United States: Implementation Of FIN 48: New Financial Accounting For Income Taxes

For the first time, in FASB Interpretation Number 48, Accounting for Uncertainty in Income Taxes, the Financial Accounting Standards Board has prescribed specific rules governing financial accounting for uncertain income tax positions. As discussed below, FIN 48 requires public and private companies issuing financial statements in accordance with GAAP in fiscal years beginning after December 15, 2006 to evaluate the merits of their tax positions under the law. These critical decisions are legal determinations that would benefit greatly from the judgment and experience that Foley & Lardner LLP tax lawyers can provide.

Historically, under the general GAAP standard for income taxes, FASB Statement No. 109, Accounting for Income Taxes, many companies generally prepared their financial statement tax accounts based on their income tax returns as filed. These companies used various methods to reflect the possibility that additional tax may be assessed on audit and established reserves for any additional tax liability deemed "probable" under the standard in FASB Statement No. 5, Accounting for Contingencies.

Under FIN 48, a company cannot recognize the tax benefit from an uncertain tax position in its financial statements unless the company concludes that it is more likely than not the benefit will be sustained on audit, on the resolution of any related appeals, or in litigation. A company must make this judgment based solely on an analysis of the applicable legal authorities, including statutes, regulations, legislative history, rulings, and case law; it may not take into account (i) the probability that the company will not face a tax audit, (ii) if audited, the probability a tax auditor will not challenge the benefit, or (iii) the probability that issues can be "traded." If this "more likely than not" standard is met, then the tax benefit the company recognizes in its financial statements is the largest amount of the tax benefit that, in the company’s judgment, is greater than 50% likely of being realized in a settlement with the taxing authorities.

Where there is an amount of a tax benefit that a company cannot recognize in its financial statements, its balance sheet will reflect a corresponding liability or an adjustment to a deferred tax asset relating to the uncertain tax position. A company must also accrue interest and, if applicable, penalties associated with the uncertain tax position. A company must monitor its tax positions and adjust the amounts of tax benefits it has recognized as warranted by new developments, such as a change in law or settlement of an issue with the IRS. FIN 48 also requires disclosures in the financial statement footnotes, including the aggregate amount of, and changes in, unrecognized tax benefits.

FIN 48 requires a company using GAAP to review all of its prior tax positions that are uncertain as of the first day of the year in which the company adopts FIN 48 (as of January 1, 2007, for calendar year companies) and apply FIN 48 to each of them. To the extent FIN 48 causes a different accounting treatment, there will be a corresponding adjustment to the company’s retained earnings, rather than an adjustment to the company’s current income tax expense and net income.

The manner in which companies respond to and adopt FIN 48 is expected to vary depending on companies’ particular circumstances. FIN 48 could lead to fundamental changes in basic tax reporting systems and processes. FIN 48 may also influence companies’ policies and procedures concerning taking uncertain positions on their tax returns.

For SEC companies, FIN 48 raises a number of SEC disclosure issues, including the need for immediate disclosure of the likely effects of adoption of FIN 48, new or revised disclosure regarding accounting for taxes in the critical accounting policies and estimates sections, ongoing disclosures relating to unrecognized tax benefits, and analysis of internal control over financial reporting and disclosure controls and procedures.

Foley & Lardner LLP can assist a company with the implementation of FIN 48 in a number of areas. The determination of whether a position meets the "more likely than not" standard and the measurement of the settlement value at the more-than- 50% level are legal judgments that would benefit from legal training and from our many years of experience in the handling of federal and state tax controversies. We can provide legal opinions that support management determinations and provide comfort to a company’s financial statement auditors and audit committees. The analysis underlying these determinations may be a roadmap for tax authorities, and the use of attorneys in the analysis may help to minimize the extent or availability of materials relating to the analysis because of the attorney-client privilege.

As noted above, FIN 48 will trigger new or revised disclosures relating to the adoption of FIN 48, critical accounting policies and estimates, and unrecognized tax benefits, among others. These disclosures can be especially sensitive due to confidential nature of the tax positions. Our securities compliance attorneys, together with our tax attorneys, can advise on what is needed and how best to accomplish them.

Finally, a company needs to consider whether it should take any tax action in contemplation of public disclosure of uncertain tax positions (and preparation of underlying analysis that tax authorities may access), such as filing for changes in accounting methods. Another possible strategy is to submit an issue to the Internal Revenue Service under its new program for Expedited Resolution of Uncertain Tax Positions – LMSB Initiative to Address Certain Implications of FIN 48. Our attorneys can counsel a company on whether using this approach is appropriate and, if so, assist in shepherding the request through the Internal Revenue Service.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.