Friday, August 12, 2011

Academic Study Explores Relationship between FIN 48 Financial Reporting and IRS Compliance Assurance Process

Authors of an academic study found that companies are motivated by financial statement considerations to participate in the IRS Compliance Assurance Program as a means of reducing their publicly disclosed FIN 48 reserves. They have strong incentives toward CAP participation when they would otherwise publicly report high tax rates and/or large FIN 48 reserves due to uncertain tax positions, concluded Paul Beck, Professor of Accountancy and Petro Lisowsky, Asst. Professor of Accountancy at the University of Illinois.

The Compliance Assurance Process (CAP) audit program is a voluntary cooperative audit process between the Internal Revenue Service and large, publicly traded corporate taxpayers that identifies and resolves material tax issues before taxpayers file their annual tax returns, noted the authors. CAP pre-commits corporations to disclose tax uncertainties to the IRS with the expectation of obtaining prompt resolution before filing their year-end tax returns and financial statements. By increasing the accuracy of tax returns prior to their filing, the CAP program aims to, among other things, reduce or eliminate the need for post-filing audit examinations and provide timely, final resolution of complex corporate tax issues.

FIN 48, or ASC 740-10-25 under the FASB codification, requires companies to evaluate the probability of success for tax benefits claimed on their tax returns, and to establish financial statement reserves if those uncertain benefits fail a more-likely-than-not probability test. FIN 48 requires firms to assess the recognition and measurement of income tax uncertainties.

The authors explained that as transactions occur during the year, ambiguous tax laws can lead to uncertainties about whether the related tax positions will ultimately be sustained upon tax audit. If taxpayers determine that their positions are more-likely-than-not able to be sustained, said the authors, then the tax benefits are recognized immediately as a reduction in financial statement tax expense and no reserve is accrued. However, positions failing to meet this threshold must be accrued as a tax reserve liability, thus increasing the current period’s tax expense included on the firm’s income statement.