Howard Telson:
And before we begin to uncertain tax positions, I think we need to talk about what exactly is a tax position to start. And then maybe if you could just elaborate on what would actually make it uncertain too. So just to kick it off, what is a tax position and what would make it uncertain?
Jinal Hira:
That’s a great question. And to start with, it’s very important to understand what a tax position is for a company, and it could differ from company to company.
So a tax position is a position a company has either taken or they expect to take on the tax return that is reflected in measuring their current or deferred income taxes in the financial statement. So in ordinary course of business, an average corporate tax return will include several tax positions. This could be in the current year, they might not file their tax return until next year but would still want to account for it on the current year financial statement expecting that position to be taken in their 2020 return, for example.
A tax position merely reflects on how the tax law is interpreted and applied to each company’s circumstances. So to give a little bit more overview, the term tax position can include a wide range of things like deciding to exclude taxable income or take a certain tax deduction or a credit on the tax return.
It could include the character of the income or loss. So, you know, kind of say if it’s ordinary or capital, again, in nature, you know, it differs from company to company on how they look at it. Also if a company is subject to a tax in certain jurisdiction, that is a deciding or a tax position that a company takes. And also something like if my entities tax exempt, or would it be considered more like a pass-through entity? So these are some examples of what a tax position could be and how it could be different for company to company.
Since tax legislation, case laws and tax authority practice do not always provide clarity on all these transactions. It is normal for companies to have some sort of uncertainty as to income and defer tax treatment of certain position, which are always open to interpretation.
So these findings usually emphasize uncertain tax position assessment. A tax position or uncertain tax position can result in a permanent reduction income tax payable. So if someone would ask, “Why is it important for my financial statement or as a company overall to track those positions?” Because this could result in a permanent reduction in income taxes payable, there could be a deferral of income taxes otherwise that you’re currently paying to future years or change expected in the realization of your deferred tax assets.
Just to kind of give an overview of what our uncertain tax position kind of could be.
Howard Telson:
Yeah, I think that that’s great context and just to kind of take a step back and summarize, you know, I think what you said is there’s kind of two pieces to this puzzle.
So one is overall: what’s a tax position, right?
Jinal Hira:
Right.
Howard Telson:
And as you said, a tax position is super broad.
Jinal Hira:
Right.
Howard Telson:
So it could be pretty much anything that happens on a tax return or even a financial statement. So any item of income deduction, credit, what characters are in income is capital or ordinary.
And then it could even be whether or not you file a tax return. So if you’re looking at a particular jurisdiction and there’s different rules that require a particular filings of tax returns, whether or not you file could even be considered a tax position.
So it’s really, really broad concept. And that’s your point: Once you kind of define tax position, you look at what’s an uncertain tax position. It’s something where there’s inherent kind of uncertainty to some position, [then] the tax law, the regulations, the rules aren’t necessarily a hundred percent clear. I think as everyone knows, whether that’s individual laws or corporate laws, which we’re kind of focusing on in this case, but the tax laws, as everyone kind of knows, aren’t a hundred percent clear.
So a lot of times, there’s items of income or deduction that are open to interpretation for how certain companies treat them. And these are the kinds of things that could result in uncertainty and ultimately result in an uncertain tax position.
And now when we talk about uncertain tax positions, I hear tax professionals throw on a lot of terms, and that’s kind of common across the full tax spectrum, but uncertain tax visions are no stranger to that. And just to level set for our listeners: What are some of the most common terms that tax folks will use to kind of describe this concept?
Jinal Hira:
So it’s funny you ask this question because, when I started my career and I was working and, you know, people mainly refer to them, or most commonly, they are known as Fin 48 adjustments and or unrecognized tax benefits. And then I went to another client and they talk about uncertain tax. I’m looking at my manager was like, “What is that? I don’t know, I’ve never heard of that term!”
And then he said, “It’s Fin 48 adjustments.”
I was like, “Oh.” [Howard laughs.]
It is very common that people use fin 48, most commonly and now I think on certain UTPs or do kind of, you know, make it more like an abbreviated version of that. But UTPs is where you hear auditors or your tax planning team or your pro tax provision team use that term a lot.
