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PRIVATELY OWNED BUSINESSES - ADDITIONAL TAX DISCLOSURES AHEAD
All business owners would like to pay the least amount of tax legally possible and often implement tax strategies to accomplish that goal. Because today’s tax laws are so complex and conclusions among practitioners and tax authorities vary, taxpayers can no longer be assured that a tax position will be sustained if challenged.
In July 2006, the rule-making body of the accounting profession known as the Financial Accounting Standards Board (FASB) issued Interpretation No. 48-Accounting for Uncertainty in Income Taxes, commonly referred to as “FIN 48”. As discussed in more detail below, FIN 48 will require the completion of a two-step tax analysis of a company’s material or significant tax positions before any tax benefit can be recorded in the financial statements.
FIN 48 applies to all business entities including corporations, partnerships, S-corporations, LLC’s and certain tax-exempt organizations that issue financial statements in accordance with Generally Accepted Accounting Principles (GAAP).
Beginning in 2007, public companies were generally required to implement these new rules. In January 2008, privately-owned businesses were granted a one-year deferral and will generally be required to implement the new rules in 2008. This means that if a privately-owned business reports GAAP basis financial statements on a calendar year, FIN 48 will need to be implemented in the 2008 financial statements.
So what does this mean? Generally a business will need to evaluate material or significant income tax positions claimed in tax returns for all years open under the statute of limitations. The statute of limitations will vary by tax jurisdiction and generally go into effect based on the filing date of the return. To the extent a tax return should have been filed but was not, the analysis will need to include all years in which a return should have been filed since the statute went into effect.
Your business may have previously evaluated uncertain tax positions covering contingencies under a broader accounting rule. The new rules adopted under FIN 48 cover all income tax matters (federal, state, and foreign) related to your business while other taxes such as sales, use, and property taxes remain subject to the broader rules related to contingencies.
In general, FIN 48 incorporates a two-step analysis of recognition and measurement. The recognition phase requires a business to analyze income tax positions claimed in a tax return for all years open under the relevant statute of limitations. Additionally, the business needs to evaluate the likelihood of success if challenged in accordance with a threshold commonly referred to as the “More Likely than Not” standard. Quantitatively speaking, “More Likely than Not” equals a more than fifty percent likelihood of success. Each tax position is evaluated on its technical merits against this standard and if the threshold is not satisfied, no benefit related to the tax position will be allowed to be claimed in the financial statements. If the tax position satisfies the threshold, the tax position moves to the phase of measurement.
The measurement phase will require judgment since the benefit related to each tax position will be allowed in an amount equal to the largest amount of benefit that is more than fifty percent likely to be realized if challenged by the tax authority. For example:
A tax position which provides $100 of benefit satisfies the recognition phase:
The amount which is more than fifty percent likely to be realized is $65. This is the amount of benefit that will be allowed in the financial statements. To the extent the entire $100 of benefit related to this tax position was included in a prior year’s return, which remains open under the applicable statute of limitations, a tax liability equal to the “uncertain” portion (or $35) will be required to be recorded in the financials statements. Applicable interest and penalties will also need to be provided. The new rule also provides guidance on classification of the FIN 48 liability in the financial statements and outlines the required disclosures with respect to uncertain tax positions. So what should you do? Given the significant complexities encountered by public companies in implementing FIN 48 in 2007, private business owners should contact their accountant and discuss how these new rules may impact the company’s net worth and the implications the additional tax analysis will have on the timing and cost of this year’s financial statement audit.
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