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Wednesday, October 6, 2010

FASB provides nonpublic entities some guidance and some relief

On September 2, 2009, FASB issued Accounting Standards Update (ASU) No. 2009-06, Implementation Guidance on Accounting for Uncertainty in Income Taxes and Disclosure Amendments for Nonpublic Entities. The ASU reports on some important amendments to the new FASB Accounting Standards CodificationTM (ASC).

According to FASB, the ASC is now the single source of authoritative nongovernmental U.S. Generally Accepted Accounting Principles (GAAP). It was released July 1, 2009, and goes into effect for financial statements issued for interim and annual periods ending after September 15, 2009. The ASC replaces the patchwork of FASB Statements of Financial Accounting Standards (FASs), Staff Positions (FSPs), Interpretations (FINs) and other guidance that previously defined GAAP. ASUs are reports that, among other things, detail specific amendments to the ASC, but they aren’t authoritative in and of themselves.

Some of the amendments covered in ASU 2009-06 provide guidance for pass-through entities, such as partnerships and S corporations, and tax-exempt nonprofits on how to apply rules related to what previously was referred to as FIN 48, Accounting for Uncertainty in Income Taxes. But perhaps the most important amendment is one that exempts nonpublic entities from certain onerous reporting requirements that apply to public entities.

FIN 48 Basics

FIN 48 was developed to ensure more consistency in how benefits related to income tax positions are accounted for. Specifically, in some cases, the relevant tax law is subject to varied interpretation, and an entity may be uncertain about whether a tax position it takes ultimately will be sustained and, in turn, whether to recognize the benefit of the tax position.

Under codification, FIN 48 has been incorporated into ASC Topic 740, Income Taxes, as Subtopic 740-10. Accordingly, the ASC requires entities following GAAP to identify uncertain tax positions and disclose any potential tax liability on their financial statements. The ASC outlines a two-step process, comprising recognition and measurement.

Generally, uncertain tax positions are those that aren’t certain to be upheld by the applicable authorities. A tax position isn’t considered uncertain — and therefore the taxpayer may recognize the related tax benefit — if it’s more likely than not that the position will be upheld on examination by the authorities, including resolution of any related appeals or litigation processes, based on the technical merits of the position. “More likely than not” is defined as a more than 50% likelihood of success.

The taxpayer must measure a tax position that meets the more-likely-than-not standard to determine the amount of tax benefit to recognize in its financial statements. The tax position is measured as the largest amount of benefit that is greater than 50% likely of being realized on ultimate settlement.

The disclosure requirements expressly apply to business enterprises including public companies, pass-through entities and nonprofit organizations that are potentially subject to income tax. They also extend to entities whose tax liability is subject to 100% credit for dividends paid including real estate investment trusts (REITs) and registered investment companies that are potentially subject to income tax.

FIN 48 took effect for public companies for fiscal years beginning after December 15, 2006, but the effective date for most nonpublic entities was deferred until annual financial statements for fiscal years beginning after December 15, 2008. The deadline is unchanged under codification or by the amendments reported in ASU 2009-6, which means all calendar year 2009 nonpublic entities following GAAP must comply with the disclosure requirements.

Addressing Nonpublic Entity Challenges

In December 2008, FASB solicited feedback on the challenges that FIN 48 would present private and nonprofit entities. FASB chose to address three of the most commonly identified issues in proposed FSP FIN 48-d. The FSP was released in May 2009 for a 30-day comment period.

After reviewing the comments, in September FASB amended the ASC to address the following issues, among others:

Issue 1: Attribution of income taxes to the entity or its owners. The amendments clarify that management of a pass-through entity must determine whether the laws and regulations of each taxing jurisdiction attribute income tax to the entity itself or to its owners. Accordingly, if the laws and regulations attribute the taxes to the entity, the amounts due to or from the taxing jurisdiction are classified as income taxes, and the uncertain tax position disclosure provisions of the ASC apply.

If the laws and regulations attribute the taxes to the owners, the amounts due are classified as a transaction with the owners, and the disclosure provisions generally won’t apply.

Keep in mind that it’s the laws and regulations of the taxing authority that determine whether the income taxes are attributable to the entity or its owners, not who actually pays the income taxes.

Issue 2: Definition of a tax position. Under the ASC, the term “tax position” refers to “[a] position in a previously filed tax return or a position expected to be taken in a future tax return that is reflected in measuring current or deferred income tax assets and liabilities for interim or annual periods.” Generally, a tax position creates an income tax deferral or a permanent income tax savings.

The ASC provides some additional, specific examples of tax positions:

  • A decision not to file a tax return,
  • An allocation or a shift of income between jurisdictions,
  • The characterization of income or a decision to exclude reporting taxable income in a tax return, and
  • A decision to classify a transaction, entity or other person in a tax return as tax-exempt.

The amendments add to this list an entity’s status, including its status as a pass-through entity or a tax-exempt nonprofit.

Issue 3: Financial statements of a group of related entities. The amendments clarify that consolidated or combined financial statements must take into account all tax positions for each entity within the group that is subject to income taxes or that has income tax assigned to it from a pass-through entity. This is true even if the reporting entity is a pass-through entity or a tax-exempt nonprofit. The ASU includes several examples that provide further guidance on these issues.

Eliminating Certain Disclosure Requirements

The amendments also provide some relief to nonpublic entities by eliminating certain onerous disclosure requirements. Nonpublic entities won’t have to provide a tabular reconciliation of the total amount of unrecognized tax benefits at the beginning and end of the periods presented or disclose the total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate. Under the amendments, only public entities must disclose such information.

According to FASB, it learned from users of nonpublic company financial statements that these disclosures wouldn’t provide information useful for making decisions. The elimination of these requirements should be welcome news to nonpublic entities, because including such disclosures would likely have cost them substantial time and money when they prepared their financial statements.

Forewarned is Forearmed

For all entities already following the uncertain tax position disclosure requirements, the amendments are effective for financial statements issued for interim and annual periods ending after September 15, 2009. For other entities, it will apply on their initial adoption of the requirements. Achieving and maintaining compliance can prove time-consuming and will likely require many resources. If your organization hasn’t yet begun its compliance efforts, now is the time.


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