FIN 48 compliance: disclosing tax positions in an age of uncertainty.EXECUTIVE SUMMARY
* The interaction of FAS 109 and FIN fin, organ of locomotion characteristic of fish and consisting of thin tissue supported by cartilaginous or bony rays. In some fish, e.g., the eel, a single fin extends from the back, around the tail, and along the ventral surface. 48 will result in greater public disclosure of tax planning Tax planning
Devising strategies throughout the year in order to minimize tax liability, for example, by choosing a tax filing status that is most beneficial to the taxpayer. techniques.
* Under FIN 48, a tax position is recorded only if the tax position is more likely than not to be sustained on examination (including related appeals or litigation An action brought in court to enforce a particular right. The act or process of bringing a lawsuit in and of itself; a judicial contest; any dispute.
When a person begins a civil lawsuit, the person enters into a process called litigation. processes).
* A material tax position is tested under a two-step process consisting of a recognition step and a measurement step.
* FIN 48 requires a reevaluation Noun 1. reevaluation - the evaluation of something a second time (or more)
rating, valuation, evaluation - an appraisal of the value of something; "he set a high valuation on friendship" of all tax positions at the end of each reporting period. Prior recognized positions may be derecognized or remeasured, and prior positions may be recognized in each reevaluation.
FIN 48 changes the way that much of the tax profession carries out its work, and it presents a number of difficulties in crafting disclosures of tax-related expenses, assets, and liabilities on U.S. financial statements. This article discusses the challenges involved with FIN 48 compliance and presents a comprehensive case study to illustrate the likely application of FIN 48 principles and their interaction with the new Schedule M-3 reporting requirements.
For financial statements prepared under U.S. generally accepted accounting principles The standard accounting rules, regulations, and procedures used by companies in maintaining their financial records.
Generally accepted accounting principles (GAAP) provide companies and accountants with a consistent set of guidelines that cover both broad accounting (GAAP GAAP
See: Generally Accepted Accounting Principles
See generally accepted accounting principles (GAAP). ), the tax effects of the entity's operations have been governed gov·ern
v. gov·erned, gov·ern·ing, gov·erns
1. To make and administer the public policy and affairs of; exercise sovereign authority in.
2. by Statement of Financial Accounting Standards (FAS) No. 5, Accounting for Contingencies Contingencies (ISSN 1048-9851) is the bimonthly magazine of the American Academy of Actuaries, providing a large and diverse readership with general interest and technical articles on a wide range of issues related to the actuarial profession. , and FAS No. 109, Accounting for Income Taxes. (1) Financial Accounting Standards Board Financial Accounting Standards Board (FASB)
Board composed of independent members who create and interpret Generally Accepted Accounting Principles (GAAP). (FASB FASB
See: Financial Accounting Standards Board
See Financial Accounting Standards Board (FASB). ) Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxes, a new interpretation of FAS No. 109 and APB APB
See Accounting Principles Board (APB). No. 28 issued in July July: see month. 2006, is effective for accounting years beginning after December December: see month. 15, 2006. (2) This interpretation presents new challenges for taxpayers, auditors AUDITORS, practice. Persons lawfully appointed to examine and digest accounts referred to them, take down the evidence in writing, which may be lawfully offered in relation to such accounts, and prepare materials on which a decree or judgment may be made; and to report the whole, together , and tax advisers. The disclosures required by the interaction of FAS 109 and FIN 48 will result in greater public disclosure of tax planning techniques, including the strengths and weaknesses of those techniques. (3)
FIN 48 is a response to the perceived public desire for greater transparency (1) The quality of being able to see through a material. The terms transparency and translucency are often used synonymously; however, transparent would technically mean "seeing through clear glass," while translucent would mean "seeing through frosted glass." See alpha blending. of financial data and is in part a result of the abusive Tending to deceive; practicing abuse; prone to ill-treat by coarse, insulting words or harmful acts. Using ill treatment; injurious, improper, hurtful, offensive, reproachful. tax-shelter activities of the 1990s and the financial accounting scandals Accounting scandals, or corporate accounting scandals are political and business scandals which arise with the disclosure of misdeeds by trusted executives of large public corporations. of the early 2000s. (4) Questions arose regarding potential manipulation of reported earnings, including managing the effective tax rate reported in financial statements. (5) Furthermore, a large number of the material weaknesses and significant deficiencies initially reported under Sarbanes--Oxley were traceable to the construct of the entity's income tax expense. In the tax realm, regulatory responses to the perceived desire for greater financial transparency led to new Schedule M-3 reporting requirements for corporations and passthrough entities, (6) which require book-tax differences to be disclosed in two columns, one for temporary differences and one for permanent differences. Items disclosed in the temporary column should agree with items used to compute To perform mathematical operations or general computer processing. For an explanation of "The 3 C's," or how the computer processes data, see computer. deferred tax assets and liabilities under FAS 109, while permanent differences should agree with items used to compute the effective tax rate.
Implementation of FIN 48 "lifts the veil" regarding tax strategies to an extent that may not be appropriate or healthy in the context of an adversarial ad·ver·sar·i·al
Relating to or characteristic of an adversary; involving antagonistic elements: "the chasm between management and labor in this country, an often needlessly adversarial . . . , voluntary-compliance tax system.
Current tax planning strategies include:
* Establishing a set of financial goals;
* Developing a tax strategy as part of overall financial goals;
* Planning and executing a series of transactions aimed at managing tax liability;
* Reporting the results of the transactions on financial statements and tax returns;
* Separately subjecting these reports to review by financial and tax auditors;
* Justifying tax positions and, when necessary, revising financial reporting if required through SEC restatements; and
* Adjusting the tax liability after settlement of a tax issue through negotiation and (perhaps) litigation.
Final resolution of a transaction's appropriate accounting and tax reporting does not occur until long after the financial statements and tax returns have been prepared. In addition, the tax expense reported in the financial statements and the tax return may differ, requiring "true-up" adjustments after the tax return is filed. An entity cannot be certain as to the final reporting of certain transactions until an IRS An abbreviation for the Internal Revenue Service, a federal agency charged with the responsibility of administering and enforcing internal revenue laws. audit is completed and any necessary adjustments are made. Thus, decisions regarding computation Computation is a general term for any type of information processing that can be represented mathematically. This includes phenomena ranging from simple calculations to human thinking. of the financial tax expense necessarily require the exercise of professional judgment regarding:
* Whether a tax return must be filed in various jurisdictions;
* How to claim and compute various income, deduction deduction, in logic, form of inference such that the conclusion must be true if the premises are true. For example, if we know that all men have two legs and that John is a man, it is then logical to deduce that John has two legs. , and credit items;
* Whether the entity's status as an S corporation, controlled foreign corporation Controlled foreign corporation (CFC)
A foreign corporation whose voting stock is more than 50% owned by US stockholders, each of whom owns at least 10% of the voting power. , or exempt organization has been maintained during the reporting year; and
* Whether IRS personnel and the courts will take exception to the taxpayer's tax return positions.
The financial accounting expense for income and other taxes can be both sizable siz·a·ble also size·a·ble
Of considerable size; fairly large.
siza·ble·ness n. and material on the financial statements and is likely one of the last accruals Accruals
Accounts on a balance sheet that represent liabilities and non-cash-based assets used in accrual-based accounting. These accounts include, among many others, accounts payable, accounts receivable, goodwill, future tax liability and future interest expense. made when computing computing - computer net income for the period. Before FIN 48 was issued, a taxpayer's required disclosure of the tax expense computation for the year was limited to a series of footnote Text that appears at the bottom of a page that adds explanation. It is often used to give credit to the source of information. When accumulated and printed at the end of a document, they are called "endnotes." discussions on the choice of tax accounting methods, policies, and various effective tax rates for the reporting year. The tax footnote discussed current-year settlements of tax audits, anticipated results of ongoing audits, and the potential expiration EXPIRATION. Cessation; end. As, the expiration of, a lease, of a contract, or statute.
2. In general, the expiration of a contract puts an end to all the engagements of the parties, except to those which arise from the non- fulfillment of obligations created of any net operating loss operating loss
The excess of operating expenses over revenue. As with operating income, operating losses exclude revenues and expenses from operations that are not considered a regular part of the business. Also called deficit. Compare operating income. (NOL NOL - Never Offline ), capital loss, and tax credit carryforwards Carryforwards
Tax losses allowed to be applied to offset future income in some specified number of future years. .
