An unforgiving environment for tax questions.

Tax issues have been in the headlines of late. The President's Advisory Panel on Tax Reform issued its long-awaited report. The Financial Accounting Standards Board (FASB) has issued an Exposure Draft on Uncertain Tax Positions. The Justice Department continues to investigate questionable tax schemes.

Additionally, one of the themes that came out of the recent Sarbanes-Oxley 404 reports was the concern over the number of material weaknesses related to tax personnel. I take offense when I hear the term "lack of competent resources." Imagine managing a tax team that is well-educated and hard-working in a company that has stated it has a material weakness because it lacks "competent resources" in its tax department. What a great motivator that must be!

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Given the myriad of accounting pronouncements that relate to tax accounting and reporting--not to mention the complexity and length of the tax code itself--I am surprised that any company feels it has adequate personnel to have 100 percent confidence in the accuracy of the judgments it used in applying all of the complex laws, codes, rules and standards in potentially hundreds of jurisdictions.

Not to mention the fact that companies are generally managed differently than they are set up legally. I am not sure it is humanly possible to have adequate personnel to cover all of that, particularly in the unforgiving environment that we are in, where some of the highly publicized scandals have put tax issues in the spotlight.

We have a new mode of second-guessing. We have individual audit partners that are a bit skittish to make a judgment call, and understandably so. In order to ensure that lawsuits did not bring down another giant accounting firm, the Justice Department and KPMG entered into a deferred prosecution agreement related to KPMG's marketing of aggressive tax structures. Under this agreement, KPMG itself agreed to certain terms, for a period of time--but no such protection was afforded the individual partners.

I believe that this causes a natural behavior change in audit partners. They may be held individually responsible for their judgment calls, and their firm may not support them. As a result, we are seeing a shift to the most conservative answer with no real concept of materiality. It's called "self-preservation." Add to that the second-guessing by the Securities and Exchange Commission (SEC), the third-guessing by the Public Company Accounting Oversight Board (PCAOB) and the fourth-guessing by the plaintiff's bar. It is an unforgiving environment.

I am convinced that most everyone wants to do the right thing. Given all of the professional judgment in determining appropriate tax accruals and disclosures that are required every step of the way, and the level of second-guessing, determining what the right thing is becomes more difficult. Anyone looking at a company's financial statements with hindsight will find a restatement, especially if it's occurring three years after the fact, like many IRS audits will.

Is IRS Gaining Insight into Company's Position?

It is against this background that FASB issued its recent Exposure Draft on Uncertain Tax Positions, largely because regulators were concerned that companies were using tax accruals as an earnings management tool. Instead of addressing the internal control and governance issues associated with tax accruals, it seems to me that FASB was put into the position of incorporating governance into the accounting and reporting of tax accruals.

More work is proposed around the specific tax issues and positions that companies are taking, and whether they believe they will prevail under audit. Many concerns have been raised about whether this is competitive information, and if it basically supplies the IRS with the company's assessment of whether a particular tax position is aggressive or not.

A company is not currently required to disclose the specifics of technical weaknesses in defense of any litigation against it; only disclosure of the potential impact of such litigation is required. Tax law is complex and subject to interpretation, and positions taken by companies may be aggressive, but entirely supportable.

Companies really need to take a hard look at their tax disclosures. These should be reasonable, but not unduly burdensome. We should allow for professional judgment, and not expect absolute certainty. We need to think about the real concerns of investors, not the taxing authorities.

Does a tax provision adequately provide investors with the right information? Investors care about the effective rate and its relationship to the statutory rate, the cash taxes paid and the items that might impact that rate going forward. Do they want to know all of the intimate details of the tax provision and the tax code? I doubt it. It is important that we keep in mind the right balance among robust disclosure, transparency and relevance.