Pre FIN 48 Approach

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Pre- FIN 48 Approach
Financial Statement Basis
FAS No 109 Deferred Tax Asset or Liability For
Temporary Differences (FAS 109 Valuation
Allowance)
As-FiledTax Basis
FAS No 5 (SOP 94-6)
FAS No. 109 provides for a valuation allowance
where the utilization of a deferred tax asset
(e.g. net operating loss or tax credit carry
forward), or a calculated portion thereof, is not
more likely than not going to be utilized
before its expiration date. Generally, this
determination was based on a an evaluation of
whether the enterprise would generate sufficient
as filed income in future years to absorb the
loss or credit (or a calculate portion of the
loss or credit).
Provided for recognition of a liability when a
disputed tax position would result in a probable
payment
Companies created reserves for taxes in less
than probable situations and arguable used the
reserves to smooth earnings.
The valuation allowance was based on the as
filed return and was not intended as a quality
determination whether a tax position would more
likely than not be sustained upon challenge by a
tax authority. However, some financial statement
issuer interpreted the standard as permitting an
allowance in the nature of a reserve.
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FIN 48 Conceptual ApproachAn Overview
Financial Statement Basis
As-FiledTax Basis
Traditional FAS 109 Calculations based on R
M Tax Return
Deferred Tax Asset or Liability for Temporary
Differences (FAS 109 Valuation)
Recognition MeasurementTax BasisThe "perfect"
return
"Carve outSeparate Liability Reporting and
Disclosure Regime
FIN 48 Liability (or reduction of a Deferred Tax
Asset)
The traditional FAS 109 computations for
temporary differences between tax return and F/S
are measured based on the "recognition and
measurement" tax basis.
The return that would be filed based on tax
jurisdiction's full knowledge of all uncertain
tax issues and the amount at which those issues
will likely be "settled" with the tax authority
based on the overriding assumption the return "as
filed" will be examined
Permanent differences and excluded temporary
differences will never create a deferred tax
amount- they only create FIN 48 liabilities.
FIN 48 Liabilities created and Uncertain Tax
Position (cumulatively) "disclosed" in tabular
form in the Financial Statements accompanied by
other disclosure items.
Current and Deferred Tax Provision, Deferred Tax
Assets and Deferred Tax Liability
Current and Non-current Tax Liability
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FIN 48 Conceptual Approach
As-FiledTax Basis
Recognition MeasurementTax Basis
Financial Statement Basis
FIN 48 Liability is created when as-filed
either fails to meet a more-likely-than-not tax
position threshold or when, the threshold is met
but the position is likely to be settled for a
lesser amount than the full benefit.
Deferred Tax Asset or Liability for Temporary
Differences (FAS 109 Valuation)
FIN 48 Liability (or reduction of a Deferred Tax
Asset)
Permanent differences and excluded temporary
differences will never create a derrered tax
amount-they only create FIN 48 liabilities
Tabular Information (FIN 48, Par. 21(a))

• Gross amounts of the increases or decreases in
  unrecognized tax benefits as a result of tax
  positions taken during a prior period
• Gross amounts of the increases or decreases in
  unrecognized tax benefits as a result of tax
  positions taken during the current period
• Amounts of decreases in the unrecognized tax
  relating to settlements with tax authorities
• Reductions to unrecognized tax benefits as a
  result of a lapse of the applicable statute of
  limitations

Cont.
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FIN 48 Conceptual Approach (cont.)
As-FiledTax Basis
Recognition MeasurementTax Basis
Financial Statement Basis
FIN 48 Liability is created when as-filed
either fails to meet a more-likely-than-not tax
position threshold or when, the threshold is met
but the position is likely to be settled for a
lesser amount than the full benefit.
Deferred Tax Asset or Liability for Temporary
Differences (FAS 109 Valuation)
FIN 48 Liability (or reduction of a Deferred Tax
Asset)
Permanent differences and excluded temporary
differences will never create a derrered tax
amount-they only create FIN 48 liabilities
Other disclosures (FIN 48, Par. 21)

• Total amount of unrecognized tax benefits that,
  if recognized, would effect the effective tax
  rate
• Total amounts of interest and penalties
  recognized in statement of operations and in
  statement of financial position
• Significant anticipated increases or decreases
  within 12 months of reporting date including the
  nature of the uncertainty, the nature of the
  event that will occur an estimate of the range of
  reasonably possible change or an statement that
  an estimate cannot be made
• Description of the tax years that remain subject
  to examination by a major tax jurisdiction

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FIN 48 Identifying Tax Positions
Other Tax Issues Methods of Accounting
- income recognition - deduction accruals
- other issues - method changes Elections
Prior tax examinations Decisions to not
file returns Merger and Acquisition tax
issues Special tax considerations -
personal holding companies - accumulated
earnings Outside tax opinions? Organization
charts that establish scope of business
activities and potential tax jurisdictional
claims