The IRS could subpoena subpoena (səpē`nə) [Lat.,=under penalty], in law, an order to a witness to appear before a court. A subpoena ad testificandum [Lat. the entity's tax accrual accrual,
n continually recurring short-term liabilities. Examples are accrued wages, taxes, and interest. workpapers, which likely include a listing of and computational Having to do with calculations. Something that is "highly computational" requires a large number of calculations. projections for tax minimization techniques considered and applied in the tax year, as well as computational assumptions and conventions used to determine the current and deferred tax expense. In a welcome spirit of "playing fair" with its adversary adversary
traditional appellation of Satan [O.T.: Job 1:6; N.T.: I Peter 5:8]
See : Devil the taxpayer, the IRS has shown restraint in obtaining tax accrual workpapers by rarely using its subpoena power. (7) The IRS recently announced that documents produced by a taxpayer or its auditors to substantiate To establish the existence or truth of a particular fact through the use of competent evidence; to verify.
For example, an Eyewitness might be called by a party to a lawsuit to substantiate that party's testimony. the taxpayer's uncertain tax position in compliance with FIN 48 are considered tax accrual workpapers and will be subject to its current policy of restraint. (8) However, the IRS chief counsel reached the opposite conclusion regarding effective tax rate reconciliation workpapers because permanent timing differences between the statutory tax rate and the effective tax rate must be reported in the Schedule M-3. (9)
The Senate's Permanent Subcommittee sub·com·mit·tee
A subordinate committee composed of members appointed from a main committee.
Noun on Investigations, chaired by Senator Carl Levin Carl Milton Levin (born June 28, 1934) is a Democratic United States Senator from Michigan and is the Chairman of the Senate Committee on Armed Services. He has been in the Senate since 1979 and Michigan's senior senator since 1995. , sent a letter to at least 30 companies, asking for details on unrecognized tax benefits reported under FIN 48, as part of its investigation into corporate tax-cutting transactions. (10)
The application of FIN 48 greatly extends the amount and type of public disclosures by GAAP taxpayers. (11) This may affect the likelihood that a tax position will be challenged in an IRS audit, especially if additional disclosures reveal the strengths and weaknesses of positions taken on the tax return. (12) It is not an exaggeration Exaggeration
legendary giant, hero of tall tales of the logging camps. [Am. Folklore: The Wonderful Adventures of Paul Bunyon]
trivial cause of a great quarrel. [Br. Hist. to state that the scope of FIN 48's effects on the financial reporting and tax communities is the most extensive in memory.
FIN 48 Disclosures
When a taxpayer applies an exclusion, exemption, or credit to an item included in financial accounting income, FAS 109 accounts for the current tax reduction as a permanent difference from book income, which reduces the entity's effective income tax rate reported in the financial statement footnotes. Permanent differences affect the computation and disclosure of the current federal, state/local, and international effective tax rates. Temporary differences give rise to either a deferred tax liability or a deferred tax asset. When a deduction is accelerated or income is deferred from that allowed for financial accounting purposes, a deferred tax liability is created and reported on the balance sheet. When a deduction is deferred or income is accelerated from that recorded in the books, a deferred tax asset is created.
For every accounting year, the financial statements record changes in the entity's deferred tax assets or liabilities that are traceable to temporary differences between book and taxable income Under the federal tax law, gross income reduced by adjustments and allowable deductions. It is the income against which tax rates are applied to compute an individual or entity's tax liability. The essence of taxable income is the accrual of some gain, profit, or benefit to a taxpayer. . Using FAS 109 terminology, the taxpayer likely prefers to create permanent tax differences so as to reduce the effective tax rate for the period and uses temporary differences to create and increase the deferred tax liability, because tax reductions improve the entity's cash-flow for the current reporting period.
Legitimate tax planning strategies include taking one or more tax return positions with which the IRS might disagree, potentially resulting in an audit adjustment and settlement through the appeals process or litigation. Entity tax departments and their tax advisers work to manage the tax liability in this way, taking supportable but taxpayer-friendly return positions and managing the risk of taking such positions in an appropriate manner. For financial accounting purposes, though, how does one account for these tax uncertainties? Should the tax return position be assumed to be fully correct such that the effective tax rate is reduced or the deferred tax benefit is recorded ha full in the current financial reporting period?
The basic rule of FAS 109 assumes that deferred tax benefits eventually will be fully realized. (13) For those items with some uncertainty as to their future realization, a valuation allowance is used to "write down" the deferred tax asset to an amount that more likely than not will be realized. Creation and maintenance of the valuation allowance entails the use of professional judgment by the tax adviser and the financial accountant to forecast the book and tax flow of future income and expense over time. To prepare for a possible audit of the valuation allowance, the entity must document the assumptions and decisions used. Before applying a valuation allowance analysis, FIN 48 requires the taxpayer first to assess the likelihood that its tax position will be sustained on review by the tax authorities. After making this determination, a valuation allowance may be recorded to address the realizability Realizability is a part of proof theory which can be used to handle information about formulas instead of about the proofs of formulas. A natural number n is said to realize a statement in the language of arithmetic of natural numbers. of the tax benefits with further computations and disclosures required in the financial statements to indicate the effects of the tax positions taken.
For example, in the case of a NOL carryforward carryforward
1. A business operating loss that, for tax purposes, may be claimed a certain number of years in the future, often up to 15 years. , if there are no uncertain tax positions regarding its computation, under FAS 109 a forecast of future revenues is made to determine if sufficient taxable income will be generated to absorb the carryforward. Likewise, even if there are no uncertain tax positions regarding the computation of a foreign tax credit carryforward, a projection of future foreign-source income Foreign-source income
Income earned from international operations. must be nude to project whether the credit actually will be used on future tax returns. The FIN 48 process is used to ensure that a tax-related asset or liability actually exists at the date the financial statements are prepared and that the tax position will be sustained on review by the tax authorities.
Before FIN 48, FAS 5 stated that a contingent tax liability was reported in the financial statements if the future event or events on which the contingency contingency n. an event that might not occur. was based were "probable" (i.e., likely to occur). Most observers believed that the probable standard required a 75% or higher probability of occurrence for an item to be recorded in the financial statements. (14) The new FIN 48 requirements override An arrangement whereby commissions are made by sales managers based upon the sales made by their subordinate sales representatives. A term found in an agreement between a real estate agent and a property owner whereby the agent keeps the right to receive a commission for the sale of many of the FAS 5 rules. The most critical of the FIN 48 requirements is the required disclosure of material financial statement effects attributable to positions taken on federal, state/local, and international income tax returns for both permanent and temporary differences between book and taxable income. A deferred tax asset or liability is recorded only if the tax position is more likely than not to be sustained on examination (including the resolution or related appeals or litigation processes). This represents a refinement and extension of the existing FAS 109 rules.
When FIN 48 applies, "uncertain" tax positions are defined as those material items not fully certain by the taxpayer to be sustainable on a later review based on their technical merits. A tax position is defined as a position on a previously filed 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 and liabilities for interim or annual periods. A tax position can result in a permanent reduction of income taxes payable, a deferral deferral - Waiting for quiet on the Ethernet. of income taxes otherwise currently payable to future years, or a change in the expected realizability of a deferred tax asset. (15) Under FIN 48, a tax benefit is included in the financial statements when:
* It is determined that it is more likely than not that a tax return position resulting in the benefit can be sustained on its technical merits, or
* A tax benefit or liability has been effectively settled by the completion of an audit, a negotiated settlement, or the issuance of a court derision. (16)
The appropriate unit of account for a tax position is a matter of judgment and requires consideration of how the enterprise prepares its income tax return and the approach that the enterprise anticipates the taxing authority will take during an examination. (17)
When FIN 48 applies, the taxpayer must disclose each of the following:
* The total unrecognized tax benefits measured at both the beginning and the end of the reporting year. The ending balance then "rolls forward" and becomes the beginning balance for the subsequent year.
* A projection in some detail regarding how the unrecognized tax benefits are expected to change over the next 12 months, including the nature of each of the uncertain tax positions, estimated dollar amounts, and the conditions under which a change in the tax benefits would occur.
* The impact on the effective tax rate of disclosed unrealized tax benefits.
* A listing of any "open" tax years under applicable statutes of limitation and by major taxing jurisdictions.
