1. ACCOUNTING FOR UNCERTAINTY
IN INCOME TAXES
Background
In June 2006, the FASB issued FIN 48 (FASB ASC
Certainty Has Been 740-10); Accounting for Uncertainty in Income
Taxes, originally effective for all entities that
Achieved apply U.S. Generally Accepted Accounting
Principles (GAAP) for fiscal years beginning after
December 15, 2006. The FASB clearly defined
The FASB Completes Their Study the applicability of FIN 48 in Paragraph one
of How Certain Aspects of ASC which states:
740 Apply to Nonpublic Entities “…the requirements of this
Interpretation apply to not-for-profit
By Andrea Gronenthal organizations. This Interpretation also
For those entities holding out for another applies to pass-through entities and
deferral of the requirements for nonpublic entities whose tax liability is subject to
entities to comply with the Financial Accounting 100 percent credit for dividends paid
Standards Board (FASB) Accounting Standards (for example real estate investment
Codification Topic (ASC) 740, Income Taxes trusts and registered investment
(which includes FASB Interpretation No. 48 (FIN companies) that are potentially subject
48) – Accounting for Uncertainty in Income to income taxes.”
Taxes – an interpretation of FASB Statement While the FASB was clear in which enterprises
(FAS) No. 109); another deferral of the deadline were subject to the requirements of FIN 48,
to comply is not likely. On September 2, 2009, little guidance was provided on how the
the FASB issued Accounting Standards Update Interpretation applied to not-for-profit or pass-
(ASU)No. 2009-06, Implementation Guidance on through entities (S-corporations and
Accounting for Uncertainty in Income Taxes and partnerships). Historically, many pass-through
Disclosure Amendments for Nonpublic Entities, entities and not-for-profit entities have not paid
which provides guidance on the application of income taxes and have not applied the
FASB ASC 740-10 for pass-through entities and provisions of FAS 109 in the preparation of their
tax-exempt not-for-profit entities and signals financial statements. The lack of clear guidance
the end of the FASB’s deferral, for certain surrounding the applicability of FIN 48 created
nonpublic entities. confusion for these types of nonpublic
enterprises as to whether the Interpretation
applied to their organization.
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2. ACCOUNTING FOR UNCERTAINTY
IN INCOME TAXES
On February 1, 2008, the FASB issued FASB Staff requirements currently within FIN 48 (FASB ASC
Position (FSP) No. FIN 48-2, Effective Date of 740-10) as these were onerous for private
FASB Interpretation No. 48 for Certain enterprises and not useful to users of their
Nonpublic Enterprises, deferring the effective financial statements.
date of FIN 48 for eligible nonpublic entities to
annual financial statements for fiscal years On May 18, 2009, the FASB released Proposed
beginning after December 15, 2007. Later in the FSP No. FIN 48-d, Application Guidance for Pass-
same year, the FASB issued FSP No. FIN 48-3, through Entities and Tax-Exempt Not-for-Profit
Effective Date of FASB Interpretation No. 48 for Entities and Disclosure Modifications for
Certain Nonpublic Enterprises, further deferring Nonpublic Entities, to propose amending FIN 48
the effective date of FIN 48 for eligible
nonpublic entities to annual financial
statements for fiscal years beginning after Private enterprises often possess
December 15, 2008. characteristics that will present additional
challenges not as commonly addressed by
These two deferrals were intended to allow the their public enterprise brethren:
FASB the time to provide additional guidance
for pass-through entities and not-for-profit Specific issues related to income
entities on how to apply FIN 48 as well as attribution for flow-through entities
provide nonpublic entities additional time to Time consuming identification
prepare for the eventual requirement. The
process, especially for enterprises
FASB considered limiting the scope of the
with consolidations, acquisitions,
deferrals to pass-through entities and not-for-
and significant state or
profit entities but decided that for purposes of
simplicity, the deferrals applied to all nonpublic
international operations
entities unless the nonpublic entity was Lack of sufficient internal tax or
consolidated with a public enterprise that U.S. GAAP expertise
applied U.S. GAAP or the nonpublic entity had Nonexistent or minimal internal
already applied the recognition, measurement, controls for tax processes
and disclosure provisions of FIN 48 (FASB ASC Poor documentation of tax positions
740-10) in their financial statements. taken by the organization
Limited tax authority history on
Following recommendations of the Private
which to base conclusions
Company Financial Reporting Committee
(PCFRC) and other key stakeholders, the FASB More aggressive tax positions taken
developed guidance on how FIN 48 (FASB ASC historically
740-10) applies to pass-through entities and
not-for-profit entities. The PCFRC also made
recommendations to reduce the disclosure
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3. ACCOUNTING FOR UNCERTAINTY
IN INCOME TAXES
(FASB 740-10) and provide guidance that “a). its debt or equity securities are
addressed the concerns of the PCFRC and its traded in a public market, including
constituents. The proposed changes in FIN 48-d those traded on a stock exchange or in
were incorporated into FASB ASU 2009-06 and the over-the-counter market; b). it is a
FASB ASC 740-10 has been amended making it conduit bond obligor for conduit debt
certain that nonpublic enterprises must comply securities that are traded in a public
with FASB ASC 740-10 in their first annual market (a domestic or foreign stock
financial statements issued for the fiscal year exchange or an over-the-counter
beginning after December 15, 2008. market, including local or regional
markets; or c). its financial statements
Why the conversion from FIN 48 to FASB 740- are filed with a regulatory agency in
10? On July 1, 2009, the FASB embarked on the
preparation for the sale of any class of
FASB Accounting Standards Codification (ASC)
securities.”
initiative. This is a structural overhaul of U.S.
