Changes in accounting principles under FIN 48 (renamed ASC 740-10) could have a big impact on your organization and its potential tax liability.
Q: What is FIN 48 (now ASC 740-10) and how is it applicable to associations?
A: Associations that have financial statements prepared in accordance with GAAP (Generally Accepted Accounting Principles) are now required to determine if the organization has any uncertain tax positions (UTPs). If an organization has taken a tax position that would not hold up on audit, then the organization could have a substantial tax liability.
Association executives must examine the tax years potentially audited by the IRS and other taxing authorities and measure the probable outcome. The requirement for such documentation is found in the Financial Accounting Standards Board's ASC 740-10 (previously known as FIN 48 and renamed in September 2009 under FASB's Accounting Standards Codification). Material uncertain tax positions should be disclosed in a footnote to the financial statements and are also required to appear on Schedule D of Form 990. An organization's auditors determine during the audit what amount is considered material.
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 audit, the organization must calculate the taxes and interest that would likely be owed. All UTPs must be ascertained for the open tax years and aggregated. If in the aggregate the uncertain tax positions are material, it must be disclosed in a footnote within financial statements. In many ways, documentation of UTPs is similar to an IRS mock audit, except that only income tax positions are in question and not taxes such as employment taxes or sales taxes.
Examples of Tax Positions
Exemption itself is a tax position; decisions to not file tax returns, expense allocation methods utilized, and determining if income is related or unrelated are also tax positions. Tax positions occur at the federal, state, local, and international levels. State income taxes can be a significant issue, especially if an association is in a partnership or an alternative investment and may be deemed as doing business in another jurisdiction. If the organization never filed a tax return, there is no statute of limitations on an assessment of tax, which is an area of concern.
For example, consider an organization with an affinity program that has excluded the entire amount of that income as a royalty, even though a significant amount of time is spent marketing the program. It is more likely than not that most of the income can be excluded as a royalty, but not the entire amount, because it is payment for substantial marketing services. The organization must determine what percentage of the income would be taxed, calculate the tax on that portion, and add interest and potential penalties. The organization must conduct analysis for all tax positions and add together the results for all tax years that could be subject to an audit.
Organizations must also document the certainty of their exempt status if the organization were to be examined. Since the IRS grants exempt status based on representations made in the application for exemption, study the original Form 1023 or 1024 and document if the organization is doing what it said it would. Also, organizations cannot have more than an insubstantial amount of unrelated activities and still keep exemption. An inventory of revenue streams is on Form 990 in the section describing income-producing activities. An organization should document that the characterization of those items is appropriate and that it's more likely than not sustainable if audited by taxing authorities. 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. Applicability of these factors should also be part of the analysis.
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.
Laura Kalick is tax consulting director at BDO in Bethesda, Maryland. Email: [email protected]