* A description of the financial accounting policies on the treatment of applicable accrued interest Accrued Interest
The interest that has accumulated on a bond since the last interest payment up to but not including the settlement date.
There are two methods for calculating accrued interest:
1) 360-day year method, used for corporate and municipal bonds. and penalties and their amounts.
Recognition and Measurement
For every material tax position that relates to the current financial statements, the taxpayer must answer the following questions:
The recognition step: Is it more likely than not (a greater than 50% probability) that the position would be sustained on its technical merits after a review by the tax authorities, including the appeal process? (18) The MLTN MLTN Maine Land Trust Network (Topsham, ME) standard is a lower threshold than the probable standard of FAS 5 but is higher than the substantial authority test required for disclosing a tax position taken on a tax return. (19)
The measurement step: If so, what is the largest tax benefit that the taxpayer more likely than not will realize as a result of that review?
Both the recognition step and the measurement step must be applied to each uncertain tax position. A position that meets the MLTN threshold is initially and subsequently measured as the largest amount of tax benefit that is more likely than not to be realized on settlement with a taxing authority that has full knowledge of all relevant information.
No determination is to be made by the taxpayer as to the likelihood of an audit per se; the taxpayer should act as though the uncertain position will be audited by the appropriate taxing authority. The MLTN standard entails a presumed lack or rejection of the return position were the item reviewed by the highest level of judicial review in the appropriate jurisdiction. It also presumes that all members of the tax community, including government personnel, possess high-level skills in tax research and analysis. Such skills include the ability to find pertinent PERTINENT, evidence. Those facts which tend to prove the allegations of the party offering them, are called pertinent; those which have no such tendency are called impertinent, 8 Toull. n. 22. By pertinent is also meant that which belongs. Willes, 319. hw and resolve differences when various tax hw sources are in conflict.
Because a high-level judicial review of the tax law is a rare occurrence, the most sophisticated types of professional judgment are required to make legal evaluations of this sort. injecting assessments such as these into the process of financial statement disclosure and into the initial decisions on how to construct a transaction and report it on the tax return brings inordinate complexity to the annual tax compliance and financial accounting cycle. (20) In effect, broad-based broad-based
Of or relating to an index or average that provides a good representation of the overall market. The S&P 500 and NYSE Composite are generally regarded as broad-based stock indexes, while the popular Dow Jones Industrial Average is biased estimates of future tax benefits and establishment of tax-payment cushions are things of the past under FIN 48. (21)
Mechanically, an application of the measurement process can be depicted de·pict
tr.v. de·pict·ed, de·pict·ing, de·picts
1. To represent in a picture or sculpture.
2. To represent in words; describe. See Synonyms at represent. in the following procedure suggested (but not required) by FIN 48. A comparable analysis must be made for every FIN 48 uncertain tax position.
Example: Assume that a NOL carryforward has a deferred tax benefit of $100. Based on the probability distribution Probability distribution
A function that describes all the values a random variable can take and the probability associated with each. Also called a probability function.
probability distribution derived by tax and accounting professionals (Exhibit 1, above), the financial statements would reflect a $40 deferred tax asset. It is more likely than not that a tax benefit of at least that amount would be realized on settlement because the cumulative probability first exceeds 51)% at the point of the $40 outcome (in this case, an 85 % cumulative probability).
The financial accounting disclosure of an uncertain tax position is made in the first annual or interim report for which the MLTN threshold is met and must be reevaluated in each reporting period, taking into account tax law, settlement, and attitudinal changes occurring throughout the reporting period. Changes in the probability assessments also should reflect changes in the taxpayer's filing status, carryover carryover n. in taxation accounting, using a tax year's deductions, business losses or credits to apply to the following year's tax return to reduce the tax liability. (See: carryback) amounts, and expiration of statutes of limitation. Substantive changes are reflected by revising projected outcomes of the uncertain items and the likelihood of their being sustained after a technical review, not by changes to valuation allowances. Continuing with the example:
* The issuance of a court case unfavorable to the taxpayer's position might reduce the anticipated reported benefit to $0.
* Adoption of a more favorable fa·vor·a·ble
1. Advantageous; helpful: favorable winds.
2. Encouraging; propitious: a favorable diagnosis.
3. attitude of negotiating settlements by the IRS might permit an increase in the probabilities of the $60 and $100 outcomes, thereby permitting restoration of the deferred tax asset to its original amount.
Computing Tax Expense and Liability Before FIN 48
A detailed discussion of the tax accrual both pre- pre- word element [L.], before (in time or space).
1. Earlier; before; prior to: prenatal.
2. and post-FIN 48 is based on the facts in the case study in Exhibit 2 (p. 28).
Before the release of FIN 48, Quasar Company would have applied the principles of FAS 109 in computing its financial income tax expense and tax payable. It would have applied FAS 5 to the three uncertain tax positions, items 5, 7, and 8. As explained below, item 6, the capital loss, is not an uncertain tax position but does require a valuation allowance because of the uncertainty of being able to use the loss within the carryforward period.
In applying FAS 5 to its uncertain tax positions, the firm likely would have carved carve
v. carved, carv·ing, carves
a. To divide into pieces by cutting; slice: carved a roast.
b. out as contingent liabilities Contingent Liability
1. The possibility of an obligation to pay certain sums dependent on future events.
2. Defined obligations by a company that must be met, but the probability of payment is minimal.
1. only those aggressive tax positions involving material audit risk. Such a tax cushion Cushion
In the context of project financing, the extra amount of net cash flow remaining after expected debt service.
See call protection. provided for the possibility of IRS disallowance dis·al·low
tr.v. dis·al·lowed, dis·al·low·ing, dis·al·lows
1. To refuse to allow: "[The government] of the items in question. Because FAS 109 offered little guidance as to which tax effects of its positions should be recognized in financial statements and in what amounts, most companies simply assumed that the current and projected tax filings could be taken at face value by reporting 100% of the tax benefits. If it is probable that the tax positions are sustainable on audit, there is no accrual for a contingent tax liability under FAS 5. For this example, the FAS 109 process will be separated into two steps. In step 1, book-tax differences and the financial tax expense are computed (Exhibit 3, above).
In step 2, Quasar records a valuation allowance. After considering ,all available evidence, Quasar concludes it is more likely than not that the expected value Expected value
The weighted average of a probability distribution. Also known as the mean value. of the capital loss carryforward Loss Carryforward
An accounting technique with which a company applies net operating losses of the current year to future year's profits in order to reduce tax liability.
Notes: is only $8,250 (55% of the total available carryforward) due to the uncertainty of projected future capital gain income. Thus, a valuation account of $2,295 must be created ($15,000 x .45 x .34), which in turn increases the net financial tax expense.
Combining these two steps, the net financial tax expense is $2,176,255 ($2,173,960 + $2,295). The journal entry to record the tax accrual is in Exhibit 4, above. (22)
Computing Tax Expense and Liability Under FIN 48
The FIN 48 two-step process, applicable for tax years ending fleer fleer
intr.v. fleered, fleer·ing, fleers
To smirk or laugh in contempt or derision.
A taunting, scoffing, or derisive look or gibe. December 15, 2006, is best illustrated by revisiting the facts of the case study (Exhibit 2, p. 28). Note that FIN 48 applies to all tax positions, not just a subset A group of commands or functions that do not include all the capabilities of the original specification. Software or hardware components designed for the subset will also work with the original. of positions called uncertain tax positions. (23) The case study assumes no prior-year tax accruals or open tax positions. Otherwise the cumulative effect of applying FIN 48 to those items would be reported as an adjustment to the opening balance of retained earnings Retained Earnings
The percentage of net earnings not paid out in dividends, but retained by the company to be reinvested in its core business or to pay debt. It is recorded under shareholders equity on the balance sheet. . It is assumed that management documents its determination that the MLTN test is met by computing the expected value of the tax position's probable tax outcomes. Although not specifically required by FIN 48, an expected-value approach considers all probable outcomes and is consistent with other financial accounting rules. (24)
It is important to note that the expected-value approach illustrated in applying the case study's MLTN test is not required under FIN 48. In performing this test, FIN 48 clearly states that it is a matter of judgment and that the enterprise should consider the facts, circumstances CIRCUMSTANCES, evidence. The particulars which accompany a fact.