GAAP that converts the standards into a topical The FASB used the issuance of ASU 2009-06 to
model that is effective September 15, 2009 for reaffirm that accounting for uncertain tax
interim and annual periods. We now have a positions are applicable to all entities, including
single authoritative source of nongovernmental tax-exempt not-for-profit entities, pass-through
U.S. GAAP. entities, and entities that are taxed in a manner
similar to pass-through entities such as real
All entities are subject to FASB ASC estate investment trusts and registered
740-10 even if the only tax position in investment companies as originally stated when
question is the entity’s status as a pass- FIN 48 (FASB ASC 740-10) was issued in July
2006.
through entity or tax-exempt not-for-
profit organization. In addition to clarifying the applicability of FASB
ASC 740-10, the FASB provided additional
guidance and illustrative examples surrounding
three significant issues plaguing pass-through
Scope entities and tax-exempt not-for-profit entities:
The additional guidance issued by the FASB in 1. Is the income tax paid by the entity
ASU 2009-06 applies to the financial statements attributable to the entity or its owners?
of all nongovernmental entities presented in
conformity with U.S. GAAP. This includes 2. What constitutes a tax position for a
nonpublic enterprises as defined in FASB ASC pass-through entity or as a tax-exempt
740-10-20 as any entity that does not meet the not-for-profit entity?
following criteria for a public company: 3. How should accounting for uncertainty
in income taxes be applied when a
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4. ACCOUNTING FOR UNCERTAINTY
IN INCOME TAXES
group of related entities comprise both An allocation or a shift of income
taxable and nontaxable entities? between jurisdictions
In response to the concerns lodged by the The characterization of income or a
PCFRC and their constituents, the FASB decided decision to exclude reporting taxable
to reduce the disclosure requirements for
nonpublic entities.
Common items evaluated in developing
an inventory of material tax positions:
Identification Financial statements and
supporting general ledgers and
FASB ASC 740-10 applies to all tax positions. An
trial balances
enterprise must evaluate all material tax
Tax returns filed for all
positions in all jurisdictions for all open years in
order to evaluate whether tax positions subject jurisdictions and supporting work
to exam are uncertain. Essentially, the papers
organization is developing a cumulative tax risk Tax examination history and
portfolio limited to income taxes that must be results
monitored and maintained contemporaneously. Tax Calendar
Documentation of existing tax
FASB ASU 2009-06 modifies the definition of a
contingencies and analyses
tax position to include additional language to
Documentation of tax positions
address tax positions related to pass-through
and tax exempt not-for-profit entities. FASB
for which full benefit is expected
ASC 740-10-20 defines a tax position as a Significant temporary and
position in a previously filed tax return or a permanent differences
position expected to be taken in a future tax Tax planning strategies
return that is reflected in measuring current or Tax due diligence reports
deferred income tax assets and liabilities for Tax opinions
interim and annual periods. A tax position can Transfer pricing reports
result in a permanent deduction of income Legal agreements and contracts
taxes payable, a deferral of income taxes Information provided from
otherwise currently payable to future years, or subsidiaries and flow-through
a change in the expected realizability of
entities
deferred tax assets. The term tax position also
Non-recurring transactions
encompasses, but is not limited to:
A decision not to file a tax return
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5. ACCOUNTING FOR UNCERTAINTY
IN INCOME TAXES
income in a tax return applicable in the evaluation of income tax
contingencies.
A decision to classify a transaction,
entity, or other position in a tax return
as tax exempt
Measurement
An entity’s status, including its status as
FASB ASC 740-10-30-7 states that “a tax
a pass-through entity or a tax-exempt
position that meets the recognition threshold is
not-for-profit entity
initially and subsequently measured as the
As part of the identification process, analysis of largest amount of tax benefit that is greater
the materiality threshold and the appropriate than 50 percent likely of being realized upon
unit of account must be considered. Both of ultimate settlement with a taxing authority that
these analyses are subjective and can have a has full knowledge of all relevant information.
significant impact on the scope of the adoption Measurement of a tax position that meets the
effort as well as create the baseline for future MLTN recognition threshold shall consider the
years. The importance of proper evaluation of amounts and probabilities of the outcomes that
these steps of the process cannot be could be realized upon settlement using facts,
underestimated. circumstances, and information available at the
reporting date.”
Each material uncertain tax position is then
subjected to a two step test: recognition and
measurement.
Nonpublic enterprises will need to
implement new processes in order to
Recognition remain up-to-date on tax legislation, court
decisions, and other rulings as well as
Once the inventory of material tax positions is develop mechanisms for those responsible
completed, the positions need to be evaluated for the monitoring of uncertain tax
based on whether it is “more likely than not”
positions to be knowledgeable about
(MLTN) (greater than 50 percent) the tax
changes in operations that may impact the
position would be sustained under examination.
evaluation.