Howard Telson:
I think Fin 48 is very common, it’s the old old standard under FAS 109 before ASC 740, and a lot of people still like to reference it with that term. So that’s helpful. Now, with that terminology kind of aside, let’s shift over for a moment on, on why these matter. So whatever we call them – UTPs, UTVs, Fin 48, there’s a couple of different kinds of perspectives we could look at here. For example, we could think of the view of the IRS and other taxing authorities, why they matter to them. We could think of why they matter to financial statement auditors like an accounting firm or from the views of people actually doing the provision or from financial statement users like an investor who’s just reviewing a 10 K or 10 Q, but overall just kind of holistically, how should we think about these? How do they impact the tax position of a company and why do these kinds of matter as a whole?
Jinal Hira:
So before 2010, I think these UTPs were not as common or were not as important to be reported. And you know, you would ask why, and certainly it has changed over the years. And especially these are intended to cut the time that IRS requires to review returns. This can now help both the taxpayer and the agency to kind of meet them halfway and kind of understand where they’re coming from, each version.
Like I mentioned before in 2014, most of the corporations that had assets of at least $10 million or more did have to file, but after 2014, the laws changed and then the IRS or the taxing authority made it more of a mandatory statement that you have to attach to your tax return. So now suddenly this has to be tracked, had to be disclosed properly for your auditors because they are going to go into your tax return and do the IRS.
So that’s why I think the impact of the position that you’re taking as a company overall matters.
Howard Telson:
Right and that’s helpful. And I think it’s interesting, you know, UTPs, because they sort of tread the line between financial statements and tax returns, right? And you mentioned now, [if] you’re a company of a certain size, you need to actually file a form with your tax return if you have any uncertain tax positions on your financial statements. So it’s sort of treading the line and merging these two disparate worlds of financial statements and tax returns.
And you mentioned it before, but uncertain tax positions at their heart really revolve around: Did you claim something on a tax return in the past – or you know, did you file or not file a tax return in the past; or do you plan on claiming something on a tax return in the future?
And if so, then what is the position of that – what’s your stance on that tax position? What’s the certainty around it or uncertainty?
And depending on that, then you’ll have to potentially accrue a liability to your financials, which we’ll get into kind of momentarily. But it’s an interesting concept that it kind of bridges the gap between that financial statement and tax return. And it really works kind of between them in both ways.
Jinal Hira:
Right.
Howard Telson:
With all that and appreciating what these are and why they’re important, can you provide some insight as to what types of items could be considered a UTP? Or put another way, what types of items could be uncertain?
Jinal Hira:
Some of the most common ones that I’ve always seen in within our organization is either to include particular entities’ taxable income or certain a deductability of amount for tax purposes and not for GAAP purposes, or for your financial statement purposes.
The other thing is transfer pricing methodology. Given that companies are going global and how each country or each jurisdiction has a different taxing authority and methodology that they want to see, it’s always [tax] position that you will be either questioned on or you will be uncertain on. So that’s another one that I’ve seen that is very common.
Also the interpretation of tax law, depending on the new court case that just happened recently. So how do you interpret that: Do you go with the court case or do you use the law that has been defined in the code section, the interpretation of legislation between the tax authority and the tax advisers, right? Also the double taxation agreement between two countries. And the other one is also like whether it’s subject to withholding taxes or not.
These are some of the most common positions that companies take and they’re uncertain about how they’re going to result it and they always have to either put of a liability or most likely than not, they’re not a hundred percent sure it will be sustained on the examination.
Howard Telson:
Definitely makes sense. I mean, one thing I just want to just point out before we get more into the nuts and bolts of UTPs: If we take a step back and think about the difference between a tax return and financial statements, and you gave good examples of what some UTPs look like here. But someone may have a question of, ‘Well, I don’t quite follow how you take a position on a financial statement versus a tax return and it’s uncertain?’ Like, how could you put an uncertain tax position on the tax return and why do you need to accrue additional liability on your financial statements?
I think that concept is a little hazy and what I would say there is we’re looking at two different standards, right? So a tax return to include a position – if you’re excluding income or taking a deduction, whatever have you – you’re looking at a substantial authority standard.