2. The facts proved are either possible or impossible, ordinary and probable, or extraordinary and improbable, recent or ancient; they may have happened near us, or afar off; they are public or , and information available at the reporting date. The largest tax benefit that is more likely than not to be realized on ultimate settlement with the taxing authority could be determined by taking into account the company's willingness to settle the issue at various levels. (25) The case study's expected-value computation is simply a tool that may assist the enterprise in making that judgment.
Applying FIN 48's Two-Step Process to Highly Certain Tax Positions
FIN 48 offers illustrative il·lus·tra·tive
Acting or serving as an illustration.
Adj. 1. guidance for addressing the issue of a highly certain tax position on a potential deduction, i.e., where a taxpayer believes that a tax position is based on clear and unambiguous tax law and the amount is therefore clearly deductible That which may be taken away or subtracted. In taxation, an item that may be subtracted from gross income or adjusted gross income in determining taxable income (e.g., interest expenses, charitable contributions, certain taxes). . (26) In such a case, the taxpayer could "recognize the flail amount of the tax position in the financial statements."(27) This statement has been interpreted as implying that highly certain tax positions use an application recognition matrix and a measurement matrix with only two possible outcomes: a 0% chance of $0 deducted de·duct
v. de·duct·ed, de·duct·ing, de·ducts
1. To take away (a quantity) from another; subtract.
2. To derive by deduction; deduce.
v.intr. and a 100% chance of the full amount being deducted. See Exhibit 5 for the matrix for the $60,000 domestic production activities deduction under Sec. 199.
The recognition test indicates that the tax position meets the MLTN standard, so the position is recognized. The measurement test indicates that the benefit of the tax position is $20,400 ($60,000 x 34%),the first potential outcome in the measurement matrix where the cumulative probability exceeds 50%. A similar analysis is applied to Quasar's other highly certain tax positions, namely, the $5,000 bad debt expense, the $6,000 meals and entertainment expense Meals and entertainment expense
A tax deduction allowed for meals and entertainment expenses incurred in the course of business. , and the $15,000 capital loss. These transactions are reported on Schedule M-3, part II, lines 23a, 23c, and 24, and part III, tines 11,22, and 32 (see appendix). (28)
Note that the capital loss and bad debt deductions are temporary differences reported in column (b), while the meal and entertainment deduction Noun 1. entertainment deduction - deduction allowed for some (limited) kinds of entertainment for business purposes
business deduction - tax write-off for expenses of doing business and domestic production activities deduction are permanent differences reported in column (c).
Applying FIN 48's Two-Step Process to Uncertain Tax Positions
The two-step process as applied to each of the uncertain tax positions is examined separately, with different probability distributions Many probability distributions are so important in theory or applications that they have been given specific names. Discrete distributions
With finite support
Partnership loss--Transaction 5: The tax position on the partnership loss qualifies for recognition because it is more likely than not that the position will be realized on settlement with a taxing authority. Based on the technical merits of the issue, management developed a probability distribution of possible outcomes (see Exhibit 6, p. 30).While not required by FIN 48, the 61% expected-value probability supports management's assertion that the MLTN test has been met based on its technical merits.
Under FIN 48, the maximum tax benefit is $20,400, the first amount of benefit having a greater-than-50% likelihood of being realized (where the cumulative probability first exceeds 50%). Thus, a FIN 48 adjustment equal to the uncertain tax benefit is made. This in turn will have interest implications for subsequent reporting periods, as explained below. The partnership loss is reported on Schedule M-3, part II, line 9 (see appendix).
Settlement of lawsuit--Transaction 7: Accruals for a judgment as a result of litigation under appeal are not currently deductible under the economic performance test of Sec. 461(h), which essentially places the taxpayer on the cash method for that item. Under the all-events test, an expense is recorded in the financial statements in the year in which the amount is fixed and determinable Liable to come to an end upon the happening of a certain contingency. Susceptible of being determined, found out, definitely decided upon, or settled.
determinable adj. , creating a deferred tax benefit. If the lawsuit lawsuit: see procedure; tort. were deemed to be without merit, no accrual would be made, and a brief discussion of the suit would appear in the footnotes to the financial statements. If management determines that it is appropriate to accrue To increase; to augment; to come to by way of increase; to be added as an increase, profit, or damage. Acquired; falling due; made or executed; matured; occurred; received; vested; was created; was incurred. a book expense, FIN 48 applies because this is a tax position that will be taken on a tax return, once the suit is settled. Based on the issue's technical merits, management developed a probability distribution of possible outcomes of the deductibility of the amount once it is paid (see Exhibit 7, above).
The tax position on the future deductibility of the payment when the lawsuit is settled qualifies for recognition because it is more likely than not that the position will be sustained on audit. The expected value of 52% can be used to document management's assertion that the MLTN threshold has been met. Under FIN 48, the maximum tax benefit is $85,000, the first amount of benefit that has a greater-than-50% likelihood of being realized. Thus, the future tax benefit of $85,000 ($170,000-$85,000) is not reflected in the tax accrual. This in turn will have interest implications for future reporting periods, as explained below. The deduction for resolution of the lawsuit is reported on Schedule M3, part II, line 25 as a temporary difference (see appendix).
Component depreciation deduction--Transaction 8: In evaluating the tax position on the $100,000 book-tax difference for the component depreciation deduction, management developed a probability distribution of possible outcomes based on the issue's technical merits (see Exhibit 8, above).
The tax position concerning the component depreciation deduction qualifies for recognition because the MLTN test is met. Under FIN 48, the maximum tax benefit is $8,500, the first amount of benefit that has a greater-than-50% likelihood of being realized (where the cumulative probability exceeds 50%). Thus, the tax benefit of $25,500 ($34,000-$8,500) should not be reflected in the tax accrual. This in turn will have interest implications for future reporting periods, as explained below. The depreciation deduction is reported on Schedule M-3, part Ill, line 31 as a temporary difference (see appendix).
Accounting for Interest and Penalties Under FIN 48
FIN 48 requires recognition of interest expense in the first period interest would begin accruing according to according to
1. As stated or indicated by; on the authority of: according to historians.
2. In keeping with: according to instructions.
3. provisions of the relevant tax law:
The amount of interest expense to be recognized shall be computed by applying the applicable statutory rate of interest to the difference between the tax position recognized in accordance Accordance is Bible Study Software for Macintosh developed by OakTree Software, Inc.
As well as a standalone program, it is the base software packaged by Zondervan in their Bible Study suites for Macintosh. with this Interpretation and the amount previously taken or expected to be taken in a tax return. (29)
The interest accrual is based on the current interest rate and the estimated intervening in·ter·vene
intr.v. in·ter·vened, in·ter·ven·ing, in·ter·venes
1. To come, appear, or lie between two things: You can't see the lake from there because the house intervenes.
2. time interval until the uncertainty of the tax position is resolved:
FIN 48 requires a company to accrue interest and penalties when there is underpayment of taxes, based on management's best estimate of the amount ultimately to be paid (not considering detection risk) in the same period that 1) the interest would begin accruing or 2) the penalties would first be assessed. The classification of interest (as interest expense or part of the income tax line item) and penalties (as part of the income tax line item or another expense classification) is an accounting policy election that should be consistently applied. (30)
Since this is the first year in which Quasar's uncertain tax positions were identified, no interest is accrued ac·crue
v. ac·crued, ac·cru·ing, ac·crues
1. To come to one as a gain, addition, or increment: interest accruing in my savings account.
2. . However, in each reporting period after an uncertain tax position is taken on the tax return, interest must be accrued at the appropriate rate for that reporting period. Since the partnership loss and the component depreciation deduction were taken on the 2007 tax return, interest on these uncertain tax positions would be accrued starting in the first reporting period after the due date of the 2007 tax return. Since the lawsuit's settlement will not be deducted until payment is made (three to five years in the future), interest would accrue only after the first reporting period the tax return is due in which the deduction is taken on the tax return. The FASB provides some flexibility in the reporting of the accrued interest:
Interest recognized in accordance with paragraph 15 of this Interpretation may be classified in the financial statements as either income taxes or interest expense, based on the accounting policy election of the taxpayer. (31)
When making this recommendation, the FASB did not consider the impact on Schedule M-3. Specifically, interest expense of this type generally represents a timing difference; categorizing the amount as tax expense would entail entail, in law, restriction of inheritance to a limited class of descendants for at least several generations. The object of entail is to preserve large estates in land from the disintegration that is caused by equal inheritance by all the heirs and by the ordinary reporting the expenditure on Schedule M-3, part III, line 2, as a permanent difference.
