Must Reading for IRS Agents?

FASB's new interpretation of how to account for uncertain tax positions could drain corporate earnings.
Helen ShawMay 31, 2006

Treasurers and corporate-tax officials are worrying that new Financial Accounting Standards Board disclosure requirements will supply Internal Revenue Service agents with a “roadmap” to companies’ most questionable and controversial tax positions.

FASB’s final guidance on how to account for uncertain tax positions, which will hit the street on or before June 30, could create a treacherous intersection among regulators. “At the same time you want to comply with FASB and the Securities and Exchange Commission, you don’t want to lay it all out for the IRS,” said corporate official who spoke on condition of anonymity.

During the May 16 FASB meeting, board members commented that the disclosures would provide relevant information that’s currently unavailable to users of financial statements. At the same time, the disclosures wouldn’t provide tax authorities or competitors with the unfair advantage of information conveying the reasoning behind the company’s tax positions, FASB members noted.

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Robert Willens, a tax analyst at Lehman Brothers, disagrees. “I believe the disclosures will become must-reading for all IRS agents,” he said. “An uncertain tax position will become an unsuccessful one once the IRS gets through with you,” said Willens.

Overall, the goal of the FASB project is to clarify the criteria for the recognition of tax benefits on financial statements under FASB Statement 109, Accounting for Income Taxes. The board hopes to bring order to the chaos spawned by the variety of ways accountants have developed for gauging the level of confidence for a corporation to record a tax benefit on its financial statements.

FASB’s final interpretation will require companies to analyze tax positions on their technical merits, without taking into account the possibility of whether the position will be audited. The positions must be evaluated under the standard of “more likely than not,” which means that a position would have a greater than 50.01 percent chance of prevailing in an audit. Currently, companies do not issue a judgment on the soundness of their tax positions.

Once the interpretation goes into effect, many corporations might ultimately suffer a drain of tax benefits from their net incomes. “The chances seem high to me that companies won’t meet this new standard for many of their tax positions,” says Willens. “That would lead to recording of liabilities or reduction of assets. In either case, your earnings will be penalized.”

Other problems might arise from the new FASB interpretation. Corporate executives are wondering, for instance, what level of due diligence they would have to meet to satisfy auditors that a tax benefit on a financial statement is accurate. External auditors might require more documentation thus ask for extra fees, the unnamed corporate official thinks. The company’s independent auditors have already mentioned that if it received a letter from an attorney concerning tax benefits, the auditors would want to look at the letter and conduct their own analysis of its. “Then do you lose your attorney-client privilege?” the official asked.

Multinationals that operate in various tax jurisdictions will be particularly affected by the requirements, notes Nicholas DeNovio, a partner at Latham & Watkins in Washington. He wonders, for example, what complications might arise when foreign tax authorities don’t agree with tax positions that companies have already taken. Further, the lawyer notes, such a conflict “affects not only U.S. federal taxes, but state and local taxes.”