FIN 48 & State Taxes
Mar 01, 2010
Turning Lemons Into Lemonade
The hot topic for public and private companies for the past few years has been the adoption of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48). Many discussions have centered on the challenge and time commitment necessary to satisfy the FIN 48 requirements and the costs of getting the job done. It’s difficult enough to interpret all the rules and regulations that govern income taxes when filing tax returns; FIN 48 takes it to the next level. What we haven’t heard much about, however, are benefits that may come from the FIN 48 efforts. Let’s revisit FIN 48 and see how we can turn lemons into lemonade.
FIN 48 Revisited
All companies issuing financial statements under generally accepted accounting principles must meet the requirement under FIN 48 for all income-based taxes, including federal, international, state, and local taxes. FIN 48 deals with “uncertainty” in income taxes. Before FIN 48, uncertain tax positions were treated as contingent liabilities and applied to a probable standard. Companies could consider detection risk and only record a tax liability when it was “probable” that they would be examined by a tax authority.
Under FIN 48, detection risk can no longer be considered. Companies must assume that they will be audited and that taxing authorities will have all the necessary facts available to evaluate all tax positions. Documentation to support tax filing positions is a must — especially if you’ve taken any “aggressive” tax positions — but even routine positions need to be considered.
Turning Lemons Into Lemonade
Yes, satisfying the FIN 48 requirements can be time consuming and grueling and has caused much anxiety for accounting and tax departments. In addition, it’s “more likely than not” that the company will incur additional costs from outside auditors and tax advisors. To get the most of out of FIN 48 compliance, however, it may only be a matter of accentuating the positive.
Lemon — Nexus and Failure to File
The failure to file in each state (and local) jurisdiction in which a company has taxable presence, known as nexus, is the most common state tax position subject to FIN 48 review. Not filing a tax return in the state or city where the company has nexus is an uncertain tax position that can quickly become material. Further, state tax agencies are more aggressive than ever in efforts to discover nonfiling taxpayers and, if discovered by the state, the time period in which taxes may be assessed begins from the initial date of business activities in the state. This could result in many years of tax assessments, plus related interest and penalties.
Lemonade — Voluntary Disclosure and Amnesty
An available solution to failing to file is state voluntary disclosure programs. These programs involve a contractual voluntary disclosure agreement (VDA) with the state tax agency in a jurisdiction where there’s nexus. The VDA will bring the company into full tax compliance and significantly reduce the tax liability by limiting the look-back periods of tax returns to be filed while abating penalties and sometimes interest. Upon entering into the VDA, nexus and failure to file would no longer be a FIN 48 “uncertain tax position” requiring disclosure or the booking of a reserve. As an alternative to a VDA, consider amnesty programs being offered in the states.
Lemon — Changing Tax Laws and Regulations
The continuous demands of operating a business, especially in weak economic times, often result in a diminished focus on tax planning. Add to the mix constantly changing tax laws and regulations across all 50 states and the District of Columbia, and you have a perfect recipe for missed state and local tax-reduction opportunities.
Lemonade — State Tax Reduction Review
Identification of uncertain state tax positions usually includes a review of previously filed tax returns and supporting work papers. A balanced approach to such a review includes maintaining an awareness of and an intentional focus on tax reduction opportunities that may have slipped by due to unknown changes in tax laws and regulations, or simply due to lack of attention during the original return preparation. Combining a state tax reduction review with a FIN 48 evaluation can lead to the discovery of missed tax deductions or an applicable tax credit not claimed. Additionally, a tax law or administrative change may have been overlooked which, if considered, could provide a refund opportunity based on the filing method or favorable apportionment items.
Lemon — FIN 48 Documentation Requirements
Analyzing tax positions in compliance with the FIN 48 recognition and measurement standards requires documentation at a level that many companies never previously employed, or possibly never fathomed. In some cases, it involves documenting or proving that a tax position is immaterial to the financial statements.
Lemonade — Audit Preparedness, Best Practices
Preparation of FIN 48 documentation may reduce future tax audit anxiety. It certainly would be nice when a tax return is selected for audit to have all the documentation in place to support the return. Potential audit adjustments would be known. Material exposures would have been previously reserved for, thereby avoiding a future unexpected hit to the financial statements and possible corresponding negative impact to stock value or loan covenant violations. Furthermore, having a company’s tax-filing positions, accounting methods, processes, and procedures well documented would be a great resource when training new employees. Compliance with FIN 48 may lead to unearthing best practices that benefit the company as a whole.
Although there are certainly costs and concerns to bear when satisfying the FIN 48 requirements, there can be many benefits derived from the process. Benefits aren’t restricted to state taxes; they can also apply to international taxes, research and development credits, and many other areas where uncertain tax positions may exist. Being proactive during the process can help to turn your lemons into lemonade. Cheers!