Income taxes: Uncertain tax positions, fundamentals

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Video , PwC US Oct 19, 2016

UTP what? Are you uncertain about the accounting for Uncertain Tax Positions (UTPs)? PwC’s Kassie Bauman translates the tax talk into plain english with easy to follow examples. Listen in to learn what an uncertain tax position is, how they relate to uncertain tax benefits, and how they are monitored and resolved.

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Transcript

Hi, I’m Kassie Bauman.

In the ordinary course of business, the average corporate tax return will include a number of tax positions. Whether an expense qualifies for a tax deduction, or whether a tax credit can be claimed - those are examples of tax positions. A tax position can also include whether the company is subject to tax in a certain jurisdiction.

A tax position simply reflects your judgment of how the tax law applies to your circumstances. Some judgments are pretty straightforward, and some can be subject to interpretation. These judgments underpin uncertain tax position assessments.

In this video, we’ll break down the model for uncertain tax positions, show you how it works with some examples, and close with how they are monitored and resolved.

The model for uncertain tax positions has two main thresholds: recognition and measurement.

Let’s start with recognition. The recognition concept relates to when you can recognize the tax benefit from the tax position in your financial statements. It does not relate to when you recognize an uncertain tax position (or UTP) liability. That is often a source of confusion as it differs from some other accounting models.

When a tax position is more likely than not to be sustained upon examination by a tax authority, based solely on its technical merits, the tax position has met the recognition threshold. When considering whether the position will be sustained, you have to assume that the tax authority has all relevant information and will examine the position. You can’t factor in detection risk when determining the likelihood that the position will be sustained.

That’s the theory, but let’s look at an example to see what it looks like in practice. Say you complete your tax return and initially conclude you owe $1,100 after taking tax positions that were certain. You then take a further look at the return and say, I think I might qualify for an additional tax credit. As a result, you take a tax position which reduces your liability by $100. Now instead of owing $1,100 in taxes, you owe $1,000. On your books, you debit tax expense for $1,000 and credit taxes payable for the same, to match the tax return. But you still have the $100 uncertain tax position to assess.

Step one is recognition. Let’s say you determine the odds are 50% or less that the tax position would be sustained. That means you are taking the credit on your tax return, but you can’t reflect that benefit on your financial statements because it doesn’t meet the recognition threshold of more-likely-than-not. So, that’s another $100 of tax expense you need to record, taking total tax expense to $1,100, with the other side of the entry being a liability for the unrecognized tax benefit of $100.

If the tax position meets the recognition criteria of more likely than not, that means that you can recognize at least some of the benefit in your financial statements. The second step in the model helps you determine the appropriate amount of benefit to record. This requires you to figure out the largest amount of benefit, determined on a cumulative probability basis, that is more likely than not to be realized upon final settlement.

So let’s look at how step two, measurement, works. Let’s assume instead that it is more-likely-than-not that the $100 credit we previously discussed would be sustained upon examination. The $100 is the gross amount of benefit to be realized. But the amount to record is the largest amount of benefit that’s more likely than not to be realized, on a cumulative probability basis. So what does that mean? Rather than picking a single dollar value you think matches up to a 51% likelihood, the model considers assigning different probabilities to individual outcomes. The outcome that provides the greatest tax benefit should be assessed first.

In our example, if the probability of realizing the full $100 was 70%, then you would stop there, record the full benefit, and would have $0 for your uncertain tax position liability. But often, the full amount of the tax position is not the amount that meets the cumulative probability threshold.

Let’s go back to our earlier example to see how the measurement assessment works. First, you identify various outcomes or scenarios, starting with the largest amount of benefit. So on the left you can see we start with $100, and go down from there. Next, you assign probabilities to each of those scenarios. These are individual probabilities, so the total should add up to 100%. Then, you determine the amount where the cumulative probability is greater than 50%. In our case, a tax benefit of $75 would ultimately be recognized, based on the cumulative probability of the first two scenarios. So the final entry to record the unrecognized tax benefit of $25 would be a $25 debit to tax expense and a $25 credit to your uncertain tax position liability.

The assessment of an uncertain tax position is a continuous process. All unresolved UTPs must be reassessed at each balance sheet date, and any changes must be based on new information. New information includes things like tax law changes, new regulations issued by taxing authorities, and interactions with the taxing authorities. Any change in UTPs should be recognized in the period the facts change. So, a change in facts subsequent to the reporting date but prior to the issuance of the financial statements doesn’t get pushed back. Disclosure is required in this situation if the amounts are material.

Ultimately, unrecognized tax benefits can be realized when the underlying tax position is effectively settled or the statute of limitations expires. When this occurs, typically the UTP liability is debited and income tax expense is credited.

For more information on the fundamentals of uncertain tax positions, as well as more complex considerations, please refer to chapter 16 of PwC’s Income tax accounting guide, available on CFOdirect.com.

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Heather Horn

Heather Horn

US Strategic Thought Leader, National Professional Services Group, PwC US

David Schmid

David Schmid

International Accounting Leader, National Professional Services Group, PwC US

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