The footnote that wouldn’t tie... Uncertain Tax Positions! In what seems to go against the laws of nature for accountants, it’s actually ok if the footnote for uncertain tax positions doesn’t match the balance sheet. Hear PwC’s Kassie Bauman explain the accounting framework for uncertain tax positions, the related disclosures, and highlights several reasons why the footnote may, or may not, directly agree to the balance sheet.
Hi I’m Kassie Bauman.
Disclosures for uncertain tax positions can sometimes be a bit more difficult to pin down than disclosures for other financial statement line items. This is because they often won’t tie out to the tax balances on the financial statements. In this video, I’ll explain the accounting framework for uncertain tax positions, identify the related disclosures, and highlight several reasons why the footnote may, or may not, directly agree to the balance sheet.
Every company takes tax positions. A tax position could be whether your company qualifies for a tax deduction or credit, or even whether your company is subject to tax in a certain jurisdiction. Some of these positions might be a stretch, and some may be slam dunks.
Uncertain tax positions can create unrecognized tax benefits, or UTBs. Here’s how the accounting model works. Say you took a tax position on your tax return that reduced your tax liability by $100. First you go through the recognition assessment for the tax position where you determine that it’s more-likely-than-not that the tax position will be sustained by the tax authority based on technical merit. Next, you go through the second step, which is the measurement assessment, and you determine that $75 is the largest amount of benefit that has a greater than 50% chance of being realized upon settlement with the tax authority. Under the Standard, that means you can recognize $75 of benefit in your financial statements. The difference between the benefit you took on your tax return of $100, which reduced your tax payable, and the benefit you can take on your financial statements of $75 is an unrecognized tax benefit. Often times, that would go on the books as a liability of $25, representing the difference between your payable benefit and your expense benefit. However, the UTB may not always show up as a liability on the face of financial statements, which we’ll get into in a minute.
The aggregate UTB liability disclosed in the financial statements is often made up of liabilities related to multiple uncertain tax positions taken in multiple tax jurisdictions. The change in the disclosed liability each year could be caused by new uncertain tax positions being taken, old positions being resolved, remeasurement of old positions due to new information, or positions being removed when the statute of limitation expires. The key objectives of uncertain tax position disclosures are to provide better transparency around reasons for movement in UTBs, and to give financial statement users information about the risks underlying the liability.
Some of the current required uncertain tax position and UTB disclosures include:
1 A tabular reconciliation of UTBs
2 Identification of uncertain tax positions that are reasonably expected to change within 12 months
3 UTBs that, if recognized, would affect the effective tax rate
4 Tax years still subject to examination by a major tax jurisdiction
Of those, the tabular reconciliation of UTBs is probably the most onerous. The guidance is fairly prescriptive about certain types of changes being disclosed on a gross basis, including changes in current and prior year positions, settlements for amounts paid, or where you used a tax attribute, like an NOL, to settle the liability, and changes driven by the lapse of a statute of limitation. Companies can disclose other line items in this reconciliation as well, depending on whether they believe additional information about changes in the balance may help with transparency.
With many financial statement disclosures, the numbers, or at least the totals, in the footnote agree to what’s on the face of the financial statements. When it comes to the UTB reconciliation, there’s often circumstances where the unrecognized tax benefits disclosed in the footnotes would not directly tie to the amount on the balance sheet. I’ll cover two common reasons for this, though there are other reasons that the disclosure may not tie to the face of the balance sheet.
One of the most straightforward reasons the UTB reconciliation footnote won’t directly agree to an uncertain tax position liability on the balance sheet is that the liability is often not significant enough to be broken out—so it often gets lumped into another liability line item. This certainly isn’t unique to uncertain tax position liabilities, but a few things can present a bit more of a challenge here: First, you could have some uncertain tax position liabilities that are expected to be settled within a year, and therefore should be classified as current in the balance sheet, and others that should be noncurrent. They may be shown as one line item on the general ledger, but split into two different aggregated line items — like “other current liabilities” and “other liabilities” — on the balance sheet.
Another common reason that the UTB reconciliation footnote won’t directly agree to an uncertain tax position liability on the balance sheet is a result of guidance the FASB issued back in 2014. This guidance basically says that if you have an NOL or similar loss carryforward, or a tax credit carryforward that you could use to “pay off” uncertain tax position liabilities, you should net those uncertain tax position liabilities against the deferred tax assets for those carryforwards.
This can complicate things in two ways: First, if your entire uncertain tax position liability is net against deferred tax assets because you have, for example, NOLs that could be used to “pay off” that entire uncertain tax position liability, that netting typically won’t be evident in the financial statements. But you could also have an instance where a portion of that uncertain tax position stays in the liability section, and a portion is net against the deferred tax asset.
Assume you had an uncertain tax position liability of $1,000 that relates to federal positions, and the rest of your liability relates to state positions. If you only have NOLs for federal purposes but not for state purposes, you would net the federal uncertain tax position against the deferred tax asset for the federal NOLs, but the state portion of your uncertain tax position liability would still be reflected as a liability in the balance sheet, and may or may not be on its own line item, depending on how significant it is, like we just discussed.
Those are just a couple of basic reasons why the UTB reconciliation may not tie out to the liability on the balance sheet. There can be other reasons that are more nuanced which make it even more challenging to reconcile amounts. The point here is that you need to understand the full inventory of unrecognized tax benefits, what’s transpired with them over the course of the past year, and what assets could be used to pay them off in order to know what should be presented in the footnote and how that may be shown on the face of the balance sheet. Of course, help from your resident tax accountant is also strongly encouraged.
For more information on the disclosure requirements for uncertain tax positions, including examples, refer to chapter 16 of our Financial statement presentation guide, available on CFOdirect.com.