Fasb - the Irs's New Best Friend: How Fin 48 Affects the Taxpayer-irs Relationship and Potential Taxpayer Challenges
| Citation | Vol. 25 No. 3 |
| Publication year | 2010 |
Georgia State University Law Review
4-1-2009
FASB - The IRS's New Best Friend: How FIN 48 Affects the Taxpayer-IRS Relationship and Potential Taxpayer Challenges
Andrew W Jones
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Recommended Citation
Jones, Andrew W. (2008) "FASB - The IRS's New Best Friend: How FIN 48 Affects the Taxpayer-IRS Relationship and Potential Taxpayer Challenges," Georgia State University Law Review: Vol. 25: Iss. 3, Article 3. Available at: http://digitalarchive.gsu.edu/gsulr/vol25/iss3/3
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FASB -THE IRS'S NEW BEST FRIEND: HOW FIN 48 AFFECTS THE TAXPAYER-IRS RELATIONSHIP AND POTENTIAL TAXPAYER CHALLENGES
"[I]t would not be overstating the case to conclude that FIN 48 may prove to be one of the most significant enforcement tools the IRS has been presented with in recent years. "l
Introduction
For Big Ben's Barbeque, business was booming. What was once just a sole street-side barbeque stand in the mountains of North Georgia had evolved into a lucrative and well-known producer of a barbeque sauce. The founder, Ben, negotiated a line of credit with a local bank to fund the day-to-day operations. To protect the bank's investment, it required the company to submit financial statements, audited by an "independent" audit firm. As his production capacity grew, Ben began selling limited quantities of barbeque sauce in North carolina.
It was this interstate expansion that added the word "nexus" to Ben's tax vocabulary. In short, once a taxpayer establishes a "substantial nexus"4 with another state, the taxpayer must file an
1. Jennifer Blouin, Cristi Gleason, Lillian Mills & Stephanie Sikes, Do Firms Eat Their Tax Cookies Before FIN 48 Reveals the Cookie Jar? (Sept. 3, 2007) (unpublished Ph.D. dissertation, University of Arizona) (on file with authors).
2. The facts of the following hypothetical are intended to illustrate the implications of FIN 48 and are not derived from any source.
3. "Independent auditors" are hired by a taxpayer to attest to the accuracy of the taxpayer's financial statements. See H. Rosenblum, Inc. v. Adler, 461 A.2d 138, 148 (N.J. 1983) (overruled on other grounds). An "independent audit" may be needed for many different reasons, such as to comply with the Securities and Exchange Commission (SEC), or, as with Ben, to comply with the terms of a line of credit. "Examiners," on the other hand, are "auditors" employed by tax agencies, like the IRS, to enforce tax laws and collect tax revenue. See generally Kevin M. McCarron, Tax Examiners, revenue agents and collectors, Occupational Outlook Quarterly, Spring, 2001, at 33, available at http://www.bls.gov/opub/ooq/2001/Spring/art05.pdf.
4. For a taxpayer, "nexus" exists within a state when the connection between the taxpayer and that state is sufficient for the state to constitutionally impose a tax on the taxpayer. See VentureLine, Nexus, http://www.ventureline.com/Glossary_n.asp.
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income tax return in that state.5 However, the line that separates what is and is not a "substantial nexus" is far from clear.6 Three years ago, for the first time, Ben's accountant determined that if the company's decision to not file a return in North Carolina were challenged, the company could lose the argument. In discussing their options, Ben simply said, "Minimize taxes, but don't break the law."
The accountant was routinely familiar with his ethical responsibilities. In accordance with his "right and responsibility to be an advocate for [his client]," he knew he could take a favorable position so long as, if challenged, the position has a "realistic possibility of being sustained." He concluded that their position easily met the "reasonably possible" standard three years ago and still does today. Accordingly, his decision not to file a return in North Carolina fell entirely within his ethical duties.
Although the independent auditors routinely inquired about potential liabilities resulting from litigation, including tax litigation, no financial statement disclosure regarding the tax position was required.9 Last week, however, just when Ben thought he knew all he would ever have to know about taxes, his accountant called, mumbling excitedly about something called "FIN 48."10 As if he had just discovered color television, he explained how FIN 48 would change the company's financial statements as a result of the
5. See, e.g., Lanco, Inc. v. Dir., Div. ofTaxation, 908 A.2d 176 (N.J. 2006) (holding that a sufficient economic presence is enough to establish a substantial nexus).
