Accounting for Uncertainty

FIN 48 and new return standards require tax preparers to assess a variety of thresholds.




FASB Interpretation no. 48 (FIN 48), Accounting for Uncertainty in Income Taxes, sets the threshold for recognizing the benefits of tax return positions in financial statements as “more likely than not” (greater than 50%) to be sustained by a taxing authority. The effect is most pronounced where the uncertainty arises in the timing, amount or validity of a deduction.

Thresholds applicable to tax practitioners have been revised from a “realistic possibility” to “more likely than not” that a tax position will be sustained, as set forth in the U.S. Troop Readiness, Veterans’ Care, Katrina Recovery, and Iraq Accountability Appropriations Act of 2007 that was signed into law in May.

A third threshold, that a tax position possesses a “reasonable basis” in tax law, has been regarded as reflecting 25% certainty. In addition, taxpayers are subject to penalties if an understatement of liability is caused by a position that lacks “substantial authority,” a threshold for which no percentage of certainty has been established but has been regarded as between the reasonable-basis and more-likely-than-not standards.

Being familiar with the different thresholds for the reporting of uncertain tax positions can help CPAs effectively advocate for their clients’ tax positions and be impartial in financial reporting.

Damon M. Fleming, CMA, Ph.D., and Gerald E. Whittenburg, CPA, Ph.D., are professors of accounting and taxation, respectively, at San Diego State University, San Diego. Their e-mail addresses are and, respectively.

L ast year, FASB issued Interpretation no. 48 (FIN 48), Accounting for Uncertainty in Income Taxes. It sets the threshold for recognizing the benefits of tax return positions in financial statements as “more likely than not” to be sustained by the relevant taxing authority. This threshold was significantly higher than tax reporting thresholds for practitioners and taxpayers, likely leading to discrepancies between how uncertain tax positions would be reported for purposes of income tax versus financial statements. In May 2007, the tax law for practitioners changed. This article describes the convergence of uncertainty thresholds for tax positions and identifies potential issues for CPAs and their clients to consider when making tax and financial reporting decisions.

FIN 48 augments FASB Statement no. 109, Accounting for Income Taxes , to increase the comparability of financial statements by providing guidance on uncertainty in tax positions. It defines a tax position as one reflected in measuring any current or future reduction in taxable income reported or expected to be reported on a tax return, the decision not to report a transaction in a tax return, or an assertion that the reporting entity is not subject to taxation. In essence, its threshold of greater than 50% certainty constitutes a positive assertion by management that the reporting entity is entitled to the economic benefits of the tax position.

FIN 48 prescribes a two-step evaluation for recording uncertain tax positions. First, determine whether the more-likely-than-not threshold is met. Second, measure the benefit of the tax position at the largest amount that is greater than 50% likely to be realized upon effective settlement.

Recognizing the benefit from a tax position in the financial statements that is less than the tax effect reported in the tax return (1) creates a current or noncurrent liability, depending on the timing of the cash flows; and/or (2) reduces the amount of tax net operating loss carryforward or amount refundable from the taxing authority. FIN 48 may also affect the measurement of deferred taxes. Deferred tax assets and liabilities should be computed as the difference between the carrying value for financial reporting purposes and the tax basis calculated using FIN 48.

FIN 48 applies to all tax positions accounted for under Statement no. 109, including tax positions to be acquired in business combinations, as of the beginning of the first fiscal year beginning after Dec. 15, 2006. However, tax positions most affected by FIN 48 are those where the uncertainty relates to the timing, amount or validity of a deduction.

Example. In January 2007, a motion picture production company acquired the rights to a film for $12 million in an isolated transaction. For financial reporting purposes, the film is considered an indefinite-life intangible and is not subject to amortization. Alternatively, the film rights can be amortized for tax purposes using the “income forecast method.” The company is certain that the entire cost of the film can be ultimately deducted, but the timing of the deductibility is uncertain.

Based on the uncertainty in the tax code and estimation of forecasted income, the company decides to deduct the entire cost of the asset over the next two years. The company believes it is 30% likely that it would be able to realize the deduction over the next two years upon effective settlement, 60% likely that it would be able to realize it over a six-year period and is certain that it would be able to sustain a 15-year amortization. Thus, the largest benefit for the current year that is more than 50% likely of being realized upon effective settlement is the tax effect of a $2 million deduction ($12 million ÷ six years).

