Accounting for uncertain tax positions has never been a cut-and-dried exercise. But now another wrinkle — this time having to do with state tax authorities — seems ready to emerge.
State legislators and tax authorities have become more aggressive about implementing and enforcing corporate tax laws, says Phil Zinn, the state and local tax practice leader at PricewaterhouseCoopers. The likely reason: a need to replenish state coffers and a desire to curb corporate tax abuses. These two high-profile state issues put the spotlight on FIN 48, the year-old clarification of Statement No. 109, the Financial Accounting Standards Board’s rule on uncertain tax positions.
FIN 48 is meant to improve comparisons between companies by making tax treatment more consistent, and it does that by setting recognition and measurement guidelines. However, state agencies may be able to take advantage of the additional transparency FIN 48 provides to get a more detailed look at how companies account for tax assets and liabilities. That could lead to more state challenges of corporate tax deductions.
Essentially, FIN 48 attempts to achieve tax treatment consistency by setting recognition thresholds and measurement guidelines via a two-step process. First, FIN 48 states that a company may book a tax benefit only if the deduction is “more likely than not” to survive an Internal Revenue Service audit. The company must assume that every uncertain tax position will be examined by the IRS. In other words, the company must calculate the possibility that its tax position will pass muster with the IRS — not the odds that the agency will find it in the first place.
In the measurement step, a company must determine how much of the tax benefit should be recognized in the financial statements. The FIN 48 formula says that the company may deduct the highest amount that has at least a 50 percent chance of being approved by the IRS in the final tax settlement.
The added transparency created by FIN 48 could mean that states will need less coaxing to dig deeper into corporate tax issues. One area that might be ripe for further examination is tax nexus, says David Dahn, a partner at tax advisory firm Dahn & Leahy LLP. There is a wide variety of corporate activities that create a connection — or nexus — that would subject a company to state taxes. For example, some states require that companies combine the tax returns of similar business units, which could trigger sales and use taxes, as well as income taxes. “Gone are the days of using a flat ’5 percent’ state tax rate,” he asserts. “The driver for state taxation is apportionment, and determining what a company does to ultimately trigger nexus within a particular jurisdiction.”
Corporate restructuring projects are another area of interest to states, says John Zefi, director of the state and local tax practice at auditing firm BDO Seidman. “Companies get in trouble because they set up a restructuring project to help reduce their tax rates but then forget to revisit the project once it’s completed,” he explains. As a result, companies forget to monitor the changes in state statutes and often get caught up in uncertain tax positions linked to new laws. “CFOs need to be proactive in managing their tax departments,” counsels Zefi.