FIN 48 Implications - LB&I Field Examiners' Guide



May, 2007

On July 13, 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes. FIN 48 is an interpretation of FASB Statement No. 109 regarding the calculation and disclosure of reserves for uncertain tax positions.

The implementation of FIN 48 is causing significant activity in the taxpayer community regarding the handling of uncertain tax positions. In other words, it is possible that taxpayers may use new approaches in managing their examinations. For example, taxpayers and their representatives may want to more tightly control the statute of limitations, especially if there is a motivation to release the contingent tax liabilities into earnings. As another example, taxpayers may request additional closing agreements on specific subject matters on a more regular and expedited basis.

Given the significant activity regarding the implementation of FIN 48, this field guide has been created to provide an awareness and examples of expected taxpayer behavior and the considerations in responding in light of existing tax law, process and procedure.

FIN 48 – Summary of Requirements

As stated earlier, FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements. FIN 48 is effective for fiscal years beginning after December 15, 2006, is applicable to all enterprises subject to US GAAP (including non-profit enterprises), and applies to all income tax positions accounted for in accordance with FASB Statement No. 109.

Evaluation of Reserve for Uncertain Tax Positions:

The evaluation of a tax position in accordance with FIN 48 is a two-step process. The first step in the evaluation process is recognition. The enterprise determines whether it is more likely than not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. In evaluating whether a tax position has met the more-likely-than-not recognition threshold, the enterprise should presume that the position will be examined by the appropriate taxing authority that has full knowledge of all relevant information.

The second step in the evaluation process is measurement. A tax position that meets the more-likely-than-not recognition threshold is measured to determine the amount of benefit to recognize in the financial statements. The tax position is measured as the largest amount of tax benefit that is greater than 50 percent likely of being realized upon ultimate settlement. Tax positions that previously failed to meet the more-likely-than-not recognition threshold should be recognized in the first subsequent financial reporting period in which:

(a) the threshold is met (for example, by virtue of another taxpayer’s favorable court decision)
(b) the position is “effectively settled” by virtue of the closing of an examination where the likelihood of the taxing authority reopening the examination of that position is remote; or
(c) the relevant statute of limitations expires.

Previously recognized tax positions that no longer meet the more-likely-than-not recognition threshold should be derecognized in the first subsequent financial reporting period in which that threshold is no longer met.

Disclosure of Reserve for Uncertain Tax Positions:

The disclosure provisions of FIN 48 provide more information about the uncertainty in income tax assets and liabilities. Besides requiring an enterprise to accrue interest and penalties (where warranted) in the financial statements with respect to unrecognized tax benefits the following disclosures are required:

(a) A tabular reconciliation of the total amounts of unrecognized tax benefits at the beginning and end of the period, which shall include at a minimum:

  1. The gross amounts of the increases and decreases in unrecognized tax benefits as a result of tax positions taken during a prior period.
  2. The gross amounts of increases and decreases in unrecognized tax benefits as a result of tax positions taken during the current period
  3. The amounts of decreases in the unrecognized tax benefits relating to settlements with taxing authorities
  4. Reductions to unrecognized tax benefits as a result of a lapse of the applicable statute of limitations

(b) The total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate;

(c) The total amounts of interest and penalties recognized in the statement of operations and the total amounts of interest and penalties recognized in the statement of financial position;

(d) For positions for which it is reasonably possible that the total amounts of unrecognized tax benefits will significantly increase or decrease within 12 months of the reporting date:

  1. The nature of the uncertainty;
  2. The nature of the event that could occur in the next 12 months that would cause the change;
  3. An estimate of the range of the reasonably possible change or a statement that an estimate of the range cannot be made;


(e) A description of tax years that remain subject to examination by major tax jurisdictions

The provisions of FIN 48 shall be applied to all tax positions upon its initial adoption. Only tax positions that meet the more-likely-than-not recognition threshold at the effective date may be recognized or continue to be recognized upon adoption of FIN 48. The cumulative effect of applying the provisions of FIN 48 shall be reported as an adjustment to the opening balance of retained earnings (or other appropriate components of equity or net assets in the statement of financial position) for the year of adoption, presented separately.

