Privately held business entities organized as flow-through entities face unique state tax issues under FASB Accounting Standards Codification (ASC) Topic 740 relating to the accounting for uncertainty in income taxes. For federal purposes, only a small percentage of flow-through entities pay income taxes, and if the scope of ASC 740 did not extend beyond federal law, the number of flow-through entities subject to it would be minimal. For state purposes, a significantly larger population of flow-through entities will be subject to ASC 740 as states move toward assessing various types of gross receipts taxes on flow-through entities.
ASSESSMENT OF AN INCOME TAX
ASC 740 applies only to business entities subject to income taxes. The question of whether a wide variety of state taxes falls under the rubric “income taxes” has raised vexing questions. Several states (most notably Texas, Michigan, Ohio and, most recently, Oklahoma) have enacted tax systems that have characteristics of both sales and income taxes. These states (and others) have issued opinions on whether these assessments are income taxes or more in the nature of fees. These determinations generally deal with whether the levy is a sales and use tax or an income tax and, if it is an income tax, whether it is deductible on the state return. The results are far from consistent.
ASC 740-10-20 defines “income tax” as domestic and foreign federal (national), state and local (including franchise) taxes based on income. While ASC 740 does not include a definition of “income subject to tax,” it does include a definition of certain types of assessments to which ASC 740 does not apply. It does not apply to a franchise tax to the extent it is based on capital and there is no additional tax based on income. If there is an additional tax based on income, that excess is considered an income tax and is subject to ASC 740. Under this very broad definition, most state assessments, including some franchise taxes based on earned surplus or income taxes, qualify as income tax payments. An increasing number of state assessments are based on gross receipts or gross income and exhibit characteristics of both fees and income taxes. Various state and local taxes may have income-tax-like elements that can potentially belie their nomenclature as something other than an income tax.
The ASC 740 analysis must be completed for flow-through entities publishing financial statements under GAAP and doing business in states such as California, Illinois, Kentucky, Massachusetts, Michigan, New Hampshire, Tennessee, Texas and Wisconsin. This makes the extension of ASC 740 to flow-through entities a much more extensive reporting requirement than most practitioners initially thought; many had considered only the very limited situations in which a flow-through entity might be subject to a federal income tax as the scope of this new reporting requirement.
For a detailed discussion of issues in this area, see “Uncertain Tax Positions for Flowthrough Entities: What Is an Income Tax?” by Kathleen K. Wright, CPA, J.D., and Jack Small, CPA, in the June 2011 issue of The Tax Adviser.
—Alistair M. Nevius, editor-in-chief
The Tax Adviser
Also look for articles on the following subjects in the June 2011 issue of The Tax Adviser:
A discussion of innocent spouse relief.
A look at the tax consequences of transaction costs.
The Tax Adviser is the AICPA’s monthly journal of tax planning, trends and techniques. AICPA members can subscribe to The Tax Adviser for a discounted price of $85 per year. Tax Section members can subscribe for a discounted price of $30 per year. Call 800-513-3037 or email firstname.lastname@example.org for a subscription to the magazine or to become a member of the Tax Section.
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