax liabilities and assets shall
be adjusted for the effect of a change in
tax laws or rates (ASC 740-10-35-4) [by
jurisdiction]
– The effect of a change in tax laws or
rates should be included in income from
continuing operations for the period that
g p p
includes the enactment date (ASC 740-
10-45-15 )

39. Use Subject M tt E
U S bj t Matter Experts
t
• Issue
– A blended federal based tax rate is used for
all issues
• Guidance
– ASC 740-10 requires taxpayers to look at all
740 10
tax positions on a jurisdictional level

40. Use Subject Matter Experts
• Examples of Subject Matter Experts:
– Federal
– IRS practice & procedures
– International – domestic treatment
– Foreign jurisdictions tax specialists
– Transfer pricing
– R&D credit
– SALT
– Compensation & benefits

41. ASC 740
Top 10
Common Pitfalls

42. ASC 740
Common Pitf ll – T 10 Li t
C Pitfalls Top List
1.
1 Valuation allowances not considered for
each jurisdiction separately.
2. Tax law changes and tax law for each
taxing jurisdiction not reflected in tax rate.
3. Recording uncertain tax positions with
deferreds,
deferreds improperly or not computing
interest and/or penalties.
4. M&A transactions tax consequences not
considered at Day 1 and during
measurement period.
5. Reporting stock options i
5 R ti t k ti incorrectly.
tl

43. ASC 740
Common Pitf ll – T 10 Li t
C Pitfalls Top List
6. Proof of Deferreds - cumulative book/tax basis
differences not supported.
7. Accounting method changes – tax or book
changes not considered
considered.
8. Interim provision not annualized properly.
9. Reporting foreign investments -
representation to permanently re-invest foreign
earnings or provide deferred tax; provide
cumulative translation adjustment when
company represents it will permanently reinvest.
reinvest
10. Provision to return reconciliations – impact of
true-up adjustments not properly reflected in
financials.
financials

44. • Presentation of Financial Statements: • Financial Instruments with
Characteristics of Equity
Characteristics of Equity
• Financial Statement • Leases
Presentation
• Di
Discontinued Operations
ti dO ti • R
Revenue Recognition
R iti
• Other Comprehensive Income • Consolidations
• Financial Instruments: • Fair Value Measurements
• Accounting for Financial • FASB‐Only Projects
Instruments
• Offsetting • Disclosure of Certain Loss
Disclosure of Certain Loss
Contingencies
• Going Concern

45. Disclosure
•To ensure compliance with Treasury Department regulations,
p y p g
any tax advice that may be contained in this communication
(including any attachments) is not intended or written to be
used, and cannot be used, for the purpose of (i) avoiding tax-
, , p p () g
related penalties under the Internal Revenue Service Code or
applicable state or local tax law provisions or (ii) promoting,
marketing, or recommending to another party any tax-related
tax related
matters addressed herein.
•Material discussed in this presentation is meant to provide
general information and should not be acted on without
professional advice tailored to your firm’s or company’s
individual needs.

46. Q
Questions?
Katherine D. Morris, CPA
kmorris@smith-howard.com
(404) 874 6244 office
874-6244
(404) 317-1883 cell