Most corporations have now come to terms with the Financial Accounting Standards Board’s requirements for accounting for tax benefits and liabilities and with filing with the IRS the Schedule of Uncertain Tax Positions (UTP). However, the two requirements often interact, as explained below.
FASB Statement 109, an Interpretation of Fin 48, requires that a tax benefit cannot be reflected for accounting purposes unless the company believes that the benefit is more likely than not to be recognized if challenged. If such belief exists, then the company must determine whether less than all of the benefit can be claimed, which may be the case if the benefits are not “highly certain” (called the “measurement step”). The company must document the Fin 48 analysis, both as to the underlying facts and the legal analysis.
Highly certain means the law is clear and unambiguous. The execution of the two steps is the responsibility of management and outside legal advice is not required. If it is sought, however, the opiner should be clear about whether it is opining on step one (more likely than not to get the tax benefit based on purely legal/factual analysis) and/or step two (what’s likely to happen in a real-life IRS audit). Different types of analysis are involved.
The outside auditor has an independent duty to evaluate the reasonableness of management’s analysis. See U.S. v. Arthur Young, 465 U.S. 805 (1985). A reasoned opinion by another tax professional can assist the auditor in accepting the company’s position.
Accounting standards require outside auditors to obtain any opinion relied on by the client for setting its tax reserve, and the IRS recognizes that the auditor may ask to review any written opinions received by the company. Ann. 2010-76. Generally, the IRS will not assert that such review waives any privilege that otherwise applies to the opinion, unless the IRS has requested the tax accrual work papers under IRM 220.127.116.11.
Uncertain Tax Positions
The company must identify an uncertain tax position on the Form UTP, even if the company believes its position is more likely than not to be sustained, when it either (a) has created a reserve due to the second step analysis described above concluding that in practice, it reasonably can expect to pay some additional tax; or (b) reserves nothing, because it decides the IRS will disagree—but that it will litigate and defend the tax position and concludes that it will more likely than not win 100 percent of the tax benefit (in part because it will refuse to ever settle and pay anything).
Note that in order to avoid both a Fin 48 Reserve and UTP reporting, the company must both expect it will win if it litigates and expect (at the more-likely-than-not level) that it will not have to litigate because the position is highly certain (e.g., the IRS should agree the position is correct).
Interaction of Fin 48 and UTP
Some who have studied publicly reported corporate financial statements have suggested that there may be a decline in reserves for potential loss of tax benefits. There could be many reasons for any such decline. However, it is possible that one reason—in some cases—might be that a company is stretching its analysis to avoid reporting a tax position on the UTP Schedule. Any such result would tend to defeat the purpose of the Fin 48 analysis.
When a company contemplates that the recorded tax benefits of a contemplated transaction may be questioned by its outside auditor, the company should consider discussing the Fin 48 treatment with the auditor well before the transaction is effected and the UTP report is due. In addition, it should consider obtaining another professional’s opinion to support the company’s position.