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December 2009

FIN 48: Accounting for Uncertainty in Income Taxes

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Eric Abati
In July 2006, the Financial Accounting Standards Board (FASB) issued Financial Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxes: an interpretation of FASB Statement No. 109, which may significantly change the way you evaluate your tax positions for recognition in your financial statements. FIN 48 was effective for fiscal years beginning after December 15, 2006. However, for certain nonpublic enterprises, there have been several deferrals, the most recent being FSP FIN 48-3, which delayed the effective date until years beginning December 15, 2008. Calendar-year companies not previously subject to FIN 48 will be required to adopt this interpretation as part of the reporting on their December 31, 2009, year-end financial statements.

The accounting for all material positions taken or expected to be taken on any income tax return is governed by FIN 48. Income tax returns include those that were filed or should have been filed with local, state, federal and international taxing authorities. FIN 48 applies to the following positions:

  • Excluding income streams that might be deemed taxable by taxing authorities
  • Asserting that a particular equity restructuring is tax-free when that position might be uncertain
  • The decision not to file a tax return in a particular jurisdiction for which such a return might be required
  • Positions that only have timing consequences, such as positions involving depreciation

Recognition

In applying FIN 48, companies will need to determine and assess all material positions taken in any income tax return as of the date they adopt FIN 48, including all significant uncertain positions in all tax years still subject to assessment or challenge by relevant taxing authorities.

FIN 48 addresses the recognition and measurement of income tax positions using a more-likely-than-not (MLTN) threshold. The MLTN threshold means that:

  • A benefit related to an uncertain tax position may not be recognized in financial statements unless it is MLTN the position will be sustained based on its technical merits
  • There must be more than a 50 percent likelihood the position would be sustained if challenged and considered by the highest court in the relevant jurisdiction

Measurement

The tax benefit of a qualifying position is the largest amount of tax benefit that is more than 50 percent likely to be realized upon ultimate settlement with a taxing authority that has full knowl­edge of all relevant information. This poses potentially significant challenges in evaluating tax positions in various state, local and foreign jurisdictions.

Interest & Penalties

A taxpayer is required to accrue interest and penalties that, under relevant tax law, the taxpayer would incur if the uncertain tax position were not ultimately sustained. Accordingly, under FIN 48, interest would start to accrue for financial statement purposes in the period in which it would begin accruing under the relevant tax law. In addition, the amount of interest expense to be recognized would be computed by applying the applicable statutory interest rate to the difference between the tax position recognized in accordance with FIN 48 and the amount previously taken or expected to be taken in a tax return. Penalties would be accrued in the first period in which the position was taken (or is expected to be taken) on a tax return that would give rise to the penalty. How a company classifies interest and penalties in the income statement is an accounting policy decision.

Common Potential Uncertain Tax Positions

Below are some general examples of potentially uncertain tax positions as defined in FIN 48:

  • State income tax filing requirements (nexus)
  • Research credit computations
  • International transfer pricing methodology
  • Accounting methods, e.g., improper timing of accrual of income or expenses
  • Sophisticated tax reduction strategies
  • Unintentional termination of S corporation election

How Will FIN 48 Affect You?

The only way to determine the effect FIN 48 will have on your company’s financial statements is to identify uncertain tax positions and apply the recogni­tion and measurement criteria. Some companies will see little, if any, impact, while others may record significant liabilities. Consult with your BKD advisor to quantify the impact and determine the disclosures that FIN 48 will have on your company’s annual financial statements.