FIN 48 Raises IRS Scrutiny for Private Enterprises

By J. Scott Harrison, Cherry, Bekaert & Holland, L.L.P. (CB&H)
Email: jsharrison@cbh.com

In 2006, FASB released Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48). Aimed at inconsistencies in accounting for uncertain tax positions (UTPs) from one company to another, this interpretation introduced the “More-Likely-Than-Not” recognition standard, which allows for a consistent approach in identifying and reporting UTPs.

FIN 48 is effective for years beginning after December 15, 2006 for public enterprises. For nonpublic (private) enterprises, including S corporations, partnerships, C corporations, not-for-profit entities, REITs, RICs, LLPs and LLCs, the effective date is for years beginning after December 15, 2007. If your company issues financial statements under U.S. GAAP, then achieving compliance with FIN 48 will be necessary beginning this year.

In most cases, the FIN 48 compliance process will provide management with a fresh look at their company’s tax exposure. Once UTPs have been identified, steps can be taken to minimize or reverse the listed exposures based on technical merit. The majority of the time will be spent documenting and monitoring these positions. Future UTPs will need continued careful analysis and monitoring.

Due to their size, private enterprises face some unique characteristics and challenges, and may find that they lack the resources required to implement FIN 48. They also tend to have weaker internal controls, since they are exempt from SOX 404 rules, and often do not have a tax audit history to reference. And since the shareholders of private companies tend to be more concerned with cash tax savings rather than the published earnings reports, private companies may be more prone to aggressive tax planning.

Best Practices
Achieving FIN 48 compliance is no small task, but it’s important that you view this process as an opportunity to catalog and examine all of your organization’s possible UTPs so as to clearly see what risks are present. This will take some time depending on a variety of factors.
Two valuable lessons can be gained from recent FIN 48 implementation experiences at public companies. First, it is always best to start the FIN 48 process early. Given the potential time needed to appropriately implement FIN 48, it is critical to initiate the process as soon as possible to accommodate potential resource constraints – especially if your organization will rely heavily on outside resources.

Obviously, if your company operates in only one tax jurisdiction and employs minimal tax strategies, then the implementation would not take as long as it would for companies with multiple tax jurisdictions and an aggressive tax planning approach. For example, FIN 48 will have less of an impact in those industries where the legal entity structure favors partnerships. FIN 48 still applies, but implementation will be less burdensome.

Secondly, it’s important to identify areas of the company which operate with autonomy. Here there will be situations, such as international operations and other decentralized operations, where segments are physically removed from the main business operations. In these scenarios, the data gathering may be hindered and could consume substantial amounts of time.

A comprehensive action plan involving relevant client employees and coordination with external auditors is a must for any successful implementation. The overall time required for implementation will be influenced by the company’s historic practices, methodologies, and controls with respect to UTPs. Management will need to change its mindset towards accounting for tax uncertainties from a liability to a recognition model. Proper tracking within the plan will assure that benchmarks and phases are completed timely.

Impact So Far
The FASB delay for private entities has extended the FIN 48 adoption burden into 2008, with the adoption reportable on the annual GAAP financial statements for years beginning after December 15, 2007. Therefore, 2008 will be a busy year for FIN 48 compliance engagements, so companies should notify their auditors early to avoid a crunch later in the year.
Moreover, please note that should a private company have publicly traded Industrial Revenue Bonds, the publicly traded nature of these bonds classifies the entity as a public enterprise. Therefore, the company will be treated as public for FIN 48 purposes, with 2007 as the required implementation year.

Conclusion
The key to a well-run FIN 48 engagement is that proper time and attention is provided through upfront planning. By avoiding the pitfalls of poor planning, we can eliminate last-minute fire drills and minimize stressful situations. Once the planning process is complete, then the discovery phase will begin. After this, checklists are utilized to address all possible scenarios where UTPs may occur.

Each UTP should then be listed and examined separately. A descriptive analysis is written on each one describing in detail the history, how it is treated currently, and the impact it has on the financial statements. From there, the process of identifying UTPs occurs with adjustments to the financial statements made as appropriate. Internal controls will need to modified and established for future discovery and monitoring of UTPs going forward, but the end result will be a smooth engagement.

Scott is a Senior Tax Manager with CB&H’s Private Business Group and Director of the Firm’s FIN 48 Practice.