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Tuesday, March 26, 2013

Disclosure of Uncertain Tax Positions: Are You in Compliance?


As a tax-exempt organization, you might think that the subject of “uncertain tax positions” doesn’t apply to you. Think again.

FIN 48 In a Nutshell
The Financial Accounting Standards Board (FASB) requires taxpayers that prepare their financial statements according to Generally Accepted Accounting Principles (GAAP) to adhere to Accounting Standards Codification Topic 740, Income Taxes, Subtopic 740-10—more commonly known as FIN 48. Under FIN 48, taxpayers must disclose in their financial statements information on uncertain tax positions (UTPs). While FIN 48 applies only to positions related to income taxes, the practices of some nonprofits could trigger the disclosure requirement. To determine whether your organization has UTPs under FIN 48, you must engage in a two-step process: recognition and measurement.

Recognition. First, identify the tax positions and determine whether, based on their technical merits, it is more likely than not (more than 50% likely) that the positions will be sustained upon examination by taxing authorities. Assume that your organization will be audited by authorities who have all relevant information on the position.

Measurement. For each position that fails to meet the more-likely-than-not threshold, measure the amount of potential tax liability, including taxes, interest and penalties. If the aggregate amount of all UTPs is material (that is, the omission or misstatement of the amount could influence the economic decision of users taken on the basis of the financial statements), it must be disclosed in the financial statement footnotes (and, in turn, on Schedule D of IRS Form 990). Where financial statements are consolidated, FIN 48 applies to each of the consolidated entities, and the UTPs are aggregated for the consolidated group to see if disclosure is required. Remember, FIN 48 applies only to income tax positions. Positions related to sales, use, payroll, excise and other types of taxes aren’t part of the analysis.

Uncertain Tax Positions and Unrelated Business Income
You may be surprised by the assertion that a tax-exempt organization could have an uncertain tax position. But uncertainty may exist. For example, if the nonprofit generates revenue from unrelated business operations, rather than only from operations related to its exempt purpose, it might be required to file a “tax” return, Form 990-T (and related state returns). The requirement to file the Form 990-T is based on gross receipts as opposed to net income. As a result, even operations that generate a net loss may trigger a filing requirement. Many organizations decide not to file Form 990-T based upon the assumption that the unrelated operation will never generate a profit. This is not the best decision as 1) you never know when a Net Operating Loss (NOL) will came in handy, 2) it is prudent to start the statute of limitations on a return and 3) it is a required filing. Unrelated business income can create uncertain tax positions. Uncertain tax positions regarding unrelated business income may include:

  • Allocation of expenses against unrelated business income,
  • Not filing income tax returns in a state, local or foreign jurisdiction for unrelated business activities conducted in that jurisdiction,
  • Apportionment of income earned in other jurisdictions, or
  • Deeming an activity that repeatedly generates net operating losses (NOLs) a business activity, and using the NOLs to offset unrelated business income.

The critical question is whether the organization is recognizing too much tax benefit as a result of the tax positions it takes on tax returns for unrelated business income.

Key Takeaway
If your organization has UTPs, be prepared with appropriate documentation. With the IRS requiring the reporting of your FIN 48 footnotes on Schedule D of Form 990, you can expect that any UTPs will be targeted in an audit. Your financial advisor can help ensure you have the appropriate documentation to withstand scrutiny of these positions.

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