FIN 48: Ample Reason to Reevaluate Tax Obligations
by David Grubb & Paul Watroba
Universal Advisor, 2007 Issue No. 2 

The Financial Accounting Standards Board (FASB), the accounting profession’s standard-setting body, has recently issued a new standard that could have a significant effect on how entities account for income tax obligations. The new standard, FASB Interpretation No. 48 (FIN 48), addresses what’s referred to as “uncertainty” in income taxes. As you can imagine, there can be a significant amount of subjectivity involved in attempting to estimate income tax obligations that may not be paid until many years in the future. There are issues related to when the taxes will be paid, how much will be paid, and the number of jurisdictions in which an entity will be subject to tax. Add to that mix the unpredictable effect of IRS and state audits, and you can see why guidance was needed from the accounting standard setters. It’s important to note that FIN 48 only addresses income tax accounting and doesn’t affect other types of taxes, such as sales and franchise taxes.

The Central Issue

The central issue addressed in FIN 48 is how to incorporate the effects of “uncertain” tax positions into income tax accounting. The definition of an “uncertain” tax position is very broad and includes not only specific items in a tax filing, but also the decision to file a tax return in a jurisdiction and whether the entity itself is subject to tax. The intent of FIN 48 is not to force us to question every number reported in a tax return, but rather to consider whether the accounting for income taxes would stand up to the scrutiny of a tax examiner. This represents a subtle, yet extremely important, change. Prior to FIN 48, most entities assumed a level of “detection risk” in their income tax accounting; that is, the accounting took into consideration the risk that they’d be audited by a taxing authority. Under FIN 48, however, entities will now need to assume that their tax returns will be audited and that the examiner will have access to all information.

For Example

Let’s assume that you’re the owner of a distribution company that ships products to multiple states. You’ve always filed tax returns in your home state and one other state. Your Plante & Moran advisor has told you that you likely have tax obligations in three other states; however, you’ve never filed returns in those states. This hasn’t previously presented a problem in estimating tax obligations, because you were able to assume a level of “detection risk”; because you’d never been audited by these states and it was assumed that you wouldn’t have to pay taxes, no tax liabilities were recorded.

Taking this same scenario under FIN 48 would likely produce a very different result. You’d be required to estimate your tax obligation to these three states assuming you were audited and that the examiner had all of the required information. If it was more likely than not (a threshold of 51 percent or more) that the state would assess a tax liability, that amount, including any potential interest and penalties, would need to be recorded.

Begin Early

The new standard will be effective for fiscal years ending on December 31, 2007 and thereafter. The implementation of FIN 48 will likely present significant challenges to many organizations because it requires a multi-disciplinary approach to addressing the issues. An early start to identifying areas of “uncertainty” and managing the overall process will be keys to successful implementation.