• Tax Income Statement
• Sec. 199
• income recognition
• Deduction allocations
• Inventory methods
• Income character
• - taxable v. non
• (e.g. 1031)
• capital v. ordinary
• Capital v. expenses
• R D and tax credit
• issues
• Compensation
• benefits

Income Statement Financial
Differences Adjustments Analysis of
Items
Balance Sheet Inventories -Unicap -
LIFO Depreciation Amortization-
useful lives Intangibles Acquisitions Accruals
and expensing- Sec, 461 (h)
M-1
M-2
M-3
Foreign pricing issues Divided remittance
issues State nexus and apportionment issues
IRS View of Industry or Specific Issues
Market Segment Specialization Papers Market
Segment Understandings Industry Specialization
Papers Settlement Guidelines
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FIN 48 Recognition Measurement
Determining what constitutes a particular tax
position, what the appropriate unit of account
is, and whether the "MLTN" threshold is met is a
matter of profession judgment based on the facts
and circumstances of the position and evaluated
in light of all the available evidence. A tax
position may be strictly a legal position (e.g.
qualifying for some special treatment - e.g.
Sec. 1031, or it may involve the tax treatment of
a population of dollar amount - e.g "reasonable
compensation" determination, or both - e.g. a
research and development tax credit where the
legal definition must be met and the proper
amounts charged to the project.
Cont.
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FIN 48 Recognition Measurement (cont.)
Cont.
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FIN 48 Recognition Measurement (cont.)
Cont.
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FIN 48 Recognition Measurement (cont.)
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FIN 48 Measurement Illustration
Transition Period
Measurement
Cumulative Probability
Tax Position
Possible start up expenditures of 400,000
deducted and no election made under Sec. 195.
FIN 48 requires an enterprise to determine the
largest amount of benefit that is greater than
50 likely of being realized upon ultimate
settlement (it is a given that- for highly
certain positions, 100 is the appropriate tax
benefit.
Comment issue discovered during review of prior
CPAs tax returns. Total expenditures during the
potential start-up period considered to be the
unit of account
Cumulative Probability Assessment (must perform)
Pre-FIN 48 Classification (also) Post-Fin 48
Classification (see Comment, below)
Journal Entry (calendar year 2007)
Because no cash payment occurs there is no
reclassification of the liability to current
status.
Note When the FIN 48 Liability arises in the NOL
year there is net reporting if the FIN 48
Liability arises in a year to which the NOL is
carried, the reporting would be gross (that
is, a deferred tax asset of 350K and a FIN 48
Liability of 70K). However, it follows that the
assumption is that the Liability will be
payable and, therefore, the valuation allowance
will be restored.
Comment The recognition and measurement of an
uncertain tax position is required regardless of
the fact that a valuation allowance exists
(e.g. because the entity does not expect to earn
sufficient future taxable income to offset the
FIN 48 Liability (absent the utilization of the
loss to offset any disallowance of the liability.
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FIN 48 Measurement Illustration No. 2
Cont.
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FIN 48 Measurement Illustration No. 2 (cont.)
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Recognition Troublesome Application Issues
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Measurement Approaches Sources

• Analysis of transactions contained within a given
  factual tax position(e.g. Business meals and
  travel and entertainment type deductions)
• Issues resolved in court (hazards of
  litigation)
• Accounting methods Revenue Procedures
  addressing resolution of incorrect methods
• Strength of argument disputes (Unicap, Sec. 199,
  Sec. 482, cost segregation positions)
• Inquiry and networking with other taxpayers or
  professionals (avoid anecdotal evidence trap)
• Construction of (client specific) tables for
  measurement tolerable settlement thresholds (see
  Measurement Under FIN 48 A Tax Professionals
  Guide to Oddsmaking, BNA Daily Tax Report, No.
  245, December 21, 2006, archived online at
  www.macpa.org/Content/23092.aspx

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FIN 48 Classification Transition
Financial Statement Classification
An entity with a classified balance sheet -

• Recognizes a liability (or an NOL reduction or
  refundable amount) for the unrecognized tax
  benefit (not a FAS 109 deferral).
• Any expected cash payment attributable to an
  unrecognized benefit to be made within 12 months
  of the balance sheet date I classified as
  current.
• A reclassification from non-current occurs only
  when a payment is expected with 12 months.
• A FIN 48 liability is not considered a "deferred
  liability" unless it arises from a taxable
  temporary difference (e.g. depreciable life
  issue inventory 263A item).
• Gross presentation is required but some
  examples of application offset a NOL deferred tax
  asset with a FIN 48 Liability (presumably because
  no actual payment will occur)
• Interest may be shown as interest or as an income
  tax expenses.
• Penalties may be shown as an income tax expense
  or as other expenses.