FIN 48 also permits as part of the tax expense any statutory penalties that would apply if the tax position did not meet the minimum statutory threshold for avoiding payment of such penalty. As a practical matter, though, it is somewhat doubtful that this situation would occur for many positions that have met the MLTN threshold unless the understatement of tax penalty applies. In Quasar's case, management must determine if any penalties would apply to the deduction for the partnership loss (since this is a listed transaction) and must make an accrual in the first reporting period after the 2007 tax year. (32)
The IRS is expected to issue guidance (33) indicating that accrued interest expense under FIN 48 should be reported on the Schedule M-3, part III, line 8, and that interest expense and accrued penalty expense should be reported on part III, line 12, rather than on part III, line 2.
Incorporating the FIN 48 Analysis in the Federal Income Tax Accrual
After applying the provisions of FIN 48, the journal entry to reflect the tax accrual can be seen in Exhibit 9 (p. 32). Note that the federal income tax expense under FIN 48 is $73,100 greater ($2,249,355 with FIN 48 and $2,176,255 without FIN 48). This difference is composed of the following elements:
Tax liability without application of FIN 48 $ 2,176,255 Plus: Increase in taxes payable for uncertain partnership loss 13,600 Reduction in deferred tax asset for uncertain lawsuit 85,000 Less: Reduction in deferred tax liability for uncertain depreciation (25.500) Tax liability with application of FIN 48 $2 249 355
For reporting purposes, the deferred tax asset, the deferred tax liability, and the taxes payable should be separated into current and noncurrent amounts. In terms of a classified journal entry, the tax accrual shown above would be broken down as in Exhibit 10 (p.32).
The $13,600 tax liability attributable to the partnership loss is reported as a noncurrent liability Noncurrent liability
A liability due in one year.
A liability not due to be paid within one year during the normal course of business. A long-term debt issue is a noncurrent liability. . Since there is no book-tax difference, the credit cannot be applied to the deferred tax liability account so it is applied to a noncurrent taxes payable account for an uncertain tax position. After applying FIN 48, Quasar has a current deferred tax asset of $6,800 from the bad debt expense and a noncurrent deferred tax asset of $90,100 from the following tax positions:
Capital loss carryover $15,000 Lawsuit contingency loss 250,000 Total favorable tax positions $265,000 x .34 Noncurrent deferred tax asset $90,100
This is offset by the $2,295 valuation allowance from the capital loss carryover. Quasar also has a deferred tax liability of $8,500 for the component depreciation ($25,000 x 34%).
After making this entry, Quasars Proper naming of quasars are by Catalogue Entry, Qxxxx±yy using B1950 coordinates, or QSO Jxxxx±yyyy using J2000 coordinates.
This page lists quasars.
It is interesting to compare the pre-and post-FIN 48 tax expense. The financial tax expense is larger ($2,249,355 vs. $2,176,255) and the deferred tax assets are smaller ($181,900 vs. $96,900). This result is likely to occur when applying FIN 48's two-step process because less than 100% of the benefit of an MLTN position is recognized.
Management must determine the quantitative and qualitative disclosures to be made in the notes to the financial statements Notes to the financial statements
A detailed set of notes immediately following the financial statements in an annual report that explain and expand on the information in the financial statements. as mandated by FIN 48. Would the following disclosure be sufficient?
Financial tax expense was increased by approximately 3% as a result of applying FIN 48 to future tax benefits resulting from depreciation and partnership loss deductions, and costs associated with settlement of ongoing litigation.
Some might believe that this disclosure is too detailed, while others might think more disclosure is warranted. (35)
Subsequent Recognition, Derecognition, and Measurement
FIN 48 requires a detailed reevaluation of all tax positions at the end of each subsequent reporting period (i.e., quarter or year). Prior positions must be reviewed for possible:
* Derecognition, if the MLTN standard no longer is met;
* Recognition, if old positions now meet the MLTN requirement; and
* Remeasurement, if new information would change the computation of the recognized amount.
Subsequent changes in judgment that lead to changes in recognition, derecognition, and measurement should result from the evaluation of new information and not from a new evaluation or new interpretation by management of information that was available in a previous financial reporting period. (36)
In addition, interest and penalties on the uncertain tax positions begin to accrue in accordance with relevant tax law in each subsequent reporting period. This may require complex computations with interest accruing from the original due date of the return, including possible interest netting from overpayments of prior years' tax liabilities. (37)
The first step in complying with FIN 48 is to create an "inventory" of uncertain tax positions as of the beginning of the first reporting year. Thoughtful guidance will be needed on issues concerning the second year of FIN 48 disclosures: How does the taxpayer construct a detailed "roll forward" reconciliation with the deferred tax balance sheet items as of the end of the prior year? How are true-up adjustments handled? What type of disclosures must be made to add or remove tax items from the prior year's accounts? These adjustments might relate to law changes, judicial developments, or changes in the taxpayer's attitude toward managing its tax risk.
Other changes may occur in a post-FIN 48 tax world. The Service's somewhat benign benign /be·nign/ (be-nin´) not malignant; not recurrent; favorable for recovery.
Of no danger to health, especially relating to a tumorous growth; not malignant. attitude of restraint toward the discovery process for tax accrual workpapers could change as FIN 48 issues surface. Workpapers might be requested to explain information contained in a tax footnote to an SEC-required filing or to support the separation of the federal tax expense into its current and noncurrent components on Schedule M-3, part III, lines 1 and 2. According to one IRS official:
In my opinion, the IRS would not want to be lessening the impact of transparency of financial information because of its tax accrual workpaper policy. (38)
The Service's policy on this topic seems to be in flux flux
In metallurgy, any substance introduced in the smelting of ores to promote fluidity and to remove objectionable impurities in the form of slag. Limestone is commonly used for this purpose in smelting iron ores. , based on comments by two IRS officials at the March 9, 2007, meeting of the Federal Bar Association Taxation Section in Washington, DC.
We really have to wait and see how FIN 48 plays out and what kinds of disclosures are made ... in deciding what issues to examine [on the tax accrual workpaper policy]. (39)
We're not changing the [tax accrual workpapers] policy. We're not currently looking to change the policy. I want to make that clear. (40)
Under current IRS policy, requests for taxpayer workpapers are mostly limited to tax shelter tax shelter: see tax exemption. issues. However, the Service has expressed an interest in reviewing the computations underlying the effective tax rate disclosed in the financial statements. Disclosure policies such as the one on tax accrual workpapers become even more problematic when a multinational taxpayer has relevant documents that reside (or affect tax computations) in more than one taxing jurisdiction.
It is the role of the IRS, not the taxpayer, to uncover the most taxpayer-friendly applications of the tax law and to apply audit tests so as to maintain the integrity of the tax system--first allowing the taxpayer to have its own say in resolving uncertainties as the tax law evolves. Even in a post-Enron world, there is the broader issue of layering the FIN 48 financial accounting process on top of the complex Schedule M-3 tax reporting requirements. The legacy of this combination may eventually be remembered not so fondly fond 1
adj. fond·er, fond·est
1. Having a strong liking, inclination, or affection: fond of ballet; fond of my nieces and nephews.
2. as classic financial and tax reporting overkill overkill Vox populi An excess of anything .
For more information about this article, contact Professor Raabe at firstname.lastname@example.org.
Exhibit 2: Case study
* Quasar Company is a calendar-year, accrual-basis corporation with no subsidiaries.
* The marginal and applicable federal tax rate is 34%.
* State and international tax effects are not considered.*
* Financial accounting income before consideration of the following items is $7,125,000.
* Since Quasar has no prior-year book-tax differences, the change to its deferred tax assets and liabilities is based solely upon current-year transactions.
* The appropriate unit of account for a tax position is each separately identified transaction.
* There are no "true up" adjustments when the tax return is filed.
* The temporary and permanent book-tax differences are disclosed on Schedule M-3, parts II and III, which is reproduced in the appendix.
1. Quasar uses the allowance method to account for bad debts for financial accounting purposes. It proposes an addition of $25,000 to the allowance for doubtful accounts Allowance for Doubtful Accounts
An estimation made by a company and documented on its balance sheet for receivables that might go uncollected.