Potential Taxpayer Concerns and Questions – Implications of FIN 48 on IRS Examinations

Under FIN 48, one occasion when the remaining benefits of uncertain tax positions can be fully and finally recognized in US GAAP financial statements is when an enterprise determines that “effective settlement” of the uncertain position occurs. FIN 48 states:

An enterprise shall evaluate all of the following conditions when determining whether effective settlement has occurred:

(a) The taxing authority has completed its examination procedures including all appeals and administrative reviews that the taxing authority is required and expected to perform for the tax position.

(b) The enterprise does not intend to appeal or litigate any aspect of the tax position included in the completed examination.

(c) It is remote that the taxing authority would examine or reexamine any aspect of the tax position. In making this assessment management shall consider the taxing authority’s policy on reopening closed examinations and the specific facts and circumstances of the tax position. Management shall presume the relevant taxing authority has full knowledge of all relevant information in making the assessment on whether the taxing authority would reopen a previously closed examination.

In the tax years under examination, a tax position does not need to be specifically reviewed or examined by the taxing authority to be considered effectively settled through examination. Effective settlement of a position subject to an examination does not result in effective settlement of similar or identical tax positions in periods that have not been examined.

In general terms, this means that when an IRS examination is closed there has been effective settlement of all uncertain tax positions for the examined year, whether such uncertainties are known to the IRS and examined or not, so long as the conditions in the immediately preceding quote are present.

As an example, assume a taxpayer did not report dividend income on its tax return based on an ambiguous tax law. Furthermore, assume the position meets the requirements of FIN 48 and accordingly, the taxpayer creates a reserve for uncertain tax positions related to this item. The tax year is audited by the Service, but the Service does not propose an audit adjustment and closes the case. Assume also that the issue is not likely to meet any of the exceptions to the Service’s policy against reopening examinations. Since the examination is closed and it is remote that the Service would reopen an examination of the issue, the taxpayer can reverse that contingent tax liability and record the tax benefit at this point in time on the US GAAP financial statements because the uncertainty is now effectively removed.

Another occasion when the remaining benefits of uncertain tax positions can be fully and finally recognized in US GAAP financial statements is when the statute of limitations terminates on those positions.

Therefore, it should be anticipated that taxpayers and their representatives will use various approaches to reach and document effective settlement of specific issues and entire examinations as early as possible, and that they may be less willing than previously to extend the statute of limitations to points beyond an expected examination closing date.

Listed below are some common questions and answers related to the requirements of FIN 48. Many of the questions and answers relate to approaches taxpayers may use to quickly gain certainty about the final outcome of uncertain tax positions in light of the requirements of FIN 48. Note that each approach should be handled in a manner appropriate to the taxpayer based on the facts and circumstances of the case, considering the Service’s need to fully examine and properly resolve tax issues, as well as taxpayer burden. In addition, the Service’s response to these possible approaches should coincide with current initiatives set out by LB&I.

Question #1:

Are FIN 48 Disclosures a Roadmap for the IRS?

Answer #1:

The disclosures required under FIN 48 should give the Service a somewhat better view of a taxpayer’s uncertain tax positions; however, the disclosures still do not have the specificity that would allow a perfect view of the issues and amounts at risk. For example, there may be a contingent tax liability listed in the tax footnotes of a large multi-national taxpayer with a description called “tax credits”; however, tax credits could be US, foreign, or state tax credits. So the “tax credits” in this example may or may not in this case have a US tax impact.

Even with the lack of specificity, tax footnotes included in financial statements, including FIN 48 disclosures, should be carefully reviewed and analyzed as part of the audit planning process. For example, if a taxpayer reflecting a contingent tax liability in the year under audit for Subpart F income does not reflect Subpart F in the tax return, questions could develop about why Subpart F income does not appear in the tax return, but is mentioned in the tax footnotes as creating a contingent tax liability.

Revenue Agents should not be reluctant to pursue matters mentioned in FIN 48 disclosures, but should be mindful of our policy of restraint on Tax Accrual Workpapers (TAW) and not cross over the boundaries contained there. If for example, there is discussion in the tax footnotes about a contingent tax liability being reversed because the statute of limitations related to the transfer of an intangible asset has expired, even though the statute may have run on that particular issue, this provides insight into how the taxpayer may be treating other intangible assets in other years where the statute of limitations is still open. In this example, this is public information that can be used without violating the TAW’s policy.