At Dec. 31, the company should reflect a deferred tax liability for the tax effect of the temporary difference caused by the difference between the $12 million book value of the asset and the $10 million tax basis of the asset computed in accordance with FIN 48 ($12 million less $2 million of amortization). The company also should recognize a tax liability for the difference between the $6 million deduction position taken on the tax return and the $2 million deduction position that is more likely than not to be sustained. In addition, an evaluation of the accrual of statutory penalties and interest on the difference between financial statement and tax reporting needs to be undertaken.

CPAs and other tax practitioners are subject to several tax position thresholds found in statutory, administrative (Treasury Department Circular 230) and professional pronouncements such as the AICPA Statements on Standards for Tax Services (SSTS). Prior to May 2007, the primary threshold of concern for tax practitioners was the “realistic-possibility” standard.

Under Circular 230, a realistic possibility exists when a reasonable and well-informed analysis by a person knowledgeable in the tax law concludes there is at least an approximately one-in-three (33%) likelihood the position would be upheld on its merits. Under subpart (a) of section 10.34, practitioners should not prepare or sign a return that they are aware takes a position that does not meet the realistic-possibility standard, unless the position is not frivolous and is appropriately disclosed in the tax return.

In May, the U.S. Troop Readiness, Veterans’ Care, Katrina Recovery, and Iraq Accountability Appropriations Act of 2007 was signed into law. The Small Business and Work Opportunity Act (Pub. L. No. 110-28) portion of this comprehensive bill modified IRC section 6694, which governs the penalty for a practitioner’s understatement of a taxpayer’s liability. Since 1989 (PL 101-239), under IRC section 6694(a), tax practitioners could be fined $250 for an unrealistic position (the inverse way of stating the realistic-possibility standard) that understates tax due. The new law makes two principal changes: (1) it establishes that there must be “a reasonable belief that the tax position would more likely than not be sustained on its merits”; and (2) that practitioners can be fined the greater of $1,000 or 50% of the income derived from services related to the return or claim for refund. Also, the new law extends these requirements to, besides income tax returns, returns for gift, estate and employment taxes.

One of the most serious repercussions of the new law, however, is that it raises the penalties and reporting threshold for practitioners above those for taxpayers. This divergence could cause conflicts between tax preparers and their clients. Preparers are more likely to ask clients to disclose all transactions for which there is any uncertainty as to the proper treatment. Consequently, the AICPA and others have recommended that Congress place taxpayers and preparers on the same footing under the “substantial authority” standard currently applicable to taxpayers. The AICPA has proposed that Congress could still apply the more-likely-than-not standard to undisclosed tax-avoidance transactions.

Exhibit 1
Tax Reporting Inclusion Thresholds
    2008 Pre-2008  
Applies to: Auditors Tax Practitioners Tax Practitioners Taxpayers
Applicable Standards and Threshold More-Likely-Than-Not More-Likely-Than-Not Realistic Possibility (1) Substantial Authority
(2) Reasonable Basis
Threshold Probability Over 50% Over 50% Over 33% Not over 50% but more than a reasonable basis (perhaps 25%)
Threshold Source FIN 48 IRC § 6694(a) (SSTS and Cir. 230 likely to change) (1) IRC § 6694(a)
(2) SSTS no. 1
(3) Circular 230 § 10.34
(1) Reg. § 1.6662-4(d)
(2) Reg. § 1.6662-3(b)
Consequence for Not Meeting Threshold Potential legal and professional liablity (1) Greater of $1,000 or 50% of income derived
(2) Unable to sign return without disclosure (SSTS no.1 and Circular 230)
(1) $250 per occurrence penalty (§ 6694(a))
(2) Unable to sign return without disclosure (SSTS no.1 and Circular 230)
20% penalty on the understatement of tax


Like tax practitioners, taxpayers are also subject to a variety of thresholds for the inclusion of a position on a tax return. Under IRC section 6662(d), taxpayers are subject to a 20% accuracy-related penalty if the understatement exceeds the greater of 10% of the proper tax liability or $5,000 ($10,000 for corporate taxpayers). This penalty can be avoided if the taxpayer has substantial authority for a position or discloses it on a tax return. “Substantial authority,” defined in regulation 1.6662-4(d), is an “objective standard” involving an analysis of the law and its application to relevant facts. The IRS states in the regulations that the substantial-authority standard is less stringent than the more-likely-than-not standard, but more stringent than the “reasonable-basis” standard.

The reasonable-basis threshold is not precisely defined by the IRS. However, in regulation 1.6662-3(b), the IRS states that “a reasonable basis is a relatively high standard of tax reporting, that is, significantly higher than not frivolous or not patently improper.” The reasonable-basis standard appears to be similar to the “arguable-basis” standard under prior law, which was generally held (as evaluated by a person knowledgeable in tax law) to be about a 25% likelihood a tax position would be upheld.