It is standard practice for a company to have funds set aside for money that cannot be collected. for the year. For tax purposes, the bad debt expense is limited to $5,000 under the direct write-off Write-Off
A reduction in the value of an asset or earnings by the amount of an expense or loss. Companies are able to write off certain expenses that are required to run the business, or have been incurred in the operation of the business and detract from retained revenues. method. The difference is not an uncertain tax position.
2. Quasar deducted meals and entertainment expenses of $12,000, only $6,000 of which is deductible for tax purposes due to the 50% disallowance rule. This is a permanent difference that is not an uncertain tax position.
3. On its tax return, Quasar qualifies for a Sec. 199 domestic production activities deduction of $60,000. This deduction is not allowed for financial accounting purposes. This is a permanent difference that is not an uncertain tax position.
4. Quasar paid a $37,000 premium on a life insurance policy on the company president. Because Quasar is the beneficiary beneficiary
Person or entity (e.g., a charity or estate) that receives a benefit from something (e.g., a trust, life-insurance policy, or contract). A primary beneficiary receives proceeds from a trust or insurance policy before any other. of the policy, no deduction is allowed for tax purposes. This is a permanent difference that is not an uncertain lax LAX - LAnguage eXample.
A toy language used to illustrate compiler design.
["Compiler Construction", W.M. Waite et al, Springer 1984]. position.
5. Quasar deducted a $100,000 ordinary loss from a partnership investment during the year. The loss is a listed transaction. Management believes the amount is deductible for both financial accounting and tax purposes and that it is more likely than not that the loss will be sustained on settlement with a taxing authority.
6. Quasar had a $15,000 capital loss on the sale of land held for investment purposes. Management is unsure that sufficient capital gain income will he recognized within the tax law carryforward period to use the loss carryforward and recommends a valuation allowance be established.
7. Quasar is the defendant in a Lawsuit alleging that the company engaged in false advertising practices. The plaintiff was awarded damages of $1 million. Management believes judgment will be reduced to $500,000 on appeal and deducted this amount on its financial income statement. Since no payment will be made until all legal appeals have been exhausted, which management expects to occur within three to five years, no deduction was taken on the tax return. [dagger]
8. Quasar relied on a component depreciation study to deduct de·duct
v. de·duct·ed, de·duct·ing, de·ducts
1. To take away (a quantity) from another; subtract.
2. To derive by deduction; deduce.
v.intr. depreciation expense of $125,000 on its tax return. Its financial depreciation expense based on the straight-line depreciation A method employed to calculate the decline in the value of income-producing property for the purposes of federal taxation.
Under this method, the annual depreciation deduction that is used to offset the annual income generated by the property is determined by dividing the method is $25,000. Based on the IRS position on the proper tax treatment of depreciation using similar component depreciation studies, management believes this is an uncertain tax position with the deduction more likely than not of being sustained on settlement with a taxing authority.
* This was done to simplify the calculations. Note that significant FIN 48 issues may arise when the state tax issue of nexus is considered. See Kwiatek, "FIN 48 and State and Local income Taxes," 38 The Tax Adviser (September 2007): 546; Wells and McFadden-Wade, "Nexus and FIN 48: States of Flux," Journal of Accountancy (September 2007): 80. [dagger[ Sec. 461(h) denies a deduction for liabilities not incurred before economic performance. In this case, the deduction cannot be taken for tax purposes until the amount is actually paid.
(1) Additional guidance on the GAAP for income taxes is found in Accounting Principles Board The Accounting Principles Board (APB) is the former authoritative body of the American Institute of Certified Public Accountants (AICPA). It was created by the American Institute of Certified Public Accountants in 1959 and issued pronouncements on accounting principles until 1973, (APB) Standards No. 23, Accounting for Income Taxes, Special Areas, and No. 28, Accounting for Income Taxes in Interim Periods.
(2) On November 15, 2007, the FASB voted to delay the effective date for all nonpublic entities to periods beginning after December 15, 2007.
(3) "This Interpretation will result in increased relevance and comparability in financial reporting of income taxes.... the disclosure provisions of this Interpretation will provide more information about the uncertainty in income tax assets and liabilities." FIN 48, Summary, p. 4.
(4) Evidence of large-scale disparity dis·par·i·ty
n. pl. dis·par·i·ties
1. The condition or fact of being unequal, as in age, rank, or degree; difference: "narrow the economic disparities among regions and industries" between book and tax income was identified in corporate failures such as Enron Enron
A U.S. energy-trading and utilities company that housed one of the biggest accounting frauds in history. Enron's executives employed accounting practices that falsely inflated the company's revenues, which, at the height of the scandal, made the firm become the seventh . McGill and Outslay, "Did Enron Pay Taxes? Using Accounting Information to Decipher Same as decrypt. Tax Status," 19 Tax Notes (August 19, 2002): 1125-36.
(5) Generally, the effective tax rote rote 1
1. A memorizing process using routine or repetition, often without full attention or comprehension: learn by rote.
2. Mechanical routine. is computed separately for the taxpayer's federal, state/local, and international operations Internal Operations (I.O., IO or I/O) is a fictional American Intelligence Agency in Wildstorm comics. It was originally called International Operations. I.O. first appeared in WildC.A.T.S. volume 1 #1 (August, 1992) and was created by Brandon Choi and Jim Lee. , as income tax expense/pretax book income. Earnings management in the tax accrual for income taxes has been well documented. Based on a random sample of 100 Fortune 500 firms, an increase in earnings per share of $.09 was found from revesal of the tax cushion in 2003-2005 quarterly earnings reports; see Gupta and Laurx, "Do Firms Use Tax Cushion Reversals to Meet Earnings Targets?" Paper presented at the annual meeting of the American Accounting Association, Chicago, August 7, 2007. Material accruals for tax contingencies by large firms were likely used for earnings management; see Gleason and Mills, "Materiality MATERIALITY. That which is important; that which is not merely of form but of substance.
2. When a bill for discovery has been filed, for example, the defendant must answer every material fact which is charged in the bill, and the test in these cases seems to and Contingent Tax Liability Reporting," 77 Acct. Rev. (2002): 317-42. Firm changes in effective tax rates from the third to the fourth quarter suggest the use of tax cushions in earnings management; see Dahaliwahl, Gleason, and Mills, "Last Chance Earnings Management: Using the Tax Expense to Meet Analysts' Forecasts," 21 Contemp. Acct. Res. (2004): 431-59.
(6) Schedule M-3 filers include corporations and passthrough entities with gross assets of $10 million or more. Additional asset, income, and ownership tests also apply to partnerships; see Everett, Hennig, and Raabe, A Practical Guide to Schedule M- 3 Compliance (CCH CCH Colegio de Ciencias y Humanidades (Spanish)
CCH Certified Clinical Hypnotherapist
CCH Cook County Hospital
CCH Certified in Classical Homeopathy
CCH Country Club Hills (Fairfax City, VA, USA) , 2008). When the Schedule M-3 reporting requirements are fully in place, perhaps as many as 250,000 annual tax returns will include the schedule.
(7) However, the IRS has sought tax accrual workpapers relating to relating to relate prep → concernant
relating to relate prep → bezüglich +gen, mit Bezug auf +acc "listed transactions" for abusive tax shelter Abusive tax shelter
A limited partnership that the IRS judges to be claiming tax deductions illegally.
abusive tax shelter
A tax shelter in which an improper interpretation of the law is used to produce tax benefits that are activities, most recently in Textron, Inc. (D. R.I. 8/28/07). Donald Korb, chief counsel for the IRS, indicated that documents produced by a taxpayer or its auditors to comply with FIN 48 are considered tax accrual workpapers, stating that the IRS is "not going to turn a blind eye" to the FIN 48 tax reserve details (Leone, "FIN 48: Standing Naked Before the IRS'" (5/22/07), www.cfo.com/article.cfm/9216349). See also the chief counsel memorandum from Korb to Deborah Nolan, "FIN 48 and Tax Accrual Workpapers,'" AM 2007-0012 (6/8/07).
(8) Field Examiners' Guide LMSB-04-0507-045, FIN 48 Implications (May 2007), www.irs.gov/businesses/corporations/article/0,,id= 171859,00.html, and LMSB LMSB Large and Mid-Size Business Commissioner Memorandum LMSB-04-0507-044, FIN 48 and Tax Accrual Workpaper (TA W) Policy Update (5/10/07). See also "Key Issues in Tax Policy: A 2007 Tax Analysts Conference on Financial Reporting and Corporate Transparency For other definitions of transparency, see .