Question #2:

What is the impact of FIN 48 on the Service’s tax accrual workpaper (“TAW”) policy?

Answer #2:

The Service’s TAW policy may be found at IRM 4.10.20. Since FIN 48 is new, we will have to experience and study FIN 48 disclosures as they are published. However, FIN 48 workpapers are tax accrual workpapers, and they are subject to the policy of restraint covering TAW.

On the other hand, FIN 48 Disclosures reported in quarterly and/or annual financial statements, and any other public documents, are not subject to the policy of restraint, and should be considered by examiners and others when conducting risk assessments. These FIN 48 disclosures might lead into discussions with appropriate taxpayer personnel during an examination, a CAP engagement, a PFA process or other taxpayer interaction.

Question #3:

Is it permissible to sign restricted consents to extend the statute of limitations?

Answer #3:

The Service has a policy regarding restricted consents:

IRM – Situations when the Service may Request Restricted Consents:

  1. Generally, the Service will not solicit restricted consents.
  2. The Service may request a restricted consent to one or more issues where, in light of reasonable tax administration, resolution of such issue or issues requires establishment of a Service position through court decision, regulation, ruling or other Headquarters action, or where other equally meritorious circumstances exist. See Rev. Proc. 68-31 (modified by Rev. Proc. 77-6 for other matters).

IRM – Period of Limitation on Joint Committee (JC) Cases (10-22-2001)

Do not use restricted consents in Joint Committee cases.

Restricted Consents – If an issue has been identified by the agent and the assessment period is about to expire, the taxpayer has the right to request a consent to extend the assessment period restricted to specific issue(s) only, while the statute of limitation is allowed to expire on all other issues. Although the taxpayer has the right to request a restricted waiver, and indeed the Service must notify the taxpayer of the opportunity, the Service has the right to limit the circumstances in which it will agree to enter into a restricted consent. Restricted waivers will only be entered under certain conditions, which are as follows: (1) the number of unresolved issues must not make it impractical for the Service to enter into a restricted waiver; (2) the specific unresolved issues covered in the restricted consent must be clearly described so that there will be no later dispute about what issues are covered in the restricted consent; (3) the issues on which the statute of limitations will be allowed to expire must be agreed, and the assessment of any deficiency or, under certain circumstances, the scheduling of refund or credit of the amount of an overassessment provided for; (4) the agent’s use of a restricted consent is approved by the agent’s group manager; and (5) the language of the restricted consent must be approved by Area Counsel.

Whether it is acceptable in a particular case depends on all the facts and circumstances involved. Determining factors include but are not limited to:

(a) what our working relationship has been like;

(b) the nature of the issues involved;

(c) whether the taxpayer has been forthcoming in identifying its uncertain tax positions;

(d) where we are in the audit plan timeline;

(e) how many issues are left to examine; whether Notices of Proposed Adjustments are signed when they are agreed to or left to linger until the end of the exam.

While we understand that unrecognized tax benefits present contingent liabilities on balance sheets for which interest must be regularly accrued, and perhaps penalties, and while that may have an impact on loan covenants and net worth, we have to protect the government’s right to having the time necessary to adequately examine returns for compliance.

We have processes in place to speed up examination and resolution of issues, both on a pre-filing and post-filing basis, and taxpayers who use those processes will undoubtedly conclude their examinations more quickly, allowing for speedier cleanup of contingent tax liabilities. Taxpayers should be encouraged to use our programs and processes to gain speed in resolving tax issues. See question #7 below.

Counsel should be consulted if a taxpayer insists on the use of a restricted consent.

Question #4:

What is the Service’s policy regarding the use of Closing Agreement(s)?

Answer #4:

The Service has the discretion to decide whether to sign a closing agreement. The Service is generally reluctant to enter into closing agreements. As a matter of policy, the Service will enter into a closing agreement only if there appears to be an advantage in having the case “permanently and conclusively” closed, or “good and sufficient reasons” are shown by the taxpayer for entering into a closing agreement and it is determined that the U.S. Government will suffer no disadvantage by entering into the agreement.

