Regulations and rules governing income tax are among the most vexing issues with which American businesses must contend each year. And even seasoned accountants acknowledge that gray areas in the tax code make it difficult to determine the true amount corporations owe the government.
However, a recent Financial Accounting Standards Board communication, FASB Interpretation No. (FIN) 48, will make life a little easier for readers of financial statements by clarifying the potential tax liability that companies face. This guideline addresses tax reserves that business entities claim and requires them to acknowledge in the notes to their financial statements whether such positions will “more likely than not” be sustained upon a tax audit.
The interpretation follows the Sarbanes-Oxley Act passed by Congress in 2002, which is directed at improving the quality and transparency in financial reporting and independent audits.
“There was a lack of guidance on what constituted an uncertain tax position and how to present such a situation,” says John M. Wyson, corporate tax partner at Haskell & White LLP.
Smart Business spoke with Wyson about the impact the new interpretation will have on accountants and their clients.
What impact could FIN 48 have on consolidated financial statements?
This new guidance will create more consistency and comparability between reporting periods. Uncertain tax positions sometimes get a bad rap. It’s not necessarily that taxpayers are taking risky positions, it’s that the tax code is complex and sometimes convoluted and you (the preparer) may not know — and the IRS may not know with 100 percent certainty — what a tax position should be.
What this guidance does is ask companies to re-evaluate all of their tax positions (e.g. R&D credits, utilization of net operating losses, etc.) and apply a consistent ‘more-likely-than-not’ standard in determining whether to recognize such tax positions. That is, the firm must ask itself, ‘If the IRS audits this tax position, will it more likely than not hold up?’ The interpretation will affect quarterly statements as well as annual statements, as the evaluation of tax positions must be made in each reporting period.
Can a company consider broadly accepted conditions to determine that its tax position will more likely than not be sustained?
FIN 48 is fairly specific in this area. The rules now require the taxpayer to assume that every tax position will be scrutinized by tax authorities based on tax law (i.e. tax codes, supporting regulations, court cases and the like). Those positions deemed uncertain may need to be disclosed under the new rules.
How will this rule improve financial reporting?
More information will have to be broken out to achieve the goal of consistency and comparability among companies. For example, there will be new disclosures in the tax footnotes to financial statements. These include the total value of uncertain tax positions; any additions and deletions to those positions in the current reporting periods; and the disclosure of open tax years (the years during which a return is subject to audit because, per the statute of limitations, the tax authority could still assess additional tax liabilities on the taxpayer).
For most companies, the new rule will affect how their 2007 financial statements are prepared. Among other things, they must report whether they are being audited. Prior to this ruling, it was vague as to what information had to be disclosed.
Why is there so much diversity in interpreting the more-likely-than-not standard?
There was not enough guidance from either the FASB or the IRS on it. The phrase could be interpreted in different ways, and this ruling provides more guidance. It provides more specificity in what ‘more likely than not’ means and gets us closer to 100 percent clarity.
Does this new rule lay out an audit plan for the IRS to use against companies?
The FASB considered this and, in essence, said that its purpose is not to protect taxpayers against the IRS, but to protect readers of financial statements. This interpretation is not requiring you to lay out the details of every tax position. The FASB’s message is that if you are taking a tax position that is so risky you are worried about the IRS seeing it, you shouldn’t be taking it in the first place. In the end, the FASB wants companies to provide valuable and consistent information to readers of financial statements. These rules get us ever closer to that.
JOHN M. WYSON, CPA, is a corporate tax partner at Haskell & White LLP in Irvine. One of the largest independently owned accounting and business advisory firms in Orange County, Haskell & White provides a full complement of tax, accounting and auditing services to public and private middle-market companies. Reach Wyson at firstname.lastname@example.org or (949) 450-6200.