On July 13, the Financial Accounting Standards Board (“FASB”) issued Financial Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes, as a clarification of the accounting and reporting of the effects of income taxes in financial statements under FASB Statement No. 109, Accounting for Income Taxes (“FAS 109”). See our Federal Tax Advisory of August 1, 2006, for a summary of the FIN 48 guidelines. 1 The focus of this advisory is to discuss the documentation prepared to comply with FIN 48 and the ability of taxpayers to protect this documentation from disclosure.

Recap of FIN 48

Documentation Prepared to Comply with FIN 48

The disclosures and calculations necessitated by FIN 48 require the taxpayer to engage in extensive analysis of its tax risk from current and past transactions in preparing its annual and interim financials. This analysis may take many forms, including formal tax opinions or legal memoranda. Although tax opinions are not required by FIN 48, “[FASB] believes that a tax opinion can be external evidence” supporting a taxpayer’s tax-risk analysis. Depending on the materiality and/or complexity of a given tax position, a taxpayer’s preparation of supporting documentation or its engagement of outside counsel for the preparation of legal opinions or memoranda may assist in meeting the MLTN threshold for recognition or in increasing the measurement of the benefit to be recognized.

Protecting the Documentation

It is possible that the IRS may never request a taxpayer’s tax accrual workpapers and thus its FIN 48 documentation will not be subject to review. IRS officials have stated that tax accrual workpapers will not be requested unless the taxpayer engaged in a listed transaction that the taxpayer failed to disclose or engaged in multiple listed transactions regardless of whether the listed transactions were disclosed. If a taxpayer prepared tax accrual workpapers for a specific tax position for a given tax year and did not engage in any listed transactions in that tax year, then it would seem that the IRS would not compel disclosure of the tax accrual workpapers.

A taxpayer should never assume, however, that its tax accrual workpapers are completely safe from IRS review. First, there is no guarantee that the IRS will continue to adhere to its current stated “policy of restraint.” No matter how many public statements by the IRS that endorse the current version of its policy, it is a self-imposed guideline that the IRS may rescind at any time. Second, there is no guarantee that current transactions will not become listed transactions in the future with retroactive effect. The possibility of the IRS recharacterizing a transaction from non-listed to listed status should give pause to even the most conservative of taxpayers. Even tax positions that seem like ordinary tax planning within an industry – e.g., U.S. banks with leasing departments that entered into multiple LILOs and SILOs – may put a taxpayer’s tax accrual workpapers at risk. Therefore, a taxpayer’s best defense against disclosure is to take steps currently to increase the likelihood that any sensitive documentation will be protected by the work product doctrine. (The attorney-client privilege is not available to protect a taxpayer’s FIN 48 tax-risk analysis because the taxpayer typically will be required to share its tax-risk analysis with its auditor.)

Under the work product doctrine, a taxpayer can protect a document from disclosure if the document was prepared “in anticipation of” litigation. Documents assembled in the ordinary course of business or documents created irrespective of litigation cannot be protected. A taxpayer’s underlying analysis in a FIN 48 evaluation is essentially the same as a non-FIN 48 document prepared by the taxpayer to assess its tax litigation risks; however, FIN 48 further requires the taxpayer to apply measurements to that analysis and publish the measurement results on its financials. To ensure that the analysis underlying a FIN 48 measurement is classified as protected work product, the analysis must be prepared, in the first instance, as an assessment of a taxpayer’s tax litigation risks “in anticipation of” possible future litigation.
To emphasize this purpose, the taxpayer must clearly show that such analysis
(1) assesses the taxpayer’s tax litigation risks and/or hazards, and (2) is not made merely to derive numbers published on the taxpayer’s financial statements. If the document is prepared only to derive financial statement numbers, the document could be viewed as an unprotected accounting-related document rather than protected work product.

Two federal district cases currently pending will provide important guidance on the extent to which the work product doctrine applies in the context of tax accrual workpapers.


FIN 48 sets forth standards for recognizing and measuring a tax position that affects amounts reported in financial statements (hereinafter referred to as “financials”). A tax position includes any position taken on an income tax return that impacts the amount of income tax reported on a taxpayer’s financials. The evaluation of a tax position under
FIN 48 is a two-step process – recognition and measurement. The recognition step looks at whether it is “more likely than not” (“MLTN”) (i.e., a greater than 50 percent likelihood) that the taxpayer will sustain the benefit of a tax position assuming an examination of the tax position’s technical merits by the relevant taxing authority, including the final resolution of all appeals and litigation. If the MLTN threshold is met for a tax position with respect to the “unit of account” chosen by the taxpayer, the taxpayer then measures the tax benefit on its financials at “the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement.” Under FIN 48, the assessment of uncertain positions must be continuously updated based on any new information. FIN 48 also requires a “tabular disclosure” of the change in unrecognized tax benefits each accounting period to take into account such events as IRS settlements, expiring statutes of limitation, and prior period changes in unrecognized tax benefits.