In summary, under IRC section 6662(d), taxpayers must have substantial authority that is higher than a reasonable-basis threshold, but less than the more-likely-than-not threshold to take a position on a tax return without disclosure. See Exhibit 1 for a comparison of the various uncertainty thresholds and Exhibit 2 for examples of their application.

Exhibit 2
Application Examples
    2008 Pre-2008  
Applies to: Auditors Tax Practitioners Tax Practitioners Taxpayers
60% probability that particular income item is nontaxable under current law

Exceeds More-Likely-Than-Not (over 50%):

  • Record full benefit

Exceeds More-Likely-Than-Not (over 50%):

  • Sign tax return
  • No disclosure

Exceeds Realistic Possibility (33%):

  • Sign tax return
  • No disclosure

Exceeds Substantial Authority (25%-50%):

  • Sign tax return
  • No disclosure
40% probability for the calculation of the amount of a research and experimentation credit

Does not meet More-Likely-Than-Not (50%):

  • Estimate and record partial benefit (if any)
  • Record adjustment for difference

Does not meet More-Likely-Than-Not (50%):

  • May not sign tax return as a preparer without disclosure

Exceeds Realistic Possibility (33%):

  • Sign tax return
  • No disclosure

Meets Substantial Authority (25%-50%):

  • Sign tax return
  • No disclosure
20% probability that an entity is not subject to tax in a particular jurisdiction

Does not meet More-Likely-Than-Not (50%):

  • Estimate and record partial benefit (if any)
  • Record adjustment for difference

Does not meet More-Likely-Than-Not (50%):

  • May not sign tax return as a preparer without disclosure

Does not meet Realistic Possibility (33%):

  • May not sign tax return as a preparer without disclosure

Does not meet Reasonable Basis (25%):

  • Subject to 20% understatement penalty if item is not disclosed


The convergence of the uncertainty thresholds may create issues that CPAs need to be aware of. Here are a few examples of areas to consider:

A Higher Reporting Threshold. The revised tax law sets forth a significantly higher threshold for the inclusion of items in tax returns than previously required. As such, tax practitioners and taxpayers need to realign their view of uncertainty to the more-likely-than-not standard for all returns filed after Dec. 31 (IRS Notice 2007-54 granted transitional relief from the May enactment date to the end of the year). The realistic-possibility standard, however, is still in play for returns filed prior to this date. Therefore, over the next several years, practitioners will have to work within both standards. Additionally, many clients are likely to be less knowledgeable about the implications of the new more-likely-than-not standard for tax reporting. Practitioners will have to help adjust their clients’ expectations about certain reported items and deal with potential conflicts such as telling a client that although an item was included in last year’s return, it is no longer appropriate to do so without disclosure this year. Thus, managing the transition to the new standard may likely require additional training concerning technical aspects of tax practice; however, this training should also focus on how to help practitioners walk the line when advocating for clients under a significantly more stringent reporting threshold.

Conflicting Roles. CPAs and clients have different motives and pressures that affect their judgments and decisions. Consequently, CPAs need to be aware of the potential for “gaming” by their clients during negotiations regarding uncertain tax positions. For example, clients with different CPAs for tax and audit may attempt to pit those professionals’ differing analyses and recommendations against each other. Additionally, non-publicly traded clients who have the same CPA handle their tax and financial reporting may attempt to leverage advice about a tax position given in one period to achieve their desired outcome in a subsequent period. Maintaining a good client-practitioner relationship and openly conveying awareness of this potential to clients may minimize such attempts. Regardless, particular caution needs to be taken when rendering advice on tax position uncertainty in these situations.

Determining the probability distribution for tax positions. All the uncertainty thresholds require determining an underlying probability distribution for a tax position. Applying FIN 48 is complicated by also having to estimate outcomes for each probability of occurrence.

Auditors no longer have the choice to avoid the tangled web surrounding uncertain tax positions—FIN 48 requires them to take it head-on. The purpose of external reporting—whether it is to shareholders or taxing authorities—is the production of financial information that provides useful information to users of those reports. Thus, being familiar with the reporting of uncertain tax positions across the areas of accounting practice should aid CPAs in more effectively advising their clients and managing issues that may arise.


Practice Guide on Accounting for Uncertain Tax Positions Under FIN 48

Accounting for Income Taxes—Applying SFAS No. 109/FIN 48: A Whole New Ballgame!, a CPE self-study course (#182792, #732793, #352792).

For more information or to make a purchase, go to, or call the Institute at 888-777-7077.


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