FIN 48, Accounting for Uncertainty in Income Taxes has been the subject of considerable controversy in financial circles, a fact acknowledged even by the chief economist of the U.S. Securities and Exchange Commission, a primary supporter of the new accounting rule.

While stressing that the opinions he expressed were his own and not necessarily those of the SEC, Chester Spatt, chief economist and director of the SEC’s Office of Economic Analysis, said in a speech on March 8, 2007, that the new standard “appears to reduce the (reporting) firm’s and, indeed, the auditor’s discretion” in dealing with uncertain tax positions.

Seeking Clarification of Earlier Rules “FIN 48 is actually a Financial Accounting Standards Board (FASB) interpretation intended to clarify two major pronouncements, FAS 109 and the even older FASB 5, which deals with contingencies,” explains Mike Bernstein, the partner in charge of audit practice in New York for Amper, Politziner & Mattia, one of the largest independent CPA and consulting firms in the New York / New Jersey region.

When it first appeared on the FASB agenda, FIN 48 was not expected to be controversial. “The main objective seemed to be getting some improved comparability and consistency in how companies approached certain tax matters,” Bernstein explains.

“ The controversy arises from the fact that FASB requires companies to assume that the relevant taxing authority will examine the company’s books and will examine that specific item. That changes the dynamic quite a bit. ”

Many companies maintain tax reserves to provide for liabilities on the balance sheet for various things that could go wrong in the tax area, such as IRS and state taxing authority examinations. “One of the reasons it has become such a hot-button issue is the extent of the disclosures it requires,” Bernstein says. “Companies were surprised by the level of transparency it promotes – such a level, in fact, that some consider it to be a roadmap for the taxing authorities. It’s definitely a concern.”

Rule’s Strictures Limit Reporting Companies’ Flexibility Controversy also surrounds the approach FASB takes and requires companies to take in applying FIN 48. Reporting firms must look at all their tax positions on the benefit side and evaluate how likely it is that a position would be upheld should it be examined by a taxing authority.

“The controversy arises from the fact that FASB requires companies to assume that the relevant taxing authority will examine the company’s books and will examine that specific item,” Bernstein explains. “That changes the dynamic quite a bit.”

Historically, when calculating appropriate tax reserves, many companies would factor in the likelihood of being examined by the relevant taxing authority, having a specific item examined and the ability to successfully defend that item.

“For example, in the past, a company might have factored in a 1% chance of being examined, a 40% chance of a particular item being examined and a 60% chance of being able to defend it, and then decided that no liability need be assumed,” Bernstein explains. “That option no longer exists.”

SEC Sought to Boost Comparability by Limiting Creative Management of Earnings The FIN 48 project came into being at FASB as a result of SEC concerns about diverse practices in accounting for uncertain tax positions and the possibilities that creates for earnings “management,” since taxes are part of the balance sheet and reported earnings, FASB Chairman Robert Herz noted at the January meeting where the board adopted the rule. “There was a lot of concern that this area was extremely opaque and a little mystical,” he said.

Some financial reporting experts were surprised at FASB’s decision not to delay implementation of FIN 48 (“flabbergasted, shocked” is how one tax expert put it), but the rule became effective for public companies as of the first quarter of this year.

“Private companies will need to incorporate the approach dictated by FIN 48 into their 2007 financial statements,” Bernstein says. “All companies need to take stock of where they stand. They must take an inventory of all their tax positions, identify any uncertain ones and make a series of evaluations of their sustainability in accordance with this pronouncement.”

For more information, please contact Frank Kimmerling at fkimmerling@gellerco.com.