In evaluating whether a tax position meets the
MLTN recognition threshold, the organization
should evaluate the position based on its
technical merits, assume it will be examined
In some cases, the determination of the
and that the examiner has the same
maximum amount that is cumulatively greater
information. Unlike FAS 5, Accounting for
than 50 percent likely of being sustained is a
Contingencies, detection risk is no longer
simple exercise. In other instances, this may
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6. ACCOUNTING FOR UNCERTAINTY
IN INCOME TAXES
not be so clear and require significant analysis simplified. The disclosure requirement to
and documentation of a variety of probable provide a tabular reconciliation of the total
outcomes in order to support the measurement amount of unrecognized tax benefits at the
of the uncertain tax position. Add to the beginning and the end of the periods presented
complexity the need to monitor for new and the requirement to disclose the total
information that may cause a change in the amount of unrecognized tax benefits that, if
analysis and conclusions in subsequent periods. recognized, would affect the effective tax rate
have been eliminated.
Nonpublic entities will still be required to
Disclosure
disclose the total amounts of interest and
While the recognition and measurement penalties recognized in the statement of
principles outlined above apply to all entities, operations and the total amounts of interest
the FASB provided relief to nonpublic and penalties recognized in the statement of
enterprises from several of the disclosure financial position. They will also need to
requirements in the originally issued FIN 48. disclose positions for which it is reasonably
possible that the total amounts of unrecognized
tax benefits will significantly increase or
decrease within 12 months of the reporting
Private entity adoption will likely date. For these changes the following
result in substantial effort, but the information must be disclosed:
adoption and the implementation of
the nature of the uncertainty;
a process for monitoring will afford
senior management the opportunity the nature of the event that could occur
to develop a cumulative portfolio of in the next 12 months that would cause
income tax risk and eliminate any the change;
potential surprises resident within
an estimate of the range of the
their income tax compliance and
reasonably possible change or a
reporting.
statement that an estimate of the range
cannot be made;
and a description of tax years that
FASB ASU 2009-06 eliminated the disclosures remain subject to examination by major
required by paragraph FASB ASC 740-10-50- tax jurisdictions.
15(a) and (b) for nonpublic entities. By
distinguishing these two subsections as While the FASB responded to concerns about
applicable to public enterprises, the disclosure the burdensome disclosure requirements for
requirements for nonpublic entities are nonpublic entities, the simplified disclosure
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7. ACCOUNTING FOR UNCERTAINTY
IN INCOME TAXES
standards will still prove a challenge for entities need to begin the process of adopting
organizations not accustomed to performing FASB ASC 740-10. Finance executives should
the level of analysis to create the disclosures. not underestimate the level of effort required
to comply with the applicable provisions of
FASB ASC 740-10. Rather utilize this as an
Process & Controls opportunity to gain a deeper understanding of
the tax positions taken and the tax implications
Nonpublic entities have not been subjected to of how the organization operates. This level of
the requirements of Sarbanes-Oxley. Many understanding of the enterprise’s cumulative
nonpublic enterprises have also not historically portfolio of income tax risk will provide the
been applying the standards of FASB ASC 740- opportunity to align this portfolio with the
10. As a result, many nonpublic organizations overall enterprise risk management strategy.
are ill equipped with processes and controls to
ensure proper implementation and continuous
monitoring.
Certainty has been achieved…
Nonpublic enterprises will need to implement
new processes in order to remain up-to-date on
Now is the time to act.
tax legislation, court decisions, and other rulings
as well as develop mechanisms for those
responsible for the monitoring of uncertain tax Andrea Gronenthal is a Managing Director
positions to be knowledgeable about changes in in True Partners Consulting LLC’s Chicago
operation that may impact the evaluation. office and can be reached at
Andrea.Gronenthal@TPCtax.com or
(312)235-3328. Information about the Firm
Now that it is clear that the FASB will not be can be found at www.TPCtax.com
issuing any additional deferrals, nonpublic
This communication is for informational purposes only and is not intended to be an analysis or recommendation based on a
particular reader’s or entity’s specific facts and circumstances. True Partners Consulting LLC does not assume any responsibility
with respect to assessing or advising the reader as to tax, legal, or other consequences arising from the reader’s particular
situation. You should consult with your professional tax advisor to discuss the potential application of this subject matter to your
particular facts and circumstances. The information contained in this newsletter is based on our understanding of the current tax
laws and published tax authorities in effect as of the date of publishing, all of which are subject to change. True Partners
Consulting LLC assumes no obligation to update this newsletter for any future changes in tax law, regulations, or other
interpretations.
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8. ACCOUNTING FOR UNCERTAINTY
IN INCOME TAXES
We are required by regulation to inform you that any tax advice contained in this communication (or in any attachment) is not
intended or written to be used, and cannot be used by any taxpayer, for the purpose of: (i) avoiding U.S. federal, state, or local
tax penalties or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed in this
communication (or any attachment).
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