Cont.
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FIN 48 Classification Transition (cont.)
Transition Rules
Effective for financial statement years
beginning after December 15, 2006

• Upon adoption FIN 48 applies to all open
  positions (in this regard it supersedes and
  replaces treatment under FAS No. 5 and SOP
  94-6)
• Enterprises will need to identify, recognize,
  and measure all uncertain tax positions for which
  the statute of limitations has not expired -
  federal, state foreign and local (income tax only
  positions)
• The cumulative effect of applying FIN 48 in the
  first fiscal reporting period is charged or
  credited to retained earnings (or similar
  accounts for special entities. Disclosure of the
  cumulative amount of the change is required.
• FAS 5 income tax reserves, accrued interest (if
  any) and any related deferred tax asset will need
  to be adjusted. This may involve in some cases,
  creating a FIN 48 tax liability in situations
  where only a valuation allowance had previously
  been used..

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The FIN 48 Process
Transition all open tax positions under the
statuteEffective date Financial statement
years beginning after December 15, 2006 FIN 48,
par. 22-24 Determine "Unit of Account" The
unit of account depends on how the enterprises
compiles and reports its tax positions and
prepares returns, and on how a tax authority is
likely to address tax positions in an examination
of the enterprises tax returns FIN 48, par. 5
If More Likely Than Not threshold is not met,
then establish a FIN 48 Liability (or net with
and NOL or tax credit deferred tax asset arising
in the same period otherwise, the accounts are
reflected on a "gross basis. FIN 48, par. 5
6 Tax Planning Strategies must be evaluated
under the Recognition Rules FIN 48, par.
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Cont.
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The FIN 48 Process (cont.)
Effectively "settled" may include the completion
of an examination for an open tax year containing
uncertain positions that were not challenged. If
this occurs, the enterprise may not consider the
same positions as settled for other open years
however, the enterprise may obtain information
with regard to such positions that allows it to
reevaluate those positions in open years. FIN
48, par. 8
Cont.
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The FIN 48 Process (cont.)
Management is prohibited from reevaluating a tax
position absent "new information." Legal
extinguishments is not necessary - see comment
about closed exams and effective settlement as
well as the possibility of obtaining information
that may permit re-measurement. Statute of
limitations issues should be carefully evaluated
because certain factors may extend the statute in
some cases. FIN 48, par. 10-12 FIN 48,
par. 13-14 (pertaining to a change in judgment)
Penalties may also be effected by the statute of
limitations similarly to taxes it is important
to note that some penalties may exist despite the
fact the tax position is meets the recognition
threshold, because a dollar penalty is imposed
for some failure such as later filing, or failure
to files a Form 5471 with regard to a foreign
subsidiary, or for failing to report under the
Reportable Transactions regime of the Internal
Revenue or similar state, foreign or local tax
statutes. FIN 48, par. 15 16

Cont.
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The FIN 48 Process (cont.)
Cash payments of refund reductions anticipated
within one year of reporting date are classified
as current. Note this applies only to cash
payments, e.g. expiring uncertain tax positions
are not classified as current however, see below
for disclosure of expiring tax position amounts
within one year FIN 48, par. 17 FAS No. 109
"timing differences" are measured by using the
recognition and measurement "tax basis" FIN
48, par. 18
Cont.
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The FIN 48 Process (cont.)
Tabular Information (FIN 48, Par. 21(a)) (1)
Gross amounts of the increases or decreases in
unrecognized tax benefits as a result of tax
positions taken during a prior period (2) Gross
amounts of the increases or decreases in
unrecognized tax benefits as a result of tax
positions taken during the current period (3)
Amounts of decreases in the unrecognized tax
relating to settlements with tax
authorities (4) Reductions to unrecognized tax
benefits as a result of a lapse of the
applicable statute of limitations Other
disclosures (FIN 48, Par. 21) b. Total amount
of unrecognized tax benefits that, if recognized,
would effect the "effective tax rate" c. Total
amounts of interest and penalties recognized in
statement of operations and in statement of
financial position d. Significant anticipated
increases or decreases within12 months of
reporting date including the nature of the
uncertainty, the nature of the event that will
occur an estimate of the range of reasonably
possible change or a statement that an estimate
cannot be made e. Description of the tax years
that remain subject to examination by a major
tax jurisdiction

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Independence Issues for Attest Service Firms That
Also Serve as Tax Advisers/Preparers

• The General Premise is that the CPA Firm is not
  independent with respect to clients where the CPA
  Firm performs services that involve management
  decisions including subjective judgment with
  respect financial statement representations
  (including subjective valuation)
• PCAOB Rules Govern Auditors of Public Companies
  (Rule 3522 Non-Audit Services (the S.E.C. also
  has oversight of public company auditors)
• These rules are very restrictive in terms of
  application with regard to assisting the client
  in performing tax accrual services including FIN
  48
• Generally auditors of public companies are unable
  to render significant services with regard to the
  identification, recognition, and measurement of
  (uncertain) tax positions for audit clients.
  They are able to assist clients in providing
  advice concerning how the client undertakes these
  tasks.
• AICPA Code of Professional Conduct Interpretation
  101-3 (of Rule 101 Independence) Governs the
  performance of attest services (including
  compilation, review and audits) for non-public
  enterprises and non-profit entities