So to include a position on a tax return, you want to get to a substantial authority standard, which is generally about a 40 percent kind of confidence that it’s upheld upon audit by the IRS or state or local taxing authority or foreign taxing authority.
But on your financial statements, you want to get to that more likely than not standard, so greater than 50 percent chance that it’s upheld on an audit. So you sort of have this gap where you can put something on a tax return that doesn’t necessarily meet the standard of your financial statement. And we get to this in-between world where, if you have something on that tax return that meets a tax return standard but that doesn’t meet your financial statement standard, then you need to kind of accrue for that item on your financial statements. Right?
Jinal Hira:
That’s very well explained, Howard. I agree, a hundred percent.
Howard Telson:
I guess with that background now that we’ve given some examples and talked about the difference between the return standard and the financial statement standard, would you mind kind of walking us through the process or steps of determining company’s UTP position? How exactly does this work?
Jinal Hira:
So like you’ve mentioned, Howard, there’s always a difference in your tax return versus your financial statements and how do you calculate that position? How do you accrue for it, or how do you disclose it on your finished statement?
So it’s a very complex calculation and it’s always where I think the FASB has realized that it’s obviously a struggling point for a lot of companies. So I think they made up, they came up with some specific guidance on how to account for uncertainty in taxes, in your financial statements.
So the model for uncertain tax position has two main thresholds that you can kind of look at. So first one is recognition and then the second one is measurement. So the recognition of the effects of tax position could be considered first and thereafter, it’s measurement. So if there’s no recognition, there’s no need to go to the second step for measurement.
Howard Telson:
So that makes sense. It’s kind of a two-step process, start with recognition and then go to measurement. So why don’t we break down those there’s two kind of key pieces a bit further, and we can start with recognition, the first step.
So what does this actually mean? Kind of from a practical perspective of how this is applied. And if you have an example or something of that nature though, that would be helpful as well.
Jinal Hira:
Absolutely. And I think an example would be great because it’s just so complicated that it’s easier to put it in the layman’s term. To provide an example, I’d say, “Hey, this is how you can do a recognition of uncertain tax positions.”
So just to kind of give an overview of what recognition, how you can come up with that threshold is an entity should recognize the effects of uncertain tax position when they believe that it is more likely than not that taxing authorities will upon examination sustain their tax position.
So when you say ‘more likely than not’ [it] means there is, in management’s opinion, a likelihood of more than 50 percent – to go back to what you had highlighted when we were talking before. So when management is making that assessment, what some of the areas that you should be kind of focusing on is assume that the text position will always be examined by revenue services and that they will have full knowledge of all the circumstances. This means an entity cannot account for an uncertain tax position because they believe that they believe the risk of an audit or detection is low, or calculate the effects of tax position based on the legislation rulings case law, and then administrative practices of revenue authorities in so far as they rightly understand. So go ahead, go through all these process. This is the steps that you want to go through before you say, “Okay, I’m going to go ahead and recognize an uncertain tax position.”
Consider the tax position on its own without offsetting it against any other uncertain tax positions, detection, risk, and administrative practices and precedents. So only when the tax position meets this recognition threshold, should it be measured to determine the amount to be recognized in financial statements. So that was all theory. Now let’s look at an example.
So let’s say you complete your tax return and initially conclude you owe $1,100 after taking a position that was certain. You then take a further look at the return and say, “Hmm. I think I may qualify for additional tax credit.”
As a result, you take a position which reduces your liability by hundreds. So instead of $1,100, now you all $1,000. So on your books, what you will do is you’ll debit a tax expense for $1,000 and credit your taxes payable for the same to match the tax return, but you still have that hundred dollars of uncertain tax position to assess. So what do you do? This is where step one is recognition. Let’s say you determine all the 50 percent or less that the tax position would be sustained. That means you’re taking the credit on your tax return, but you can’t reflect that benefit on your financial statement because it doesn’t meet the recognition threshold of more likely than not, which is more than 50 percent.
So that’s another $100 of tax expense you need to record taking a total tax expense to $1,100 with the other side of the entry being a liability for the unrecognized tax benefit of $100.
So this was the first one that we went and said, “Okay, it doesn’t meet the criteria.” So we had to book $200 as a unrecognized tax benefit of our books. But let’s say if the tax position meets in recognition criteria for more likely than not, that means you can recognize at least some of the benefit in your financial statement.
