Accounting For Uncertainty In Income Tax For Nonpublic Enterprises 91509

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ACCOUNTING FOR UNCERTAINTY

IN INCOME TAXES

Certainty Has Been

Achieved

The FASB Completes Their Study

of How Certain Aspects of ASC

740 Apply to Nonpublic Entities

By Andrea Gronenthal

For those entities holding out for another

deferral of the requirements for nonpublic

entities to comply with the Financial Accounting

Standards Board (FASB) Accounting Standards

Codification Topic (ASC) 740, Income Taxes

(which includes FASB Interpretation No. 48 (FIN

48) – Accounting for Uncertainty in Income

Taxes – an interpretation of FASB Statement

(FAS) No. 109); another deferral of the deadline

to comply is not likely. On September 2, 2009,

the FASB issued Accounting Standards Update

(ASU)No. 2009-06, Implementation Guidance on

Accounting for Uncertainty in Income Taxes and

Disclosure Amendments for Nonpublic Entities,

which provides guidance on the application of

FASB ASC 740-10 for pass-through entities and

tax-exempt not-for-profit entities and signals

the end of the FASB’s deferral, for certain

nonpublic entities.

Background

In June 2006, the FASB issued FIN 48 (FASB ASC

740-10); Accounting for Uncertainty in Income

Taxes, originally effective for all entities that

apply U.S. Generally Accepted Accounting

Principles (GAAP) for fiscal years beginning after

December 15, 2006. The FASB clearly defined

the applicability of FIN 48 in Paragraph one

which states:

“…the requirements of this

Interpretation apply to not-for-profit

organizations. This Interpretation also

applies to pass-through entities and

entities whose tax liability is subject to

100 percent credit for dividends paid

(for example real estate investment

trusts and registered investment

companies) that are potentially subject

to income taxes.”

While the FASB was clear in which enterprises

were subject to the requirements of FIN 48,

little guidance was provided on how the

Interpretation applied to not-for-profit or pass-

through entities (S-corporations and

partnerships). Historically, many pass-through

entities and not-for-profit entities have not paid

income taxes and have not applied the

provisions of FAS 109 in the preparation of their

financial statements. The lack of clear guidance

surrounding the applicability of FIN 48 created

confusion for these types of nonpublic

enterprises as to whether the Interpretation

applied to their organization.



IN INCOME TAXES

On February 1, 2008, the FASB issued FASB Staff

Position (FSP) No. FIN 48-2, Effective Date of

FASB Interpretation No. 48 for Certain

Nonpublic Enterprises, deferring the effective

date of FIN 48 for eligible nonpublic entities to

annual financial statements for fiscal years

beginning after December 15, 2007. Later in the

same year, the FASB issued FSP No. FIN 48-3,

Effective Date of FASB Interpretation No. 48 for

Certain Nonpublic Enterprises, further deferring

the effective date of FIN 48 for eligible

nonpublic entities to annual financial

statements for fiscal years beginning after

December 15, 2008.

These two deferrals were intended to allow the

FASB the time to provide additional guidance

for pass-through entities and not-for-profit

entities on how to apply FIN 48 as well as

provide nonpublic entities additional time to

prepare for the eventual requirement. The

FASB considered limiting the scope of the

deferrals to pass-through entities and not-for-

profit entities but decided that for purposes of

simplicity, the deferrals applied to all nonpublic

entities unless the nonpublic entity was

consolidated with a public enterprise that

applied U.S. GAAP or the nonpublic entity had

already applied the recognition, measurement,

and disclosure provisions of FIN 48 (FASB ASC

740-10) in their financial statements.

Following recommendations of the Private

Company Financial Reporting Committee

(PCFRC) and other key stakeholders, the FASB

developed guidance on how FIN 48 (FASB ASC

740-10) applies to pass-through entities and

not-for-profit entities. The PCFRC also made

recommendations to reduce the disclosure

requirements currently within FIN 48 (FASB ASC

740-10) as these were onerous for private

enterprises and not useful to users of their

financial statements.

On May 18, 2009, the FASB released Proposed

FSP No. FIN 48-d, Application Guidance for Pass-

through Entities and Tax-Exempt Not-for-Profit

Entities and Disclosure Modifications for

Nonpublic Entities, to propose amending FIN 48

Private enterprises often possess

characteristics that will present additional

challenges not as commonly addressed by

their public enterprise brethren:

� Specific issues related to income

attribution for flow-through entities

� Time consuming identification

process, especially for enterprises

with consolidations, acquisitions,

and significant state or

international operations

� Lack of sufficient internal tax or

U.S. GAAP expertise

� Nonexistent or minimal internal

controls for tax processes

� Poor documentation of tax positions

taken by the organization

� Limited tax authority history on

which to base conclusions

� More aggressive tax positions taken

historically



IN INCOME TAXES

(FASB 740-10) and provide guidance that

addressed the concerns of the PCFRC and its

constituents. The proposed changes in FIN 48-d

were incorporated into FASB ASU 2009-06 and

FASB ASC 740-10 has been amended making it

certain that nonpublic enterprises must comply

with FASB ASC 740-10 in their first annual

financial statements issued for the fiscal year

beginning after December 15, 2008.

