FASB to Consider Deferral of New Tax Accounting for Uncertain Tax Positions

Implications: FASB Interpretation No. 48 ("FIN 48"), Accounting for Uncertainty in Income Taxes, is scheduled to become effective for a company's first quarter beginning after December 15, 2006 (i.e., the quarter ended 3/31/07 for calendar year companies).  The FASB announced today that it will consider deferring the effective date by one year when it meets on January 17, 2007.  The possible delay was likely prompted by numerous concerns that have been expressed to the FASB by hundreds of companies.  Implementation of FIN 48 will impact most companies' balance sheets, earnings and cash flows.



Analysis: Due to numerous concerns expressed by hundreds of companies, the FASB announced that it will consider deferring the effective date of FIN 48 by one year.  Adoption of the new interpretation would have had an immediate impact on most companies' balance sheets; in some cases, a material impact. Thereafter, earnings would have likely been impacted as well.  In addition to the balance sheet and statement of earnings impact, companies would also be required to provide far more information regarding its tax strategies in its income tax footnote disclosures.  This could lead to more effective auditing by the taxing authorities.

The FASB will likely consider whether companies have had adequate time to identify all of their uncertain tax positions.  This can be a very extensive process for any company, let alone for conglomerates and multinational companies.  In addition to identifying the positions, companies also need to quantify the appropriate amount of the additional liability for each uncertain tax position.  Concerns have also been expressed about the transparency of the footnote disclosures and their impact on future income tax audits.  The FASB has already indicated that the principal of full disclosure trumps these concerns.  So, it is likely that he FASB will focus on the former concern (i.e., time constraints).

The following is a recap of the interpretation in its current state:

Uncertain tax positions exist because of certain ambiguities in the tax code. Generally, a taxpayer must only have a "realistic possibility" of prevailing in a tax matter in order to avoid the imposition of penalties. Therefore, taxpayers often take aggressive tax positions in their tax return filings. Some companies are less aggressive and others are more aggressive; this is often driven by management's tolerance for uncertainty and the nature of a company's business activities.

Beginning in 2007, all public companies will have to comply with the provisions of FIN 48. FIN 48 will generally result in the recording of more liabilities for uncertain tax positions than its predecessor, Financial Accounting Standard ("FAS") 5. Initially, companies will be required to increase their liabilities for existing uncertain tax positions with a corresponding adjustment to retained earnings (as of January 1, 2007 for most companies). Thereafter, companies will be required to make adjustments to their liabilities for uncertain tax positions (both increases and decreases) and these adjustments may impact earnings, depending upon the nature of the tax position. Some companies will see an increase in the volatility of the their effective tax rates (ETR) while others will not. Generally, the more aggressive the company (with regard to tax positions), the more volatility it will experience in its ETR.

Not only will some companies experience more volatility in their ETRs, they will also experience an overall increase in their provision for taxes (i.e., income tax expense). This is likely for two reasons: First, companies that have been historically aggressive in their tax positions may decide to become somewhat less aggressive in their tax positions given the new accounting treatment for these positions; Second, the additional footnote disclosures required under FIN 48 may result in taxing authorities (e.g., the IRS) having greater success in detecting aggressive tax strategies.

Though not effective until Q-1 of 2007, SEC Staff Accounting Bulletin ("SAB") 74 requires companies to disclose the effects of FIN 48 in their 2006 K-1s (available in early March of 2007 for most companies). Therefore, the amount of the additional liability to be recorded in Q-1 of 2007 resulting from the transition from FAS 5 to FIN 48 should be disclosed (i.e., quantified in the tax footnote) in the 2006 K-1s.