IRC Section 7121 is not a mandate by Congress, but is rather an authorization to enter into closing agreements. Although Congress authorized the Service to enter into these agreements, it allowed the Service the discretion to reject a taxpayer’s request for an agreement or to impose conditions on a taxpayer before executing the agreement. Similarly, it is left to the Service to determine whether the U.S. Government will sustain a disadvantage as a result of a closing agreement.

Question #5:

Can a closing agreement contain a stipulation by the IRS that, although the statute of limitations has not legally expired, it is deemed to be expired and further examinations of the subject year(s) is consequently barred?

Answer #5:

No. Counsel has stated that we have no authority to make such agreements.

Question #6:

Is it permitted to close a case by executing a Form 866, Agreement as to Final Determination of Tax Liability, if the taxpayer requests that be done?

Answer #6:

This action would completely bar the Service and the taxpayer from later changing the tax liability for that tax year for any reason.

This Form has rarely been used by the field and the field avoids the issuance of qualified liability determinations in a Form 866.

Counsel should be consulted if a taxpayer insists on the use of this Form.

Question #7:

How can we help taxpayers gain certainty more quickly in regard to their FIN 48 unrecognized tax benefits?

Answer #7:

We have witnessed through our FIN 48 initiative that some taxpayers do want certainty sooner because of FIN 48. We have also proven through our FIN 48 initiative that we can examine and resolve issues very speedily when taxpayers are transparent about the details of the issues that matter greatly to them. Accordingly, we anticipate that taxpayers will desire to have certainty regarding otherwise uncertain tax positions much sooner on average than in the past since the financial statements can be negatively affected much more than was the case in the past by continuing uncertainty.

We can remind taxpayers that candor, transparency and the right motivations, coupled with programs and processes we have in place today can quickly generate certainty on tax issues. Those programs and processes include:

(a) Pre-filing:

  1. Industry Issue Resolution
  2. Pre-filing Agreements
  3. Advance Pricing Agreements
  4. Compliance Assurance Program

(b) Post-filing:

  1. Joint Audit Planning
  2. LIFE
  3. Advanced Issue Resolution
  4. Appeals Fast Track Program
  5. Accelerated Issue Resolution
  6. Early Referral to Appeals

Question #8:

There is an interesting thing about FIN 48 and undisclosed Listed Transactions. Under the Jobs Creation Act, the statute of limitations is extended until one calendar year after the IRS receives proper disclosure of Listed Transactions. So if a closed transaction should become a Listed Transaction, until one year after proper disclosure to the IRS, interest must be accrued in the P&L on the unrecognized tax benefit (perhaps all of the benefit because the “more likely than not” threshold may not have been met) under the rules of FIN 48, and the tax benefit taken on the return will never be recognizable in the financial statements. So, in that circumstance, each year the accrued interest gets larger and the P&L is negatively impacted.

Has the Service considered this issue?

Answer #8:

LB&I has consulted with FASB on this point and they agree that that is the result. As good taxpayer service, and in order to ensure that we obtain disclosure about Listed Transactions, it may be a good practice to remind taxpayers about this provision affecting Listed Transactions and the way they impact on the application of FIN 48 in their financial statements.

Question #9:

Will the IRS reopen an examination cycle that has been closed because of disclosures that are made in financial statements in accordance with FIN 48?

Answer #9:

Our longstanding policy is that we do not reopen tax years that have been examined and closed. IRM, P-4-3 (12-21-1984). However, there are exceptional circumstances stated in this policy, the existence of which would allow us to reopen an examination for a tax year that was previously examined and closed. The Service has no plans to modify its policy against reopening examinations.

However, since FIN 48 does require more information to be disclosed about uncertain tax positions than was the case before FIN 48 was issued, it is possible that reopenings will occur more frequently because of the potentially increased availability of information warranting reopening.

Question #10:

Where can one learn more about FIN 48?

Answer #10:

In general – Further information is available on the websites of the FASB, the AICPA and numerous research services.

IRS FIN 48 Internet Site