Then the second step in the model helps you determine the appropriate amount of benefit to record. That’s where you’re going to go and go to the next step of measurement.
Howard Telson:
Right.
Jinal Hira:
So this requires you to figure out the largest amount of benefit and determine the cumulative probability basis, and we’ll talk more about it when we kind of covered the threshold of measurement and how that works.
Howard Telson:
I think that’s really helpful and that example kind of sheds light on this whole paradigm where, like you said, a taxpayer maybe found that they have a hundred dollars of a credit rate that could be an R&D credit, a foreign tax credit, right? It could be any type of credit that…
Jinal Hira:
Right. It could be any kind of credit. Yup.
Howard Telson:
Yep and they said, “Well, now that we see that we may have this credit, now we need to look at the certainty behind this tax position. We need to measure it and we need to look at the recognition threshold.” So they kind of look at all the guidance, all the tax law, all the regulations, the case law, administrative practices, and they say, “Does this position make sense to claim? Do we have enough support for this position to claim it on a tax return?”
Jinal Hira:
Right.
Howard Telson:
And they may say yes, or they may say no.
And if they say no, if they don’t claim it on a tax return, well then they’re not going to take the credit and you’re kind of done, you don’t need to worry about it, right?
Jinal Hira:
Yes.
Howard Telson:
If you didn’t meet that substantial authority greater than 40 percent likelihood of being sustained, they’re not going to claim it on a tax return and you don’t really need to worry about it. But let’s just say they do think that some or a portion of the credit they would be able to take to offset their tax liability and then they claim it on a tax return, they meet that substantial authority threshold. The question [then] is: Could they get to that more likely than not threshold? And like you said, if so, how much?
Jinal Hira:
How much. Exactly.
Howard Telson:
Is it a portion? Is it all? Maybe it’s not, maybe you’ve reached the substantial authority for the $100 on the tax return, but you can’t reach the more likely than not on your financial statements.
So that’s sort of step one, right?
Jinal Hira:
Right.
Howard Telson:
And now we could get into step two. So once we figure out recognition and we determined what the item is, we look at all the guidance and we figure out what we think we could claim on our tax return. How do we kind of measure this now? How do we go to step two and kind of measure how much of the benefit we can actually take in terms of our financials here?
Jinal Hira:
So the important thing in step two and how you can do that – measure that particular approach of most likely than not – is going to be based on a cumulative probability approach. So what does that mean? What it means that the effects of the uncertain tax position should be measured by the amount for which the probability is higher than 50 percent.
So again, what does this process involve? How do I say that, “Hey, yes, my probability is higher than 50 percent”?
So this process involves determining a range of outcomes and assigning a probability to each one of those. So this is a matter of judgment and will depend on a lot of factors, such as the nature of the tax position and the weight of legislation in the entity’s favor or the degree to which the entity is prepared to defend the position. There could be a situation where this position could go, don’t agree, and could end up going to a court or end up, “Are you open a settlement?” Like I mentioned before, are you willing to meet your tax authorities halfway?
And also, if no single outcome has higher than 50 percent probability, the effects will be measured for the highest amount of which the cumulative probability exceeds 50 percent. So to go and use our example that we did before to say that, let’s assume, instead of that, it’s more likely than not that the hundred dollar credit we previously discussed would sustain upon examination. So then the hundred is the gross amount of benefit to be realized. But the amount to record is the largest amount of the benefit that’s more likely than not be realized on a cumulative basis. So what does that mean? So rather than picking a single dollar value you think matches up to your 50 percent likelihood, the model that you’re going to use, using the probability, considers assigning different probabilities to individual outcomes.
So you’re going to look at more of an individual level for each probability. So the outcome that provides the greatest tax benefit should be assessed first.
So in our example, if the probability of realizing the full hundred was 70 percent, then you would stop there, regard the full benefit and would have zero for your uncertain tax position liability. But often the full amount of tax position, not the amount that means the cumulative probability, does show that most of the time companies [will] be a little conservative in that approach. So let’s go back to our example and see how the measurement assessment works, assuming that it’s not going to be 70 percent and we can now fully realize it.