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AICPA Code of Professional Conduct
Interpretation 101-3 Nonattest Services

• Attest Service Independence is NOT impaired when
  Nonattest Services, including tax, are performed
  by the CPA for the client and the client
• Designates an individual who possesses suitable
  skill, knowledge, expertise, preferably within
  senior management, to oversee the services and
• Evaluates the adequacy and results of the
  services performed
• The rule provides that the responsible individual
  need not be able to perform or re-perform the
  particular services in order for the client to
  assume responsibility for the CPAs services
• Tax advisory and preparation services do not
  necessarily involve the client making subjective
  judgment with regard to potential adjustments to
  returns by tax authorities or the amount of those
  adjustments.
• Attest tax accrual services performed by the CPA
  normally can be objectively reviewed by means of
  mechanical tests (i.e. comparing financial
  statement and tax return amounts to measure
  timing and other differences between them).

Cont.
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AICPA Code of Professional Conduct
Interpretation 101-3 Nonattest Services (cont.)

• FIN 48 Frequently Asked Questions
• Provides that FIN 48 services can be rendered by
  the CPA provided the client can make informed
  judgment on the results of the CPAs services
• In connection with this exception, the CPA may
  assist the client in understanding why tax
  positions do or do meet the MLTN (recognition)
  threshold and the basis for any unrecognized tax
  benefit (measurement) so that the client can
  accept responsibility for the amount reported and
  disclosed in the financial statements (which the
  client will presumably acknowledge in the
  representation letter).
• This may be easier said than done.

Cont.
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AICPA Code of Professional Conduct
Interpretation 101-3 Nonattest Services (cont.)

• FIN 48 Frequently Asked Questions (cont.)
• FIN 48 recognition (MLTN) involves subjective
  professional judgment
• FIN 48 measurement of the tax benefit to be
  recorded requires considerable subjective
  professional judgment
• FIN 48 identification of tax positions (certain
  and uncertain) involves subjective judgment
  particularly with regard to undiscovered tax
  positions (e.g. nexus and foreign presence
  issues)
• The ability of client personnel at many
  non-public enterprises (and especially non-profit
  organizations) to
• Designate an individual who possesses suitable
  skill, knowledge, expertise, preferably within
  senior management, to oversee the services and
• Evaluate the adequacy and results of the services
  performed,
• may not exist in reality.
• CPA firms performing significant tax services and
  attest services for clients should use an
  abundance of caution in determining whether or
  not they can perform significant FIN 48 services
  without impairing independence.

Cont.
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AICPA Code of Professional Conduct
Interpretation 101-3 Nonattest Services (cont.)

• Solutions to Independence Impairment
• Client retains a FIN 48 Assurance Provider
• The AP reviews the clients tax returns etc. and
  performs the FIN 48 determinations
• The AP reviews the attest/tax preparation
  firms FIN 48 determinations in behalf of (and as
  consultant for the client) and confirms the
  determinations
• Client retains a FIN 48 Assurance Adviser
• The AA meets with the client and the attest/tax
  preparation firm and assists the client in
  gaining the appropriate understanding of and
  making the appropriate evaluation of the CPA
  firms FIN 48 determinations.
• The AA may or may not review the attest/tax
  preparation firms determinations and the
  clients tax returns in preparation for the
  meeting depending on the scope and complexity of
  the issues
• This approach would seem particularly suitable
  for smaller audit engagements, for reviewed
  statements and for non-profit organizations.

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Selected Resources

• FIN 48 (http//www.fasb.org/)
• FSP 48-1 (http//www.fasb.org/)
• AICPA Practice Guide on Accounting for Uncertain
  Tax Positions Under FIN 48 (http//tax.aicpa.org/R
  esources/ProfessionalStandardsandEthics/Practic
  eGuideonAccountingforUncertainTaxPositions
  UnderFIN48.htm)
• AICPA CPE Course FIN 48 Uncertainty in Income
  Taxes A Must Know for Tax CPAs and
  Accountants/Auditors! (http//www.cpa2biz.com)
• FIN 48 Accounting for Uncertain Tax Positions
  (Kip Dellinger, order from the California CPA
  Education Foundation - http//www.educationfoundat
  ion.org/)
• FIN 48 Accounting for Uncertain Income Tax
  Positions (Warren, Gorham Lamont, Thomson/RIA)
• FIN 48 Manager (CCH Tax Research Network)