FIN 48 Will No Longer be Deferred for Private Companies

Candy Vaughn, Senior Manager – Assurance and Advisory Services

The Financial Accounting Standards Board (FASB) issued Financial Interpretation No. 48 "Accounting for Uncertainty in Income Taxes" (FIN 48) in 2006. FIN 48 was effective immediately for public companies, while adoption and implementation for non-public entities is effective for fiscal years beginning after December 15, 2008.

This interpretation applies to all U.S. GAAP financial statements and provides a definitive, comprehensive accounting model with prescriptive disclosure requirements related to income tax uncertainties. The adoption of FIN 48 will likely result in the need for changes to your accounting policies, financial statement disclosures, data gathering processes, and internal controls. FIN 48 could also impact existing corporate tax planning and management processes.

What is FIN 48?

FIN 48 is an interpretation of Financial Accounting Standard (FAS) No. 109 "Accounting for Income Taxes" (FAS 109). Under FAS 109, companies are required to reconcile their income tax reporting to their accrual-based financial statements by recording deferred income tax assets or liabilities based on the estimated future tax effects of temporary timing difference. One of the perceived shortcomings of FAS 109 was that it lacked specific guidance on income tax-related uncertainties, which could ultimately result in a potential future obligation of the company (for example, a disallowed tax position in an income tax return).

Because there was no specific guidance, the majority of public companies accounted for these uncertainties in accordance with FAS 5 "Accounting for Contingencies" and recorded a general accrual for potential obligations associated with income tax filings based on their historical results and experiences of tax jurisdiction examinations. Most private entities concluded that all tax positions would be allowed and therefore there was no contingent liability. The main difference in this approach between public and private entities is that public companies assumed they will be audited and certain positions would be ultimately disallowed, while private companies assumed the chance of audit was remote and that all positions would stand due to lack of scrutiny. As you might imagine, without specific guidance on this issue, each company could decide what constituted a contingent liability, which lead to disparity in practice and inconsistent reporting of income taxes for financial statement purposes. FIN 48 is intended to address this issue by increasing both the relevance and consistency of income tax reporting in the financial statements.

How does this impact my financial reporting?

The impact on financial reporting will vary by entity and will either be (1) the recognition of a liability described as an "unrecognized tax benefit" (UTB); (2) the reduction of a deferred tax asset, if one has been recognized on the balance sheet; or (3) additional disclosure requirements for all entities, even those with a full valuation reserve or no UTBs. Each private entity will be required to take the following steps upon adoption of FIN 48:

• - Update the company's income tax accounting policy for FIN 48 adoption
• - Possibly update the company's significant estimates policy
• - Include the following in the Income Tax Footnote:
  • UTB recognized in the financial statements
  • Expected significant changes to UTB's within 12 months of the reporting date
  • Description of tax years that remain subject to examination by major tax jurisdictions
  • Policy on classification of interest and penalties
  • Cumulative effect of the change in retained earnings as of the date of adoption (1st year only disclosure requirement)

How do I determine my Unrecognized Tax Benefit?

A FIN 48 analysis is a two-step process; the first step being recognition and the second step measurement.

Recognition: Companies must review income tax returns still open to examination (in other words, those for which the statute of limitations has not expired) and identify and document all tax positions taken within the returns. Income tax returns include those that have been filed or that should have been filed with local, state, federal, and foreign taxing authorities. A tax position refers to a position taken in a previously filed income tax return or a position expected to be taken in a future tax return that is reflected in measuring current or deferred income tax assets or liabilities.

For each tax position identified, companies must determine whether or not a tax position will be sustained upon examination by the relevant taxing authority. Companies must assume that open income tax returns will be examined. In assessing the sustainability of each identified tax position the company should apply the "More Likely than Not" (MLTN) threshold, as defined in FIN 48. Each identified tax position should be categorized into one of the following categories:

• Highly certain position
• Positions meeting the MLTN threshold
• Positions NOT meeting the MLTN threshold

• Highly certain positions require no additional analysis. One hundred percent of their benefit has already been recognized in the financial statements through the application of FAS 109.
• Positions meeting the MLTN threshold are further analyzed in the measurement step, as described below.
• Positions NOT meeting the MLTN threshold should be fully recognized as a UTB in the financial statements. This would be captured in the measurement step, but no additional analysis is required.

Measurement: Once all uncertain tax positions meeting the MLTN threshold have been identified, the expected UTB is measured by estimating the probable outcomes that could be realized upon settlement. All UTB's would then be recognized in the financial statements based on their future tax effect.

This analysis will need to be performed on an on-going basis and updated for subsequent recognition, derecognition, and measurement. Additionally, if application of FIN 48 results in an underpayment of taxes, interest and penalties must be accrued based on management's best estimate of the amount ultimately to be paid.

How do I get started?

Download FIN 48 Will No Longer be Deferred for Private Companies - September 14, 2009 Article