So first, you’ll identify various outcomes or scenarios starting with the largest amount of benefit. So then we start with the hundred and go down from there.
So like 100, 75, 55, right? Based on the probability. So once you do that, you will assign the probabilities to each of these scenarios. So for $100, you can assign 25 percent of what the taxing authorities might accept and the collective probability of acceptance, probably 25 percent. For $75, you say 30 percent probability of tax authorities accepting it, and the collective probability of acceptance will be 55 percent based on our calculation. And then 55, and so forth and so on.
So in this case, a tax benefit of 75 would ultimately be recognized, based on the cumulative probability of the first two scenarios. So the final entry that you will record to an unrecognized tax benefit would be a $25 debit to your tax expense and a $25 credit to your uncertain tax position liability.
Howard Telson:
It gets sort of like peeling back the layers of the onion.
Jinal Hira:
Yes.
Howard Telson:
So you start with a hundred bucks. You say, you know, “I think I may have this credit of a hundred dollars.” And then I look at it and I say, “Out of a full hundred dollars, what do I think my probability success is here?” And like you said, in your example, I’m at 25, right?
Then you peel back a layer. And I say, “Okay, what if I took a little bit less? What if I were only going to take a $75 credit instead of the a hundred dollars credit? What do I think my probability of acceptance there is going to be?”
And then, you know, you’ve got to an additional kind of 30 percent. And then when I add those together, I got to 55 percent and all of a sudden now I’m that more likely than not right amount, greater than 50 percent.
So I can sort of stop. I could say, “Okay, I’ve met my threshold for my financial statements. And I’m able to accrue that $75 benefit to my financial statements.” And on my tax return, I met that probability at 40 percent, that’s substantial authority and I can accrue it to my tax return. Once I hit the 40 percent, peel back the layers of the onion. You look at the full benefit. And then you look at, you know, what’s the probability of acceptance there. And then, you know, if you’re below 50, then you go to the next level and then you keep going basically until you’re above that, more likely than not threshold, right? And whatever portion, isn’t more likely than not. Then you have to look at that recording that UTP entry and proving a UTP liability, a hundred bucks. Right?
Jinal Hira:
The collective probability of accepted should not be over a hundred percent. It should be, it should add up to a hundred percent. Right?
Howard Telson:
Right.
Jinal Hira:
So at 25, then you have your 55, then you started fine. And then, you know, if it comes to a hundred, you stop there. Right. So that’s the approach that you take. Yeah. So, so like you said, in our example, $75 would be a good read. I don’t need to go any further because that kind of meets my, you know, most like you’re not on my 51 percent threshold and it’s 50, you know, I’m going to go ahead and use, take that amount as my benefit that will be recognized.
Howard Telson:
And I think when we talk about these percentages from just a practitioner perspective and just, you know… someone even who’s not as familiar with tax, I’m sure it seems kind of… wonky, right? Look at all the support out there, all the regulations, the tax laws, etc., and to come up with a percentage that you think this item is going to have success on an IRS auditor, state audit, or a foreign audit… It’s a wonky concept.
And I think in reality, and I’m curious Jinal of your experience too – but I think in reality on the items that are really unclear where it really is [that] the water really is money. You know, I think a lot of taxpayers will go ahead and actually seek out a tax opinion. Right? They’ll go to a law firm or an accounting firm, and they’ll try to get a tax opinion and understand based on all that available evidence, what the standard reached by that law firm or accounting firm is. And they’ll have that support as audit support for particular positions. Does that sound right?
Jinal Hira:
Yes… Absolutely. And I think obviously our example is much more simpler, right? And our percentages look so much easier. But like you said, given the tax laws and how you are going to come up with those percentages, you don’t have that expertise or you always need a second opinion. And that’s where most of the companies always rely on either the tax law firms or Big Four to advise them and support the stand they’re taking for their tax position [with] like something, like a memo or something from them that stands ground when you do present your financial statement and disclose those, right?
Howard Telson:
Yes.
Jinal Hira:
Because your auditor will say, “Hey, how did you come up with this?” Or, “What support do you have to take that stand?”
And that’s where you can provide second opinion or review memo or something from either in authority or also, you know, just from one of the Big Four.
