Dollars & Cents
Guidance for Documentation of Uncertain Tax Positions Under ASC 740-10
Dollars & Cents
By: Laura Kalick
|Summary: Accounting Standards Codification 740-10, previously and popularly known as FIN 48, requires associations to determine and note whether or not the organization has uncertain tax positions. Notation of the UTPs is a two-step process: identifying the tax positions and then measuring how well the position can be sustained upon examination by the IRS and other taxing authorities.|
Accounting Standards Codification (ASC) 740-10, previously and popularly known as FIN 48 (Financial Accounting Standards Board Interpretation No. 48), now requires that associations with financial statements prepared in accordance with Generally Accepted Accounting Principles (GAAP) must determine if the organization has any uncertain tax positions (UTPs). If an organization has taken a tax position that would not hold up under examination, then the organization could have a substantial tax liability.
Association management must examine all open tax years as if the IRS and other taxing authorities were auditing them and measure the probable outcomes. Material UTPs must be disclosed in a footnote to the financial statements and also are required to appear on Schedule D of Form 990. An organization's auditors determine during the audit what amount is considered material. If the financial statements are consolidated, then ASC 740-10 is applied to each of the consolidated entities, and any UTPs are aggregated and compared to the materiality level for the consolidated group to determine if disclosure is required. Note also that large taxable corporations will be required to file a new Schedule UTP (Uncertain Tax Position Statement) with Form 1120.
Documentation of UTPs is a two-step process:
- First, an organization must identify tax positions and whether or not, based on the technical merits of the position, it is most likely that each position would be sustained upon audit by a taxing authority. For purposes of ASC 740-10, an organization must assume that it will be audited.
- Step two is measurement. If, based on the technical merits, it appears not more likely that the position could be sustained upon examination, the organization must calculate the taxes, interest, and penalties that would likely be owed. All UTPs must be ascertained for the open tax years and aggregated. If in the aggregate the UTPs are material, it must be disclosed in a footnote within financial statements. Measurement is not an all-or-none exercise. In other words, probabilities must be taken into account of whether factors might point to less than the entire position being sustained. For example, one might be able to conclude that 80 percent of a certain payment could be excluded as a royalty but that 20 percent would be taxed as unrelated business income because of marketing services provided.
An organization must provide auditable documentation of its tax positions. The more highly certain a position is, the less documentation is needed. And, obviously, the converse is true, i.e., a less certain position should have more documentation to show that it is more likely than not to be sustained upon audit.
The following are hot spots that your association should be aware of:
State income taxes can be a significant issue. In addition to having an office in a jurisdiction that establishes nexus, an association that is a partner in a partnership with a physical location in another state may be deemed to be doing business in another jurisdiction. If an organization has never filed a tax return, there is no statute of limitations on the assessment of tax, which should be an area of concern.
Many organizations are involved in foreign activities either directly or through subsidiaries. Any uncertain positions with regard to foreign taxes also must be considered as part of the analysis.
Exemption itself is a tax position. There are several factors that can place an organization's exemption at risk depending upon the type of organization and the code section under which it is exempt.
Political activity. If an organization is a 501(c)(3) organization, then it is prohibited from engaging in political activity, and management should affirmatively state that there has been no political activity. If an organization is a 501(c)(4),(5), or (6) organization, political activity cannot be the primary purpose. If the primary purpose is called into question, the organization should provide documentation to show that political activity is less than 50 percent of the organization's activities and expenditures. In cases such as these, timesheets and good record keeping are key. Non-501(c)(3) organizations are also liable for tax on political expenditures, even though they are allowed to make them (Form 1120-POL).
Substantial unrelated business activity. Another concern about exemption can arise if unrelated business activities are substantial. Note that substantial unrelated business is an activity test as opposed to an income test. Sometimes organizations take on new activities that were not approved originally by IRS in the organization's application for exemption. If the activity is questionable, it would be necessary to look at contracts and agreements, research the law, and possibly get an opinion that the activity is not an unrelated trade or business. Also, even if an activity that would be an unrelated activity is being conducted in a taxable subsidiary, is the subsidiary being operated as a separate entity or are the organizations being operated as if they are one? Factors to document here would include respecting the corporate formalities of separate organizations such as separate board meetings and minutes, separate bank accounts, sharing agreements, and so on.
Expense Allocations and Net Operating Losses
Finally, organizations should consider expenses used to offset unrelated trade or business income, especially when those expenses come from activities that consistently generate losses. To be an unrelated trade or business, the activity must not be related to the organization's tax-exempt purpose, must be carried on regularly, and must be a trade or business that requires a profit motive. If the activity generates annual losses, there may not be the requisite profit motive, and the IRS could disallow using the losses to offset other unrelated business income.
In many ways, documentation of UTPs is similar to an IRS mock audit, except that only income tax positions are in question and not issues such as deferred compensation compliance, employment taxes, or sales taxes. Associations should consider whether a mock audit to cover these other issues may be an appropriate next step.
Laura Kalick, JD, LLM, is director of nonprofit tax consulting at BDO USA, LLP, in Bethesda, Maryland. Email: firstname.lastname@example.org