RSM Resources

In 2006, the Financial Accounting Standards Board substantially changed the way companies account for income taxes when it issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes. FIN 48, as it’s known, seeks to increase consistency in reporting income taxes by prescribing a more rigorous and methodical assessment of tax decisions than is currently required under FASB Statement No. 109, Accounting for Income Taxes. For public companies, FIN 48 is effective for fiscal years beginning after Dec. 15, 2006. Due to a recent change, privately held companies must comply with FIN 48 for fiscal years beginning after Dec. 15, 2007. 

Public companies got their first taste of FIN 48 compliance with quarterly 2007 filings,   but many privately held companies have work ahead of them to comply with FIN 48. Although not guided by SEC rules, many private companies are required by loan covenants to comply with generally accepted accounting principles, including FIN 48. Whether private or public,companies will see the impact of FIN 48 in a variety of ways.

Planning for FIN 48
After the FASB issued FIN 48, corporate tax departments began planning to comply with its requirements. Bulletins were read, meetings were held and staffing considerations were discussed. Resources normally spent on other corporate tax and accounting projects were transferred to FIN 48 projects. In addition to indirect costs such as these, corporate preparation for FIN 48 will generally require additional outside accounting, tax and legal services.     

Implementing FIN 48
Subsequent to all the planning, the real work of FIN 48 compliance begins. As many tax professionals already know, FIN 48 requires a two-step process for evaluating tax positions: recognition and measurement. First, companies must identify all uncertain federal, state and local, and foreign income tax positions — including decisions to not file returns — and determine whether these uncertain positions are “more likely than not” to be sustained if audited. When analyzing uncertain tax positions, companies must assume that taxing authorities have full knowledge of all relevant information. In other words, companies cannot consider audit risk when calculating tax reserves.  

If a tax position meets the first step, companies are required to measure the tax impact. Here, FIN 48 requires companies to determine the largest amount that is more than 50 percent likely to be realized on ultimate settlement of the position with the taxing authority, including penalties and interest. These positions must be calculated for all open years. Since some tax positions have long statutes of limitations(or no limitations), companies may need to extend their calculations back many years. From a practical standpoint, companies can expect to review their previous three to four years of tax returns and last six to 10 years of activity to measure their tax positions.

Once uncertain tax positions are recognized and measured, companies must book the cumulative change to retained earnings. Later changes are booked as increased reserves or reductions in deferred tax assets in the first interim period where the recognition threshold is met. Companies also need to document their FIN 48 due diligence for outside auditors.

Future impact of FIN 48
Companies will continue to see the economic impact of FIN 48 long after they initially comply. Complying with FIN 48 will require continuous monitoring and measuring of uncertain tax positions. For example, acquiring or selling companies or engaging in business in new jurisdictions may require FIN48-related changes to reserves or deferred assets under FIN 48. Also, since FIN48 requires companies to reserve for uncertain tax positions for all open tax years, periods that close under a jurisdiction’s statute of limitations will reduce tax liabilities.

Changes to balance sheet and income statement accounts may also affect the way company finances are viewed by outsiders. For example, FIN 48 accounting may impact financial ratios used by banks and investors. FIN 48 should also add more transparency to financial statements and reduce management’s ability to manage earnings through tax reserves.

Audit roadmap?
Perhaps the most controversial impact of FIN 48 is the federal, state and other tax authorities’ use of FIN 48 disclosures and workpaper details as a roadmap in a corporate audit. While the extent of such use is not yet known, concern has been raised and continues to be monitored. At the very least, a FIN 48reserve for a position reduces the strength of a company’s negotiating position with a taxing authority.

Plan now
FIN 48 is here. Companies will feel its impact when they plan for FIN 48 and comply with its requirements. They will likely see its impact on future transactions and operating decisions. There’s no quick fix for implementing FIN48, but companies that plan for it now will help limit its impact on their budgets.  

Joe Neff is national managing director of RSM McGladrey state and local tax practice and Sean Kelley is a manager in RSM McGladrey state and local tax practice. For more information, contact them at joe.neff@rsmi.com or sean.kelley@rsmi.com, respectively.