6. See, e.g., Jean T. Wells & Gwendolyn McFadden-Wade, Nexus and FIN 48: States of Flux, 204 Tax Practice Corner 3 (Sept. 2007), available at http://www.journalofaccountancy.com/ Issues/2007/Sep/NexusAndFin48StatesOfFlux.htm.
7. Statement on Standards for Tax Serv. No. 1, Tax Return Positions, 1 4 (Am. Inst. of Certified Pub. Accountants 2000).
8. Id. 1 2.a. (realistic possibility standard); 1 9 (providing that a position may be taken even if it is not warranted). A "tax position," in general terms, is a decision that a certain factual circumstance should be accorded a certain tax treatment, which is reflected in a tax return. See id. 1 1.
9. See Statement of Fin. Accounting Standards No. 5, Accounting for Contingencies, 1 10 (Fin. Accounting Standards Bd. 1975), available at http://www.fasb.org/st/ [hereinafter FAS 5], (not requiring any disclosure when there is "no manifestation by a potential claimant of an awareness of a possible claim...").
10. Fin. Accounting Standards Bd. Interpretation No. 48, Accounting for Uncertainty in Income Taxes (2006), available at http://www.fasb.org/st/ [hereinafter FIN 48]. FIN 48 superseded FAS 5 for income taxes. Id. app. C, 1 2.
2009] FIN 48 AND THE TAXPAYER 769
company's decisions not to file tax returns in North Carolina.11 "Yes," he said, "in this case, not filing a return is a 'tax position'
12
under FIN 48." Because some of these positions—taken in the current year and in prior years—do not have a fifty percent or higher likelihood of prevailing if challenged by a tax agency, the company
13
will have to recognize additional liabilities not only for a portion of the unpaid tax, but also for interest and penalties, even though, most likely, no interest or penalties would ever be paid.14
But the tax accountant didn't stop there. Furiously pounding his ten-key, he calculated how much he thought the liability would increase over the subsequent year. This too would have to be disclosed in the current year's financial statements, along with the "nature of the uncertainty" and the nature of the cause of the increased sales in North Carolina.15
Ben was concerned not only about his accountant's heart rate but also that such a financial statement disclosure could affect his debt-covenant ratios,16 allowing the creditor to immediately call his line of
17
credit. Most of all, however, he worried that the level of detail required in the footnote disclosures would practically invite litigation
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with the North Carolina tax agency. His sole debatable tax position is the "nexus" issue, and everybody knows the only other state with which his company could arguably be "connected" is North Carolina. Thus, as he saw it, this disclosure would effectively say, "North
11. See id. 1 23.
12. See id. 1 4.a.
13. When an event is "recognized," it is reflected in the financial statements, as opposed to mere footnote disclosure or no disclosure at all. See id. 1 10.
14. See FIN 48, supra note 10, 1 7 (requiring the presumption that any tax position will be challenged in applying the "more-likely-than-not" standard); id. 1 15-16 (requiring recognition of a liability for interest and penalties); id 1 23 (applying FIN 48 to positions taken in prior years).
15. See id. 1 21.d.
16. For example, a creditor might require that if a debtor's liabilities divided by its assets (the "Debt to Assets Ratio") ever exceeds a certain number, the creditor shall have the right to call the loan, that is, to deem it immediately collectible. See Financial Education, Debt to Assets, http://financial-education.com/2007/01/30/debt-to-assets/.
17. See, e.g., Internal Revenue Service, Frequently Asked Questions About FIN 48, http://www.irs.gov/businesses/corporations/article/0,,id=171859,00.html ("[FIN 48] may have an impact on loan covenants . . .").
18. See discussion infra Part I.D. (discussing how FIN 48 could be a "roadmap" for a tax agency).
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Carolina, if you examine me, this is the issue you should focus on, and this is how much I think you will probably win." In other words, he thought this would reveal his tax strategies and legal theories—his "work product" —to his opponent in potential future litigation. Distraught, Ben and his accountant began to evaluate their options.
Could Big Ben's Barbeque object to making the disclosure itself? If not, he knew the company would have to prepare FIN 48 workpapers to satisfy the independent auditors and that these workpapers would contain his legal theory supporting the position and an evaluation of the potential loss or gain to the tax agency.19 Would North Carolina's tax agency request his workpapers? If they are requested, could he refuse to provide them? If the agency simply requests the same workpapers from the independent auditor, could he prevent the independent auditor from disclosing them to the agency?
Ben's situation illustrates the concerns of taxpayers nationwide. Collectively, the requirements provide tax agencies with a roadmap—
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a tool it...
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