The Sarbanes-Oxley Act brought the tax manager into the financial statement reporting process as never before. As SOX Section 404 internal control certifications were made with respect to each input into the financial statements, it became clear that one of the weakest areas for SOX 404 compliance was accounting for income taxes.Under FASB Statement No. 109, Accounting for Income Taxes, the process of providing for deferred income taxes had become so subjective and subject to differing interpretations that certification of the results was difficult, and comparability across financial statements appeared to be lacking.

At the same time, the Internal Revenue Service, in its attack on tax shelters, had started to increasingly focus on book/tax differences as a key area to look at in identifying abusive tax shelters. Schedule M-3 was developed on the tax side to force tax preparers to better document differences between the book and tax treatment of business activities and transactions.

The most recent compliance requirement forcing tax and accounting people to work more closely together is FIN 48, an interpretation of the Financial Accounting Standards Board on Accounting for Uncertainty in Income Taxes. FIN 48 is designed to solve some of the problems highlighted by the SOX internal control analysis by setting more explicit standards for the accounting for income taxes in financial statements. Those new standards include standards for initial asset recognition, liability recognition and disclosures.


Prior to FIN 48, uncertain income tax positions were treated like other tax contingencies under FASB Statement No. 5, Accounting for Contingencies. FASB Statement No. 5 focuses on the creation of liabilities where loss contingencies were probable and subject to reasonable estimation. FIN 48 instead focuses on asset recognition in a two-step process.

First, a tax position is evaluated as to whether it is more likely than not, based on the tax law authority and not on the probability of audit, that the position will be ultimately sustained. Previously, it was common to consider the probability of audit detection in evaluating the potential liability exposure.

Second, once a position meets the more-likely-than-not threshold, the asset that is recognized is to be measured based on the largest amount of tax benefit that is greater than 50 percent likely to be realized upon settlement. FIN 48 requires taxpayers to develop units of account to determine the appropriate level at which to evaluate a position, and then to apply them consistently from one period to the next.

Where additional information comes to light in subsequent periods that changes the analysis, resulting in no longer recognizing a previously recognized tax position, recognition of a position that was previously unrecognized, or a change in measurement of a previously recognized position, those changes are to be treated as discrete statement items in the year that the change occurs.


Tax positions that do not rise to the level of warranting asset recognition must be evaluated for liability recognition. These liabilities are to be recognized separately from the general deferred taxes category, and are to be classified as current to the extent that a cash payment is anticipated within one year.

FIN 48 also requires liability recognition for interest expense anticipated for differences between the tax positions recognized under FIN 48 and positions taken on the tax return. Also, penalties must be recognized where the tax position taken would not qualify for penalty protection under the penalty provisions of the Internal Revenue Code.


The financial statements are required to include a tabular reconciliation of the total amounts of unrecognized tax benefits at the beginning and end of the period. Disclosure is also required for unrecognized tax benefits that, if recognized, could alter the taxpayer's effective tax rate, the total interest and penalties recognized, and a detailing of open tax years.

Disclosure is also required if the taxpayer anticipates that there is more than a remote chance that the total amount of unrecognized tax benefits will change significantly over the coming year.


FIN 48 is clearly requiring close cooperation between the persons responsible for the financial statement functions and the tax functions in a business. SOX 404 compliance was required only for public companies, but is starting to become the standard by which any audited financial statements may be judged. FIN 48, coming from the Financial Accounting Standards Board rather than the Securities and Exchange Commission, automatically becomes a standard for audited financial statements.

For companies complying with SOX, however, FIN 48 compliance should tie nicely into 404 compliance for the income tax portion of the statements. Certainly, like SOX compliance, there will be considerable time and resource costs in gearing up for FIN 48 compliance.

Making the recognition evaluation of tax positions and making the measurements are much more difficult undertakings than had been required under the prior standards. Probability tables are being developed to determine the individual and cumulative probabilities for each possible settlement outcome for a given tax position.

Many companies are debating the need for tax opinions on some or all of the tax positions to support the recognition or non-recognition decision. The cost and availability of those tax opinions will also be affected by tighter IRS standards on tax opinions under recent revisions to Circular 230.

The scope of FIN 48 is broad. While limited to income taxes, practitioners are just starting to fully comprehend its application in areas beyond federal income tax, in the state tax area and international tax issues including transfer pricing.

Like Schedule M-3, it is also anticipated that this greater disclosure with respect to tax positions in financial statements will provide more of an audit roadmap to the IRS than might have been available in the past.

While government spokespersons are starting to give recognition to the fact that some SOX and Circular 230 requirements may have been an overreaction in the post-Enron environment, and some retrenchment in these new requirements may be warranted, FIN 48 can only be categorized as adding significant additional compliance burdens on top of those already imposed by these other major changes in recent years. FIN 48 is effective for fiscal years beginning after Dec. 15, 2006.

George G. Jones, JD, LL.M, is managing editor, and Mark A. Luscombe, JD, LL.M, CPA, is principal analyst, at CCH Tax and Accounting, a WoltersKluwer business.

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