FIN 48: What it does and what it will do

FIN 48 potentially throws firms' tax positions into sharp relief.  Relatively modest preemptive actions and changes in internal control can significantly blunt the extent to which firms are subject to undesired disclosure with respect to their tax positions.

FIN 48 specifies a two-step test that firms must use to determine the necessary accounting and disclosure for their tax positions. These tests focus on the probability that specific tax positions will be ultimately sustained by tax authorities along with the monetary value of associated tax benefits. These tests will determine whether tax benefits associated with tax positions will increase current period income or be reflected in liabilities. Beyond rules for financial statement recognition, FIN 48 specifies disclosures that firms must make in the footnotes to their financial statements. These disclosures include identifying the aggregate gross tax positions that firms assess to be uncertain as defined by FIN 48.

Concern over investors upwardly revising risk assessments, tax authorities using disclosed information as an audit roadmap, and disclosed information drawing adverse public attention from FIN 48 disclosures may result in firms taking actions to blunt the affect of FIN 48.  Two actions firms may take to mitigate these effects include the following:

1. True up tax reserves at the end of 2006 so that end of year 2006 tax reserves are near to the tax liability that will have to be reported under FIN 48 as of the start of 2007.  While truing up the reserve will likely not be observable to financial statement users, failing to do so will require an explicit adjustment to Retained Earnings on the Q1 2007 10-Q that will be readily observable. 

2. Establish policy and related internal control procedures that will tie the maintenance or taking of a tax position to the benefit recognition thresholds detailed in FIN 48’s two-step evaluation process. Specifically, if a tax position fails the benefit recognition thresholds the decision to take the position or not will be forwarded to higher management.  Doing so will insure that tax benefits are recognized as tax positions are taken and that uncertain tax positions are properly vetted.