Third in a series on ASC-740 fundamentals. Subscribe to the TaxOps blog for the full series.
What is ASC-740?
ASC-740 attempts to shed light on how companies should account for and report the effects of taxes based on income on their financial statements. The requirements of ASC-740 can significantly impact how a company reports its current and future income tax expense or benefit on the income statement, as well as how deferred tax assets or liabilities are reported on the balance sheet.
Additionally, ASC 740 addresses how a company reports uncertain tax positions on its financial statements under a “more-likely-than-not” recognition threshold (formerly known as FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes or “FIN 48”). This standard requires specific uncertain tax position disclosures in the annual financial statements, including a reconciliation of total unrecognized tax benefits, classification of income tax-related interest and penalties, identification of years that remain open to examination, and unrecognized tax benefits expected to significantly change within 12 months of the reporting period.
Why should companies be concerned with ASC-740?
The uncertain tax position guidance contained in the ASC-740 standard has the effect of requiring organizations to track uncertain tax positions for both tax compliance and financial reporting. For many companies, implementing a plan and associated processes and procedures to ensure that evaluation and tracking occurs can be overwhelming, particularly for organizations subject to multiple tax jurisdictions.
Where companies get into trouble with the standard varies. Companies that take aggressive taxable income positions that exceed a threshold set by ASC-740 must disclose the uncertain position in the footnotes to the financial statements. Any footnote that indicates an uncertain position raises the risk that an IRS, state, or foreign tax authority could challenge the validity of the tax position taken on the company’s previously filed income tax returns. Companies with a large number of uncertain tax positions may trigger an audit that could potentially increase tax revenues for the taxing jurisdiction. When it comes to a challenge by a tax authority, companies that lose could be forced to eliminate deductions or include additional items of income that could ultimately result in an upward adjustment to previously reported taxable income and in turn decrease net income reported on the financial statements.
What is the scope of ASC-740?
ASC-740 establishes standards of financial accounting and reporting for currently payable income taxes as well as deferred income taxes payable at some point in the future. The provision takes into consideration:
- revenues, expenses, gains, and losses that are recognized as taxable income in prior year’s or a later year.
- other events that create differences between the tax bases of assets and liabilities and their carrying amounts for financial reporting
- operating loss or tax credit carrybacks for refunds of taxes paid in prior years and carryforwards to reduce taxes payable in future years
What income taxes are covered by ASC-740?
ASC-740 covers federal, foreign, state and local (including franchise) taxes based on income. Also covered are an enterprise’s domestic and foreign operations that are consolidated, combined, or accounted for by the equity method, and foreign enterprises that prepare financial statements in accordance with U.S. GAAP.
Among the taxes not covered are:
- Sales and use taxes
- Property taxes
- Payroll taxes
- Excise taxes
- VAT taxes
- Capital (equity) based franchise taxes
Although not directly addressed by ASC-740, there are several taxes worth considering under these requirements, including:
- Withholding taxes
- Tax systems that heavily modify their tax base
- Any system that produces a liability even when the company is producing losses (AMT)
What is a tax position?
ASC 740-10-20 defines a tax position as a position in a previously filed tax return or a position expected to be taken in a future tax return that is reflected in measuring current or deferred income tax assets and liabilities for interim and annual periods. A tax position can result in a permanent deduction of income taxes payable, a deferral of income taxes otherwise currently payable to future years, or a change in expected deferred tax assets.
The term tax position also encompasses, but is not limited to:
- A decision not to file a tax return
- An allocation or a shift of income between jurisdictions
- The characterization of income or a decision to exclude reporting taxable income in a tax return
- A decision to classify a transaction, entity, or other position in a tax return as tax exempt
- An entity’s status, including its status as a pass-through entity or a tax-exempt not-for-profit entity (FASB ASU 2009-06 modifies the definition of a tax position to include additional language to address tax positions related to pass-through and tax exempt not-for-profit entities.)
What is an “uncertain tax position?”
ASC-740 defines an uncertain tax position as the “recognition of tax balances on financial statements that are not recorded on corporate tax returns, if those returns include uncertain tax positions.” Some examples of “tax positions” include determining whether a meal expense is 50 percent or 100 percent deductible or determining whether or not a tax return should be filed in another state.
How does an organization determine an “uncertain” tax position? Under ASC 740, organizations must develop a cumulative tax risk portfolio limited to income taxes that is contemporaneously monitored and maintained. Material tax positions must be evaluated in all jurisdictions for open years in order to evaluate whether tax positions subject to exam are uncertain.
What characteristics of private companies make complying with ASC-740 more difficult than their public company counterparts?
While all entities are subject to ASC-740, private enterprises often possess characteristics that will present additional challenges under ASC-740 that are less common issues for public enterprises, and include:
- Specific issues related to income attribution for flow-through entities
- Time consuming identification process, especially for enterprises with consolidations, acquisitions, and significant state or international operations
- Lack of sufficient internal tax or U.S. GAAP expertise
- Nonexistent or minimal internal controls for tax processes
- Poor documentation of tax positions taken by the organization
- Limited tax authority history on which to base conclusions
- More aggressive tax positions taken historically
What is the difference between ASC-740 and ASC-740-10?
ASC-740 applies to all public and private institutions. ASC-740-10 clarifies requirements of pass-through entities and tax-exempt not-for-profit organizations.
Notably, ASC-740 is required only under United States Generally Accepted Accounting Principles (US-GAAP) and is not present in international accounting standards.
For question regarding these FAQs or other ASC-740 provision matters, please contact Daniel DeLau at 720-227-0065 or delau@taxops.com.
