When the Financial Accounting Standards Board (FASB) issued its standard addressing how to account for uncertainty in a company’s income tax provision more than three years ago, it was expected that all companies would be following the new guidance beginning in 2007. However, as a result of two last-minute deferrals in late 2007 and 2008, nonpublic companies will now finally be required to implement the standard, referred to as FIN 48, beginning in 2009. As we approach the end of 2009, now is the time for companies to make sure they’re prepared to address FIN 48.

It should be of little surprise that there’s uncertainty in the accounting for income taxes, since many tax laws and IRS audits themselves are shrouded in uncertainty. When assessing where uncertainty lies in an entity’s tax positions, there are several key areas to consider, including:

• Decisions not to file a tax return in a particular jurisdiction.
• Allocations or shifts of income between jurisdictions.
• Characterization of income or a decision to exclude taxable income from a tax return.
• Classification of transactions as tax exempt.
• An entity’s tax status, including its status as a pass-through entity or a tax-exempt entity (e.g., a not-for-profit entity).

Though the areas on this list are very broad, the intent of FIN 48 is not to question every number reported (or not reported) on a tax return. Rather, the intent is to identify issues or positions that wouldn’t meet a more-likely-than-not standard of surviving an audit while assuming that the taxing authority has full knowledge of all relevant information. This latter statement is a key concept, as many entities have historically allowed for some level of detection risk in their income tax accounting. Under FIN 48, entities will now need to assume that their tax returns will be audited by a knowledgeable taxing authority when recording income taxes for financial statement purposes.

As noted above, FIN 48 includes decisions related to returns not filed. For example, consider a multistate distribution company. Historically, the company filed tax returns only in its home state but had been advised that it has tax filing obligations in other states. In the past, the company took the position that it was unlikely that the other states would find and audit the company, and no tax obligation was recorded. Under FIN 48, the distribution company is now required to assume that it will be audited and should report its income tax exposure to the other states in its financial statements.

FIN 48 also applies to the allocation or shifting of income between jurisdictions. Allocation of income becomes an issue when companies have transactions with related foreign companies (e.g., parent, subsidiaries, or brother-sister companies). In these situations, changes in intercompany (or “transfer”) pricing will change the allocation of income between the United States and foreign countries. The United States and foreign jurisdictions have increased their enforcement of transfer pricing rules to protect their relative tax bases. Pricing between related companies must meet an arm’s length standard with documentation to show that the pricing method complies with U.S. or foreign jurisdiction rules. In the absence of adequate documentation that the transfer pricing meets the arm’s length standard, a company may be required to record a tax obligation based on an assumed audit by the IRS and foreign taxing authorities.

Implementation of FIN 48 may present challenges to many organizations, because it must address all federal, state, local, and international income tax issues. Successful implementation requires documentation of all significant tax positions (including positions involving the nonfiling of tax returns) and management of the overall
process. The timeline for completing the FIN 48 analysis will vary by company, but now is the time to make sure that the organization is prepared to implement the new standard.