Corporate transparency is a form of radical transparency : The construct removing all barriers to - and facilitating of - free and easy public access to corporate, political and personal information and the laws, rules, social ," 2007 TNT TNT: see trinitrotoluene.
in full trinitrotoluene
Pale yellow, solid organic compound made by adding nitrate (−NO2) groups to toluene. 144-39, Doc. 2007-17299, p. 21 (July 13, 2007).
(9) Chief Counsel Notice 2007-015 (6/20/07). Robin Greenhouse of McDermott Will & Emery emery: see corundum.
Granular rock consisting of a mixture of the mineral corundum (aluminum oxide, Al2O3) and iron oxides such as magnetite (Fe3O4) or hematite (Fe2O3). disagrees. "Effective tax rate reconciliation workpapers, whether created by the taxpayer or the auditor auditor n. an accountant who conducts an audit to verify the accuracy of the financial records and accounting practices of a business or government. A proper audit will point out deficiencies in accounting and other financial operations. , are part of the tax accrual workpapers" and are thus subject to restraint. Coder, "IRS Position on Definition of Tax Accrual Workpapers Generates Skepticism skepticism (skĕp`tĭsĭzəm) [Gr.,=to reflect], philosophic position holding that the possibility of knowledge is limited either because of the limitations of the mind or because of the inaccessibility of its object. ," 2007 TNT 137- 3, Doc. 2007-16617, p. 2 (July 17, 2007).
(10) Drucker, "Why Firms' Tax Cuts Get Senate's Attention," Wall Street Journal, September 11, 2007, p. A3. The full text oft oft
Often. Often used in combination: his oft-expressed philosophy; oft-repeated tales.
[Middle English, from Old English; see upo in Indo-European roots. .he letter is available at 2007 TNT 170- 24, Doc. 2007-20090 (August 23, 2007).
(11) See Nichols, Briggs, and Baril, "And the Impact Is... First- Quarter Results from Adopting FIN 48," 2007 TNT 147-39, Doc. 2(107-16167 (July 31, 2007), for an analysis of the 2007 first-quarter disclosures.
(12) Leone, "FIN 48: Standing Naked Before the IRS" (5/22/07), www.cfo.com/article.cfm/9216349. Tammy Whitehouse argues that "such disclosures would provide the IRS with a roadmap for auditing the tax return and weaken taxpayers' ability to defend their tax positions" (Whitehouse, "Oh, Joy: IP, S Eager for FIN 48 Data" (8/7/07), www.complianceweek.com/index.cfm?fuseaction=article. viewArticle&article_ID=3573). However, a recently issued IRS Large and Mid-Size Business (LMSB) Division Field Examiners' Guide indicated that the disclosures should not be viewed as a road map because they do not have the specificity that would allow a perfect view of the issues and amounts at risk (Field Examiners' Guide LMSB-04-0507-045, FIN 48 Implications (May 2007)).
(13) FAS 109 [paragraph] 21 lists four possible income sources that may be available under the tax law to realize such a tax benefit: (1) future reversals of existing taxable temporary differences, (2) future taxable income exclusive of reversing temporary differences and carryforwards, (3) taxable income in prior carryback carryback n. in taxation accounting, using a current tax year's deductions, business losses or credits to refigure and amend a previously filed tax return to reduce the tax liability. (See: carryover) year(s) if a carryback is permitted under the Code, and (4) tax planning strategies implemented to accelerate taxable income amounts, change the character of taxable or deductible amounts, or switch from tax-exempt to taxable investments.
(14) Early drafts of FIN 48 used the "probable" standard, but public response led to the adoption of the "more likely than not" (MLTN) test.
(15) FIN 48 [paragraph] 4 states that a tax position also encompasses but is not limited to (1) a decision to file a tax return, (2) an allocation The apportionment or designation of an item for a specific purpose or to a particular place.
In the law of trusts, the allocation of cash dividends earned by a stock that makes up the principal of a trust for a beneficiary usually means that the dividends will be treated as or shift of income between jurisdictions, (3) the characterization A rather long and fancy word for analyzing a system or process and measuring its "characteristics." For example, a Web characterization would yield the number of current sites on the Web, types of sites, annual growth, etc. of income or a decision to exclude reporting taxable income in a tax return, or (4) a decision to classify clas·si·fy
tr.v. clas·si·fied, clas·si·fy·ing, clas·si·fies
1. To arrange or organize according to class or category.
2. To designate (a document, for example) as confidential, secret, or top secret. a transaction, entity, or other position in a tax return as tax exempt.
(16) FASB Staff Position, FSP FSP - File Service Protocol FIN 48-1, posted May 2, 2007, changed the original wording of FIN 48 from "tax matter is ultimately settled" to "tax position is effectively settled." See also Brazzil and Stein Stein , William Howard 1911-1980.
American biochemist. He shared a 1972 Nobel Prize for pioneering studies of ribonuclease. , "FIN 48 and IRS Settlements," 2007 TNT 167-39, Doc. 2007-18264 (August 28, 2007).
(17) FIN 48 [paragraph] 5.
(l8) If the statute of GLOUCESTER, STATUTE OF. An English statute, passed 6 Edw. I., A. D., 1278; so called, because it was passed at Gloucester. There were other statutes made at Gloucester, which do not bear this name. See stat. 2 Rich. II.
MARLEBRIDGE, STATUTE OF. limitation for the relevant authority to examine and challenge a previously unrecognized tax position has expired ex·pire
v. ex·pired, ex·pir·ing, ex·pires
1. To come to an end; terminate: My membership in the club has expired.
2. , the tax benefit will then be recognized in the financial statements.
(19) Pegs. Sec. 1.6662-4(d). The MLTN standard is also applied in assessing the Sec. 6694(a) tax preparer penalty, which is the greater of $1,000 or 50% of the income derived (or to be derived) by the tax return preparer.
(20) Sec. 6694(a)(2) requires that a position would more likely than not be sustained on its merits or it must be adequately disclosed on the tax return to avoid a tax preparer penalty. Tax-payers may be required "to provide more documentation to support aggressive tax positions and [this] may result in increased tax preparation fees to cover more research on complex tax rules" (Herman. "The IRS Has a New Weapon," Wall Street Journal, July 11, 2007, p. D1). "To the extent that the likelihood of the tax position being sustained would fall between the realistic possibility standard and the more-likely-than-not threshold, a company would no longer recognize the benefits of the tax position in its financial statements. This could adversely affect debt ratios, increase interest expense, and increase a company's effective tax rate" (Jones and Campbell, "Financial-Reporting Effects of Uncertain Tax Positions," CPA (Computer Press Association, Landing, NJ) An earlier membership organization founded in 1983 that promoted excellence in computer journalism. Its annual awards honored outstanding examples in print, broadcast and electronic media. The CPA disbanded in 2000. Journal (March 2007): 2).
(21) Blouin, Gleason, Mills, and Sikes Sikes can refer to: People
(22) This will be broken down into its current and noncurrent components later.
(23) In FIN 48, Appendix B, [paragraph] 12, the FASB noted: "The Board concluded that limiting the application to only uncertain tax positions, or tax positions with specified attributes, would create a rules-based standard that would result in inconsistent application and would add complexity to the accounting guidance for income taxes."
(24) FASB Statement FASB Statement
A standard set by the Financial Accounting Standards Board regarding a financial accounting and reporting method. Essentially, FASB statements determine the acceptable accounting practices that Certified Public Accountants use in reporting of Financial Accounting Concepts No. 7, Using Cash How Information and Present Value in Accounting Measurement.< FIN 48, Appendix B, [paragraph] B26, indicates that an expected-outcome measurement would he conceptually superior when uncertainty exists became that measurement would require consideration of all potential outcomes.
(25) See Kimmelfield, "Measuring Tax Benefits in the Real World," 2006 TNT 210-26, Doc. 2006-21304 (October 30, 2006). The author argues that the standard could be met by evaluating the MLTN chance of settlement by an appellate Relating to appeals; reviews by superior courts of decisions of inferior courts or administrative agencies and other proceedings. conferee con·fer·ee also con·fer·ree
1. A participant in a conference.
2. One upon whom something, such as an honor, is conferred.
Noun 1. or from litigation and then selecting the FIN 48 adjustment to make, depending on whether the company is willing to litigate the is,sue.
