Recognizing and measuring tax benefits from uncertain tax positions.

• Author: Ellentuck, Albert B.

Once all uncertain tax positions have been identified, FASB Accounting Standards Codification Subtopic 740-10 creates a two-step process to recognize and measure the tax benefits arising from those positions. An important factor in this analysis is that the information considered must be available on the reporting date. Subsequent information cannot be used to assist in recognizing the tax benefit. Information that becomes available after the reporting date, but before the financial statements are issued, should not be used in assessing any tax benefit. However, as discussed later, that information will be used in reassessing the tax benefits in subsequent periods.

Meeting the More-Likely-Than-Not Standard

If the more-likely-than-not (MLTN) standard is not met, no tax benefit can be claimed. If, however, the MLTN standard is met, the client and practitioner must then determine the tax benefit to recognize.

Example 1. Meeting the MLTN standard: B Inc. has been aggressive in deferring income to future years from the sale of services. In 2015, B deferred $1 million to 2017, resulting in a tax benefit in 2015 of $350,000. Upon analysis, B concludes that this position does not meet the MLTN standard. Accordingly, B cannot recognize the $350,000 tax benefit in 2015. Its financial statements will show an unrecognized tax liability of $350,000.

The recognition requirement is met if it is more likely than not that the client's position will be sustained in a dispute with the appropriate taxing authority. Clients and practitioners must consider the impact of the decision on a variety of taxing authorities. For example, a depreciation decision might involve consideration at both the federal level and the state level. On the other hand, an allocation of income among four states would only involve the various state taxing authorities.

Deciding whether a tax position meets the MLTN standard must be based on the technical merits of the position. The analysis of the position must consider the underlying statute, tax treaty, committee reports (indicating legislative intent), regulations, administrative rulings, and case law as those authorities are applied to the facts and circumstances in the tax position. This requires both a good understanding of the facts, as well as a thorough analysis of the applicable tax law. Additionally, the client and practitioner must assume that the taxing authority and the examining agent will have full knowledge of all relevant information. The analysis must support the conclusion that the client is more likely than not to prevail if the position is challenged and the case is heard by the court of last resort. However, as discussed later, the measurement of the tax benefit is based on the tax benefit likely to be realized upon ultimate settlement with the pertinent taxing authority. This means that the MLTN standard is actually higher than the measurement standard. To recognize any benefit, the client must believe it is more likely than not that the court of last resort would sustain the position. However, in determining the amount of tax benefit to recognize in the financial statements, the client can base that benefit on what tax deduction the taxing authority might likely allow in a settlement.

The court of last resort will depend on the tax position and rights the client has to litigate the decision of the taxing authority. For federal decisions, it would seem that the court of last resort would be the U.S. Supreme Court. However, there is no right of appeal to the Supreme Court. Instead, the Court grants a writ of certiorari upon a request by a party for a hearing. Thus, for federal tax issues, the better...