Why the conversion from FIN 48 to FASB 740-

10? On July 1, 2009, the FASB embarked on the

FASB Accounting Standards Codification (ASC)

initiative. This is a structural overhaul of U.S.

GAAP that converts the standards into a topical

model that is effective September 15, 2009 for

interim and annual periods. We now have a

single authoritative source of nongovernmental

U.S. GAAP.

Scope

The additional guidance issued by the FASB in

ASU 2009-06 applies to the financial statements

of all nongovernmental entities presented in

conformity with U.S. GAAP. This includes

nonpublic enterprises as defined in FASB ASC

740-10-20 as any entity that does not meet the

following criteria for a public company:

“a). its debt or equity securities are

traded in a public market, including

those traded on a stock exchange or in

the over-the-counter market; b). it is a

conduit bond obligor for conduit debt

securities that are traded in a public

market (a domestic or foreign stock

exchange or an over-the-counter

market, including local or regional

markets; or c). its financial statements

are filed with a regulatory agency in

preparation for the sale of any class of

securities.”

The FASB used the issuance of ASU 2009-06 to

reaffirm that accounting for uncertain tax

positions are applicable to all entities, including

tax-exempt not-for-profit entities, pass-through

entities, and entities that are taxed in a manner

similar to pass-through entities such as real

estate investment trusts and registered

investment companies as originally stated when

FIN 48 (FASB ASC 740-10) was issued in July

2006.

In addition to clarifying the applicability of FASB

ASC 740-10, the FASB provided additional

guidance and illustrative examples surrounding

three significant issues plaguing pass-through

entities and tax-exempt not-for-profit entities:

1. Is the income tax paid by the entity

attributable to the entity or its owners?

2. What constitutes a tax position for a

pass-through entity or as a tax-exempt

not-for-profit entity?

3. How should accounting for uncertainty

in income taxes be applied when a

All entities are subject to FASB ASC

740-10 even if the only tax position in

question is the entity’s status as a pass-

through entity or tax-exempt not-for-

profit organization.



IN INCOME TAXES

group of related entities comprise both

taxable and nontaxable entities?

In response to the concerns lodged by the

PCFRC and their constituents, the FASB decided

to reduce the disclosure requirements for

nonpublic entities.

Identification

FASB ASC 740-10 applies to all tax positions. An

enterprise must evaluate all material tax

positions in all jurisdictions for all open years in

order to evaluate whether tax positions subject

to exam are uncertain. Essentially, the

organization is developing a cumulative tax risk

portfolio limited to income taxes that must be

monitored and maintained contemporaneously.

FASB ASU 2009-06 modifies the definition of a

tax position to include additional language to

address tax positions related to pass-through

and tax exempt not-for-profit entities. FASB

ASC 740-10-20 defines a tax position as a

position in a previously filed tax return or a

position expected to be taken in a future tax

return that is reflected in measuring current or

deferred income tax assets and liabilities for

interim and annual periods. A tax position can

result in a permanent deduction of income

taxes payable, a deferral of income taxes

otherwise currently payable to future years, or

a change in the expected realizability of

deferred tax assets. The term tax position also

encompasses, but is not limited to:

� A decision not to file a tax return

� An allocation or a shift of income

between jurisdictions

� The characterization of income or a

decision to exclude reporting taxable

Common items evaluated in developing

an inventory of material tax positions:

� Financial statements and

supporting general ledgers and

trial balances

� Tax returns filed for all

jurisdictions and supporting work

papers

� Tax examination history and

results

� Tax Calendar

� Documentation of existing tax

contingencies and analyses

� Documentation of tax positions

for which full benefit is expected

� Significant temporary and

permanent differences

� Tax planning strategies

� Tax due diligence reports

� Tax opinions

� Transfer pricing reports

� Legal agreements and contracts

� Information provided from

subsidiaries and flow-through

entities

� Non-recurring transactions



IN INCOME TAXES

income in a tax return

� A decision to classify a transaction,

entity, or other position in a tax return

as tax exempt

� An entity’s status, including its status as

a pass-through entity or a tax-exempt

not-for-profit entity

As part of the identification process, analysis of

the materiality threshold and the appropriate

unit of account must be considered. Both of

these analyses are subjective and can have a

significant impact on the scope of the adoption

effort as well as create the baseline for future

years. The importance of proper evaluation of

these steps of the process cannot be

underestimated.

Each material uncertain tax position is then

subjected to a two step test: recognition and

measurement.

Recognition

Once the inventory of material tax positions is

completed, the positions need to be evaluated

based on whether it is “more likely than not”

(MLTN) (greater than 50 percent) the tax

position would be sustained under examination.