I mean, just to give an example of a person we had with New Jersey changing their laws and their proportion in my prior company: We actually went to the state to get the ruling and written down and prove, so that we’ll have that for the position that we were taking. So that tomorrow, if there’s an audit, we have that ruling from the state. Right?
Howard Telson:
Right.
Jinal Hira:
Because based on what we decided, or we were uncertain of how the state is going to interpret the law, we wanted something in written from the state itself saying that, “Okay, it’s okay to do this.”
Howard Telson:
Right.
Jinal Hira:
And obviously we had to help with one of the Big Four and we went and did that. So just to have agreed to exactly what you’re saying: Yes, it is always a case where you will go to a third party to kind of help you or to stand your ground.
Howard Telson:
Yeah, I think that’s a great point. Gaining the certainty through discussing with the tax authority or getting some documentation from the taxing authority that a certain position acceptable in their eyes, because you have that documentation, you could sort of take that tax position in the future and you wouldn’t have to consider it uncertain. Because you have some certainty around where the taxing authority is going to go with that.
But just with all that, I think we could shift gears for a moment. And there’s another element to UTP that I think folks commonly encounter and that’s interest in penalty calculations. So it seems like the UTP is always come with these interest in penalty calculations. And I’m curious if you can provide our listeners a little bit of context as to why that is and then how exactly do these computations kind of get layered into the amounts that we were just talking about for purposes of accruing UTP amounts of the books?
Jinal Hira:
So that’s a great point, Howard, and always when you have tax returns or taxes underpaid, payment of taxes always has interest and penalty factored to it, right? And as an organization, if you’re going to have uncertain tax positions and you are not sure which way it’s going to go, you always want to have those interest and penalty amounts added into that viability amount that you are going to put on your financial statement.
But how do we record this? So usually interest and penalties are going to go on your income statement, under interest or penalties, which you will track, year after year or quarter after quarter, depending on how you do it. So interest basically is calculated every time that you make a change to the amount.
And just to take a step back – all these tax positions, they have to be assessed yearly. So after [the] year is done, you want to reassess them and see if there are any changes in the tax law and if you need to make any changes at your end, for that particular position that you had taken. So your interest calculation will change and so will your penalty. Interest is going to change quarter of the quarter because it goes by the amount of period you have either underpaid, and for penalties [there’s] a certain percentage of your underpayment. Those two will be on your income tax or your P&L. It’s going to get accrued on your balance sheet as well.
Howard Telson:
I just want to note on the interest and penalty side, when we talk about uncertain tax positions, accruing an amount, looking at the tax return versus the financial statements, and we’re saying if you took a position on your tax return that’s not more likely than not, we’re going to accrue that delta to the financial statements. So we get to a point where you’re at a tax position, that he is more likely than not.
And I think kind of the key with uncertain tax positions is you have to kind of keep following the logic where you say, “Okay, you took this tax position on a tax return that didn’t meet the financial statement standard. Therefore, when you get audited by the IRS or state, local, taxing authority or foreign taxing authority, they may disallow that deduction you have, or the credit you took, or whatever it may be, or they may say you have additional income.
And then not only that, but when the IRS or a taxing authority assesses an amount on an audit, generally that amount is also come potentially with interest and penalties. So of course they’re auditing tax return potentially a couple of years later after it was filed and you didn’t really pay requisite amount of tax at that period of time. So they could potentially assess that interest and penalties. And because of the nature of UTPs, basically we’re saying on the financial statements, you actually need to accrue for that interest in penalties as well. So you sort of see the item all the way through…
Jinal Hira:
Yes.
Howard Telson:
… all the potential add-on impacts of that item. And that includes to that interest and penalties that you just discussed.
Jinal Hira:
I one hundred percent agree to that. And then it’s not only that, right? You also have to keep reassessing them – like I mentioned – every time you reassess the position. So it could change and you will have to accrue them every year and change it as if it falls off, you take it off. Right?
Howard Telson:
Yes.
Jinal Hira:
If the statute expired and you know, you no longer have a risk of the texting authority examining it, you can take that interest or penalty off as well with your tax position that you’re going to write off.
