Companies taking an aggressive position on their tax returns will need to be more conservative and more consistent in reporting the benefit on their financial statements if a proposed position by the Financial Accounting Standards Board is finalized as drafted.
FASB issued a draft interpretation titled, “Accounting for Uncertain Tax Positions,” which says companies must meet a higher level of certainty that a tax benefit will pass muster with the Internal Revenue Service if they want to recognize the benefit on financial statements. Specifically, FASB says the tax position must meet a “probable recognition threshold,” which is loosely defined as certainty of about 70 to 75 percent.
Rules for tax reporting and for financial reporting are separate and set by different entities, said Dan Noll, director of accounting standards with the AICPA. While financial reporting standards are governed by FASB and the Securities and Exchange Commission, tax reporting is governed by the Internal Revenue Service and the U.S. Treasury Department.
Ochsenschlager
In tax reporting, companies generally follow a standard that they can take a deduction if there’s a one-in-three chance it will fly with tax authorities, said Tom Ochsenschlager, vice president of taxation with the AICPA. That means companies may legitimately take a stronger position on their tax returns than on their financial statements.
The gap in certainty, however, leaves companies with a judgment call to make in how to report the tax position on their balance sheet. Is it a benefit or liability? “FASB is saying companies have been all over the map,” Ochsenschlager said. The new interpretation is intended to more clearly define and raise the threshold of certainty companies must meet before they can report a tax benefit on their balance sheets, he said.
Bread Crumb Trails
As an example of how the certainty threshold differs in financial vs. tax reporting, Ochsenschlager said a company might decide to purchase new machinery for a manufacturing plant, but it will need to make $1 million in modifications to a building to house the new equipment. Some in the tax field would argue the $1 million cost should be expensed immediately as a repair cost, resulting in an immediate tax benefit of about $350,000. Others would hold it should be capitalized over the life of the building, which would significantly delay the realization of the tax benefit.
The company may choose to claim the immediate deduction with tax authorities according to tax law, but FASB says in its draft interpretation they must be at least 70 to 75 percent certain it will pass IRS unchallenged if they want to report it as a tax benefit on their financial statements, Ochsenschlager said. If they’re not at least that certain, they must show it as a prospective liability on the financial statements.
Ciesielski
The rule change would prevent companies from stalling the appearance of bad news on their balance sheets, according to Jack Ciesielski, owner of research and advisory firm R.G. Associates.
“A firm could take an aggressive position on a tax matter, one that they know wouldn’t stand up if inspected, and the Treasury is often outgunned by the firm, which has more resources at its disposal,” he said. “Maybe the Treasury would prevail in the long run, but the position could be effectively stalled by the firm for years while it issues financials with a position that they know wouldn’t hold water when examined.”
Ciesielski said FASB’s interpretation won’t be well liked by corporations because required disclosures will “provide a bread crumb trail for revenue-hungry tax auditors,” Ciesielski wrote in a monthly report he issues. However, they likely won’t protest very loudly either, for fear of calling attention to their tax strategies.
Instead, Ciesielski predicts companies with unreported aggressive positions may start doing a “quiet tax housecleaning” to taper off the effect on their balance sheets. “Firms showing sharp changes in their tax positions after the standard is effective would be wearing bulls-eyes on their backs for the IRS to see,” he wrote.
The proposed interpretation and original accounting standard, issued back in 1992, are available from the box above, right.
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