Tax contingency reporting.

• Author: Guertin, Scott

Tax advisers are often asked whether Financial Accounting Standards Board (FASB) Statement (FAS) No. 109, Accounting for Income Taxes, changes the accounting for tax contingencies. The answer is undoubtedly "no" However, the statement has drawn new attention to tax contingency reporting; the unwary could apply the wrong standard to their evaluation of tax contingencies and their relationship to deferred taxes.

Background

When there is a loss contingency, the likelihood that a future event(s) will confirm the loss or an impairment of an asset or the incurrence of a liability can range from probable to remote. FAS No. 5, Accounting for Contingencies, states, in part, that a "loss contingency" will be charged to income if (1) it is probable that a loss has been incurred at the date of the financial statements and (2) the amount of the loss can be reasonably estimated. If neither of these requirements is met, disclosure is required if it is reasonably possible that a loss has been incurred. There is no support for an accrual if the chance of the future event(s) occurring is slight or remote. FAS 5 does not quantify the terms "probable," "reasonably possible" or "remote." In practice, CPAs generally interpreted "probable" or "likely" as greater than a 60% to 70% chance of occurrence, "reasonably possible" as between 10% to 20% and 60% to 70%, and "remote" as less than 10% to 20%.

While these standards are very difficult to apply in practice, supporting and documenting any conclusions may be even more complicated. However, documentation is still required, no matter how difficult. In many cases, it may not be possible to estimate the likelihood of a tax contingency being assessed. In addition, openly disclosing in financial statements, tax positions that might be challenged by the IRS or other taxing authorities, is also undesirable.

The Securities and Exchange Commission (SEC) commented on disclosure at the AICPA National Conference on Current SEC Developments, held in Washington, DC, on Dec. 6-8, 2004. It observed, "while registrants may have concerns regarding the disclosure of confidential income tax positions, those concerns are not valid reasons for noncompliance with GAAP."

Handling Contingencies

Once a company determines that a tax contingency exists, it must:

1. ...