Howard Telson:
Right… I think that’s a great point. So you’re saying that the IRS or other taxing authorities, they have a limited window to audit your tax returns. Generally it’s about three years after you file in the US and then states sometimes can be a little bit longer, maybe four years.
Jinal Hira:
Yeah. The states could differ. But yeah, for federal purposes, always going to be three years. And sometimes for foreign, I think it’s been for four years, maybe?
Howard Telson:
Let’s just say on average four years. So after that time lapses after you file your tax return and you wait, take your clock out and three years pass, you’re able to take that position off your books because, at that point, your risk of audit has just pretty much on that –unless you did something serious, like a gross mistatement or fraud – your risk of audit essentially goes to zero on that item. And therefore you’re able to kind of take that position down, like you said. That’s a great point.
And just along those lines, when we’re talking about actually disclosing UTPs in a financial statement, it seems like there’s a lot of movement. There’s items coming on and items coming off and on financial statements. How do we disclose that? And we keep track of all that.
Jinal Hira:
There are certain requirements that you have to have the uncertain tax position disclose. So a couple things to keep in mind is it has to be in a tabular reconciliation, like a tabular format. Identification, for instance, index position, they’re reasonably expected to change within 12 months need to be disclosed UTPs that you’ve recognized would affect your ETR have to be disclosed, any tax that will still subject to examination, or it’s a major tax jurisdiction related position, then you might want to disclose that as well
Now there are different disclosures, not different like wildly different, but there are disclosures that you have for your public entities versus just all the entities overall. So in other words, companies providing a rule for, from one year to the next or three-year period, like you mentioned for three year statute of limitation for all the items that are uncertain and, or the ones that may be challenged by the IRS or any other authority. And if the company has less than 50 percent confidence factor, that the position would be sustained, they have to keep disclosing there on their financial statement.
Howard Telson:
Within a company’s tax footnote and their financial statements, they need that tabular roll forward that shows everything coming on and going off. And then it also, as you said, explains the nature of most significant items.
Jinal Hira:
Yes.
Howard Telson:
So that’s helpful. And I think that’s good context. So we talked about how they’re calculated the nature of the calculation, what UTPs are, how the financial statements kind of disclose them.
But just taking a step back, you know, from a practical perspective, is there any advice or best practices you would provide to practitioners who were assessing or calculating their UTPs, particularly around if there’s a way to standardize or automate this process at all?
Jinal Hira:
So the question kind of provides a glimpse into some of the complexity companies face, especially with the tax reform that has happened and how that has changed the complexity or implementation of lots of different tax law. It’s not as simple, it’s not as easy to understand, and there are too many layers to that.
So what companies I think need to do is monitor and evaluate the guidance as it is issued, as well as consider educating and engaging with policy makers or, implement those challenges, which is affecting their business operations.
And to kind of automate that process? I mean, yes, there are tools available outside the form of technology that you can also implement for your organization very much again, to standardize the process and have a more streamlined process of how you’re tracking those. It’s still not as common, or you would think people would have already done this. It’s not as common still. There’s still people struggling [laughs] with having those things done in Excel and it could be a lot of work. So the most, from what I’ve seen in my career for most of these situations, people rely heavily on the tax advisory work or advisors from, or a subject matter expert from one of these consulting companies.
Howard Telson:
Right, right. And I think the point you made about tax reform and tax law changes is pivotal when it comes to uncertain tax positions because – let’s just say you’re looking at a tax position that maybe a company’s taken for several years, or maybe just a law that’s been around for many years – companies can get the lay of the land and understand how taxing authorities are sort of looking at a position and they could, they could really come up with a confidence factor in a certain way that they’re including something on their return if something’s been around a long time.
But if something is new, if something’s brand new and the IRS, maybe hasn’t even audited the position on many taxpayers at all, if – let’s just take the example of 2017 tax reform when people were including things for the first time of their 2018 return and 2018 financial statements – they didn’t have a history of what the IRS has been looking at. They didn’t have a history of what the state to look at. And, you know, there wasn’t a lot of IRS regulations there wasn’t a lot of IRS guidance. So taxpayers were sort of left in a spot where they needed to do the analysis for themselves and they didn’t have a lot of support and that’s inherent uncertainty and that would kind of lead to potentially more uncertain tax positions. So I think that’s a great point.
