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The Financial Accounting Standards Board (FASB) has issued Interpretation No. 48 (Accounting for Uncertainty in Income Taxes), which is designed to increase transparency and consistency in the reporting of income tax positions. FIN 48 applies to all enterprises, for-profit and tax-exempt, that issue financial statements that are intended to comply with generally accepted accounting principles (commonly referred to as GAAP). FIN 48 is generally effective for fiscal years beginning after Dec. 15, 2006. Enterprises that prepare their financial statements in accordance with GAAP have long been required to accurately report their tax benefits and liabilities. FASB Statement No. 109, issued in 1992, requires all financial statements to reflect current and deferred income tax liabilities and benefits. However, many of the notorious corporate scandals of the past several years, such as those involving Enron and WorldCom, and the proliferation of corporate tax shelters, highlighted the lack of clear guidelines with respect to when and how tax positions should be reported. FIN 48 is intended to provide such guidance. Both FASB Statement No. 109 and FIN 48 apply to the reporting of any tax position relating to federal, state or local income taxes (property taxes, sales taxes and other transfer taxes are not covered). For purposes of FIN 48, the term “tax position” refers to a position taken in a tax return that creates either tax benefits or liabilities. A tax position can result in a reduction of income taxes payable, a deferral of income taxes otherwise currently payable or a change in the expected realization of tax benefits. A tax position includes, but is not limited to, any of the following: A decision not to file a tax return; An allocation or a shift of income between taxing jurisdictions; The characterization of income or a decision not to include taxable income in a tax return; and A decision to classify a transaction, entity or other position in a tax return as tax exempt. FIN 48 requires an enterprise to apply a two-step analysis to all of its tax positions. First, an enterprise will be required to recognize a tax position for financial statement purposes only when it is more likely than not that the position will be sustained upon examination. Second, an enterprise must measure the reportable impact of any tax position that meets the more likely than not recognition threshold. The term more likely than not means that there is more-than 50 percent likelihood that the tax position will be sustained upon examination of the facts by the relevant taxing authority, including the resolution of any related appeals or litigation. In assessing whether a tax position is more-likely-than-not to be realized, FIN 48 requires a presumption that the tax position will be examined by the relevant taxing authority, who will have full knowledge of all relevant information. In assessing the degree of likelihood that a tax position will be sustained, the enterprise must consider all of the technical merits of the tax position based upon statutory authority, legislative intent, regulations, rulings and case law. Past administrative practices and precedents of the taxing authority in its dealing with the enterprise or similar enterprises may also be taken into account. After a tax position has satisfied the more likely than not recognition threshold, the second step of the analysis required under FIN 48 is that the impact of the tax position must be measured for reporting purposes. Where an enterprise has taken a tax position that it believes is based upon clear and unambiguous tax authority, the enterprise may report the full (i.e., 100 percent) impact of the tax position. However, the impact of a tax position that meets the more likely than not threshold but the favorable resolution of which is not highly certain must be measured and reported as the largest amount of tax benefit that is greater than 50 percent likely to be realized upon an ultimate settlement with the relevant taxing authority. The measurement of an “uncertain” tax position that meets the recognition threshold must consider the amounts and probabilities of the outcomes that could be realized upon ultimate settlement with the taxing authority. This measurement aspect of FIN 48 can be illustrated by the following example contained in FIN 48: An enterprise has determined that a tax position resulting in a benefit of $100 would, more likely than not, be sustained upon examination but the full realization of the benefit is still uncertain. Because $60 is the largest amount of benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement, the enterprise would report a tax benefit of $60 in its financial statements. If the more-likely-than-not recognition threshold is not met in the reporting period for which a tax position is taken, an enterprise will be required to recognize the benefit of the tax position in the first reporting period that meets any one of the following three conditions: The more likely than not recognition threshold is met by the reporting date within the subsequent period; The tax matter is ultimately settled through negotiation or litigation; and The statute of limitations for the relevant taxing authority to examine and challenge the tax position has expired. Conversely, an enterprise that has recognized a tax benefit because it satisfied the more likely than not recognition threshold in a prior reporting period is required to “derecognize” the tax position in the first reporting period in which it is no longer more likely than not that the tax position would be sustained upon examination. Subsequent recognition, de-recognition and measurement shall be based on management’s best judgment given the facts, circumstances and information available at the reporting date. Although FIN 48 is first applicable to fiscal years beginning after Dec. 15, 2006, in reality, FIN 48 must be applied not only to tax positions initially taken in the first fiscal year subsequent to the effective date but also with respect to tax positions taken in every prior period that remain open to examination by the relevant taxing authority. In general, most income tax matters are subject to a three-year statute of limitation, running from the date of the filing of the enterprise’s income tax return reflecting the tax position. It is important to note that FIN 48 only provides guidance with respect to the recognition of tax positions for financial reporting purposes and not for the purposes of preparing and filing income tax returns. In many instances, an enterprise may take a tax position in its tax return that does not satisfy the more likely than not threshold. For example, a tax practitioner will be sanctioned for signing a tax return only if the return contains a tax position that has no “realistic possibility” of being sustained on the merits. This threshold merely requires that the practitioner believes that the tax position has at least a one-in-three chance of being sustained on its merits. Similarly, the “realistic possibility” standard is applied to avoid the negligence penalty when the taxpayer takes a tax position that is contrary to published rulings or notices. The more stringent more likely than not standard is relevant for tax return preparation purposes only in the area of tax shelters and other “listed transactions.” If, as a result of applying FIN 48, the amount of the tax benefit recognized in a financial statement differs from the amount taken or expected to be taken in a tax return, the difference represents either an unrecognized tax benefit or tax liability which must be disclosed on the financial statement. In addition, FIN 48 contains a list of other disclosure requirements applicable to an enterprise’s tax positions, including the disclosure of any interest or penalties that may be required to be recognized as a result of the tax positions. Although FIN 48 is intended to provide greater transparency and consistency in the reporting of tax positions, it will also impose significant burdens on businesses and tax exempt organizations and additional obligations on tax practitioners. As summarized above, FIN 48 will require all enterprises to catalog all of their tax positions and to engage in the mandated two-step analysis concerning the recognition and measurement of the tax positions. Although FIN 48 specifically states that a legal tax opinion is not required to demonstrate that the more likely than not recognition threshold is met with respect to any tax position, legal opinions are cited as external evidence that can be used to support management’s judgment with respect to a tax position. Accordingly, tax practitioners will likely be called upon more frequently to render formal tax opinions to support tax positions taken for financial reporting purposes. This possibility also raises interesting issues concerning privileged communications since such tax opinions will likely be disclosed to auditors and such disclosure could jeopardize the attorney-client privilege with respect to the subject matter of the opinion. MARK L. SILOW is the administrativepartner and chief operating officer of FoxRothschild. Silow formerly was chairman of thefirm’s tax and estates department. Silow’s workinvolves a broad range of commercial and tax matters including business and tax planning, corporate acquisitions and dispositions, real estate transactions, estate planning and employee benefits.

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