In evaluating whether a tax position meets the

MLTN recognition threshold, the organization

should evaluate the position based on its

technical merits, assume it will be examined

and that the examiner has the same

information. Unlike FAS 5, Accounting for

Contingencies, detection risk is no longer

applicable in the evaluation of income tax

contingencies.

Measurement

FASB ASC 740-10-30-7 states that “a tax

position that meets the recognition threshold is

initially and subsequently measured as the

largest amount of tax benefit that is greater

than 50 percent likely of being realized upon

ultimate settlement with a taxing authority that

has full knowledge of all relevant information.

Measurement of a tax position that meets the

MLTN recognition threshold shall consider the

amounts and probabilities of the outcomes that

could be realized upon settlement using facts,

circumstances, and information available at the

reporting date.”

In some cases, the determination of the

maximum amount that is cumulatively greater

than 50 percent likely of being sustained is a

simple exercise. In other instances, this may

Nonpublic enterprises will need to

implement new processes in order to

remain up-to-date on tax legislation, court

decisions, and other rulings as well as

develop mechanisms for those responsible

for the monitoring of uncertain tax

positions to be knowledgeable about

changes in operations that may impact the

evaluation.



IN INCOME TAXES

not be so clear and require significant analysis

and documentation of a variety of probable

outcomes in order to support the measurement

of the uncertain tax position. Add to the

complexity the need to monitor for new

information that may cause a change in the

analysis and conclusions in subsequent periods.

Disclosure

While the recognition and measurement

principles outlined above apply to all entities,

the FASB provided relief to nonpublic

enterprises from several of the disclosure

requirements in the originally issued FIN 48.

FASB ASU 2009-06 eliminated the disclosures

required by paragraph FASB ASC 740-10-50-

15(a) and (b) for nonpublic entities. By

distinguishing these two subsections as

applicable to public enterprises, the disclosure

requirements for nonpublic entities are

simplified. The disclosure requirement to

provide a tabular reconciliation of the total

amount of unrecognized tax benefits at the

beginning and the end of the periods presented

and the requirement to disclose the total

amount of unrecognized tax benefits that, if

recognized, would affect the effective tax rate

have been eliminated.

Nonpublic entities will still be required to

disclose the total amounts of interest and

penalties recognized in the statement of

operations and the total amounts of interest

and penalties recognized in the statement of

financial position. They will also need to

disclose positions for which it is reasonably

possible that the total amounts of unrecognized

tax benefits will significantly increase or

decrease within 12 months of the reporting

date. For these changes the following

information must be disclosed:

� the nature of the uncertainty;

� the nature of the event that could occur

in the next 12 months that would cause

the change;

� an estimate of the range of the

reasonably possible change or a

statement that an estimate of the range

cannot be made;

� and a description of tax years that

remain subject to examination by major

tax jurisdictions.

While the FASB responded to concerns about

the burdensome disclosure requirements for

nonpublic entities, the simplified disclosure

Private entity adoption will likely

result in substantial effort, but the

adoption and the implementation of

a process for monitoring will afford

senior management the opportunity

to develop a cumulative portfolio of

income tax risk and eliminate any

potential surprises resident within

their income tax compliance and

reporting.



IN INCOME TAXES

standards will still prove a challenge for

organizations not accustomed to performing

the level of analysis to create the disclosures.

Process & Controls

Nonpublic entities have not been subjected to

the requirements of Sarbanes-Oxley. Many

nonpublic enterprises have also not historically

been applying the standards of FASB ASC 740-

10. As a result, many nonpublic organizations

are ill equipped with processes and controls to

ensure proper implementation and continuous

monitoring.

Nonpublic enterprises will need to implement

new processes in order to remain up-to-date on

tax legislation, court decisions, and other rulings

as well as develop mechanisms for those

responsible for the monitoring of uncertain tax

positions to be knowledgeable about changes in

operation that may impact the evaluation.

Now that it is clear that the FASB will not be

issuing any additional deferrals, nonpublic

entities need to begin the process of adopting

FASB ASC 740-10. Finance executives should

not underestimate the level of effort required

to comply with the applicable provisions of

FASB ASC 740-10. Rather utilize this as an

opportunity to gain a deeper understanding of

the tax positions taken and the tax implications

of how the organization operates. This level of

understanding of the enterprise’s cumulative

portfolio of income tax risk will provide the

opportunity to align this portfolio with the

overall enterprise risk management strategy.

Certainty has been achieved…

Now is the time to act.

Andrea Gronenthal is a Managing Director

in True Partners Consulting LLC’s Chicago

office and can be reached at

[email protected] or

(312)235-3328. Information about the Firm

can be found at www.TPCtax.com

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Consulting LLC assumes no obligation to update this newsletter for any future changes in tax law, regulations, or other

interpretations.



IN INCOME TAXES

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Accounting For Uncertainty In Income Tax For Nonpublic Enterprises 91509