(26) FIN 48, Appendix A, [paragraph][paragraph] A19 and A20.
(27) FIN 48, Appendix A, [paragraph] A20.
(28) If indeed the Schedule M-3 can be viewed as a "road map" to the IRS for book-tax differences, it is important to reconcile the temporary differences disclosed on the Schedule M-3 with those included in the tax accrual workpapers.
(29) FIN 48 [paragraph] 15.
(30) Jones and Campbell, "Financial-Reporting Effects of Uncertain Tax Positions," CPA Journal ( March 2007): 4.
(31) FIN 48 [paragraph] 19.
(32) FIN 48 [paragraph] 16. "If a tax position does not meet the minimum statutory, threshold to avoid payment of penalties, an enterprise shall recognize an expense for the amount of the statutory penalty, in the period in which the enterprise claims or expects to claim the position in the tax return."
(33) Based on comments made by Judith McNamara, IRS Senior Program Analyst, at EEI EEI Edison Electric Institute
EEI Estación Espacial Internacional (Spanish: International Space Station)
EEI Electrical and Electronics Institute (Thailand)
EEI Electro Energy, Inc. Schedule M-3 seminar, Chicago, June 15, 2007.
(34) Assuming there is no true-up adjustment, lines 1 and 2 of Schedule M-3, part III, 3 represent the current U.S. financial income tax expense of $2,321,860 and the 3 U.S. deferred income tax expense of-$72,505 (-$74,800 + $2,295) for a total of $2,249,355.
(35) For a discussion of the adequacy of FIN 48 footnote disclosures, see Nichols, Baril, and Briggs, "Early Indications of the Impact of FIN 48," 2007 TNT 132-21, Doc. 2007-15070 (June 22, 2007).
(36) FIN 48 [paragraph] 12.
(37) Throndson and Urban, "Thinking Beyond Uncertain Tax Positions: Understanding the Potential Impact of Interest Computations and Penalties," PricewaterhouseCoopers LLP LLP - Lower Layer Protocol , February 1, 2007, available at www.tinyurl.com/368jd.
(38) Robert D. Adams, senior advisor In some countries, a Senior Advisor is an appointed position by the Head of State to advise on the highest levels of national and government policy. Sometimes a junior position to this is called a National Policy Advisor. to Deborah Nolan, LMSB Division Commissioner, in remarks to the District of Columbia District of Columbia, federal district (2000 pop. 572,059, a 5.7% decrease in population since the 1990 census), 69 sq mi (179 sq km), on the east bank of the Potomac River, coextensive with the city of Washington, D.C. (the capital of the United States). Bar Taxation Section (February 8, 2007). Nolan announced that the IRS was reevaluating its accrual workpaper policy in a speech at a District of Columbia Bar Taxation Section forum (April 12, 2007).
(39) Kathryn A. Zuba, IRS special counsel with the associate chief counsel for procedure and administration, quoted at 2007 TNT 48-6 (March 12, 2007).
(40) Dita Tonuzi, IRS Office of the Chief Counsel, quoted at 2007 TNT 48-6 (March 12, 2007).
Cherie J. Hennig
Florida International University Florida International University, primarily at University Park, Miami; coeducational; chartered 1965, opened 1972. A research university, it has 18 colleges and schools and many specialized centers and institutes, including those in biomedical engineering, database
William A. Raabe
Ohio State University Ohio State University, main campus at Columbus; land-grant and state supported; coeducational; chartered 1870, opened 1873 as Ohio Agricultural and Mechanical College, renamed 1878. There are also campuses at Lima, Mansfield, Marion, and Newark.
John O. Everett
Virginia Commonwealth University Formed by a merger between the Richmond Professional Institute and the Medical College of Virginia in 1968, VCU has a medical school that is home to the nation's oldest organ transplant program.
Exhibit 1: Probability distribution Tax benefit Probability of being resulting from realized on settlement taking position with a taxing authority $100 0% $60 45% $40 40% $0 15% Exhibit 3: Basic calculations for pre-FIN 48 accrual of income taxes Income Item Financial Taxable Other income $7,125,000 $7,125,000 1. Bad debt expense ( 25,000) ( 5,000) 2. Meals and entertainment ( 12,000) ( 6,000) 3. Domestic production -0- ( 60,000) activities deduction 4. Life insurance premium ( 37,000) -0- 5. Partnership loss ( 100,000) ( 100,000) 6. Net capital loss ( 15,000) -0- 7. Contingent liability ( 500,000) -0- 8. Component depreciation ( 25,000) ( 125,000) Total $6,411,000 $6,829,000 Tax @ 34% $2,179,740 $2,321,860 Financial tax expense, net $2.173,960 of permanent difference [double dagger] Book-tax differences Item Temporary Permanent Other income 1. Bad debt expense $20,000 * 2. Meals and entertainment $6,000 3. Domestic production (60,000) activities deduction 4. Life insurance premium 37,000 5. Partnership loss -0- -0- 6. Net capital loss 15,000 * 7. Contingent liability 500,000 * 8. Component depreciation (100.000) ([dagger]) Total $435,000 $(17,000) Tax @ 34% $147,900 $(5,780) Financial tax expense, net of permanent difference Note: Because Quasar has no prior-year book-tax differences, the changes to its deferred tax assets and liabilities are: * change to the deferred tax asset of $181,900 [($20,000 + $15,000 + $500,000) x.34] Exhibit 4: Journal entry to record tax accrual Debit Credit Financial tax expense * $2,176,255 Deferred tax asset $ 181,900 Valuation allowance $ 2,295 Deferred tax liability $ 34,000 Taxes payable $2,321,860 * When reporting the pre-FIN 48 income tax expense on Schedule M-3, line 1 would report the current U.S. financial income tax expense of $2,321,860 and line 2 would report the U.S. deferred income tax expense of--$145,605, for a total income tax expense of $2,176,255 reported on the books. Exhibit 5: Evaluation of the tax benefit of the $60,000 domestic production activities deduction Recognition test Possible Expected deduction value allowed Probability probability 100% 100% 100% 0% 0% 0% Expected value 100% Measurement test Possible tax benefit Cumulative dollars Probability probability $20,400 100% 100% 0 0% 100% Exhibit 6: Evaluation of the tax benefit of the $100,000 partnership loss deduction Recognition test Possible Expected deduction value allowed Probability probability 100% 10% 10% 80% 20% 16% 60% 25% 15% 50% 30% 15% 40% 10% 4% 20% 5% 1% Expected value 61% Measurement test Possible tax benefit Cumulative dollars Probability probability $34,000 10% 10% $27,200 20% 30% $20,400 25% 55% $17,000 30% 85% $13,600 10% 95% $ 6,800 5% 100% Exhibit 7: Evaluation of the tax benefit of $500,000 lawsuit settlement, a contingent liability Recognition test Possible Expected deduction value allowed Probability probability 100% 10% 10% 70% 20% 14% 50% 40% 20% 30% 20% 6% 20% 10% 2% 10% 0% 0% Expected value 52% Measurement test Possible tax benefit Cumulative dollars Probability probability $170,000 10% 10% $119,000 20% 30% $ 85,000 40% 70% $ 51,000 20% 90% $ 34,000 10% 100% $ 17,000 0% 100% Exhibit 8: Evaluation of the $100,000 component depreciation book-tax difference Recognition test Possible Expected deduction value allowed Probability Probability 100% 10% 10% 80% 15% 12% 75% 25% 19% 25% 25% 6% 20% 15% 3% 10% 10% 1% Expected value 51% Measurement test Possible tax benefit Cumulative dollars Probability probability $34,000 10% 10% $27,200 15% 25% $25,000 25% 50% $ 8,500 25% 75% $ 6,800 15% 90% $ 3,400 10% 100% Exhibit 9: Journal entry to reflect tax accrual Account titles Debit Credit Financial tax expense 2,249,355 Deferred tax asset $ 96,900 Valuation allowance $ 2,295 Deferred tax liability $ 8,500 Taxes payable $2,335,460 Exhibit 10: Journal entry to reflect tax accrual, current vs. noncurrent amounts Account titles Debit Credit Financial tax expense $2,249,355 Deferred tax asset, current $ 6,800 Deferred tax asset, noncurrent $ 90,100 Valuation allowance $ 2,295 Deferred tax liability, noncurrent $ 8,500 Taxes payable, current $2,321,860 Taxes payable, noncurrent $ 13,600