FIN 48: Avoiding the Roadmap Trap

Private companies are in the process of implementing FASB Interpretation No. 48 (“FIN 48”), which imposes radically new accounting rules for uncertain income tax positions.1 These companies need to be mindful that their FIN 48 workpapers may be subject to discovery by the IRS and other tax authorities. Those workpapers may provide tax authorities with a roadmap to the Company’s most vulnerable tax positions and to the company’s evaluation of the legal merits and settlement prospects for those positions. However, by engaging counsel to assist with the process, the company may be able to significantly mitigate this roadmap trap.


Under the rules applicable prior to FIN 48, tax positions reported on the tax return were presumed to be correct, and a loss contingency reserve was recorded only if (a) it was probable that the return position would be disallowed and (b) the amount or range of loss could be reasonably estimated. See FASB Statement No. 5 (“FAS 5”). As a result of these rules, a company’s FAS 5 workpapers tended to have a limited amount of information regarding only those few positions for which a loss contingency reserve was accrued.


FIN 48 effectively reverses the presumption of FAS 5. Under FIN 48 (applicable for private companies’ 2009 annual financial statements), every tax return position is presumed to be incorrect unless the company can establish that it is more likely than not, based solely on the technical merits, that the position will be sustained upon examination (taking into account any administrative or judicial appeals). For this purpose, FIN 48 clarifies that the company must presume that the tax position will be examined by the applicable tax authority, that the tax authority will have full knowledge of all relevant facts, and that each tax position will be decided separately (i.e., no “issue trading”).

If the return position survives this threshold recognition test, the amount of tax benefit to be recognized in the financial statements is the “largest amount of tax benefit that is greater than 50 percent likely of being realized upon ultimate settlement with a taxing authority that has full knowledge of all relevant information.”

These new rules mean that private companies issuing GAAP financial statements must inventory all of their material tax positions and then analyze each of those positions to determine whether the company has a better than 50% chance of winning the issue on the technical merits (the recognition test). If it can’t satisfy the recognition test, none of the tax benefit of the position is recognized in the financial statements (i.e., the tax position is fully reserved). If the recognition test is satisfied, then the company applies the measurement test and recognizes in its financial statements the amount of the tax benefit that has a 50% or greater chance of being accepted by the tax authority in settlement of the issue. This analysis must be appropriately documented in the company’s financial accounting workpapers.


There may be a tendency among private companies and their accounting advisors to prepare detailed FIN 48 workpapers that (a) comprehensively analyze the technical merits of each uncertain tax position, including the arguments for and against a favorable outcome in litigation, and (b) for those positions that meet the recognition test, analyze the relative probabilities of various settlement outcomes. While this approach is consistent with FIN 48, it creates a roadmap to the company’s uncertain tax positions, to weaknesses in the factual and legal defenses for its uncertain tax positions, and to the company’s evaluation of the settlement prospects for those positions. If these FIN 48 workpapers were to fall into the hands of the IRS or other affected tax authorities, they could significantly increase the company’s exposure to deficiencies (including related interest and penalties).

The IRS currently has a policy of restraint with respect to requesting production of financial accounting workpapers related to reserves for uncertain tax positions (so-called “tax accrual workpapers”). However, recent litigation reveals the limits of that policy and the difficulty companies have trying to resist the IRS’s requests for discovery of tax accrual workpapers under traditional principles of attorney-client privilege and work-product.2 Moreover, the IRS policy of restraint is under reconsideration. And state taxing authorities, which are increasingly hungry for tax revenues, generally have no such policy of restraint.


Companies with material uncertain tax positions should seriously consider separating the process of identifying, quantifying, and assessing the technical merits of their tax positions from the process of complying with FIN 48. The former process (legal analysis) can be conducted with assistance of counsel in a manner that protects the analysis from discovery under the attorney-client and work product privileges. Once the former process has been completed, the latter process (accounting compliance) of applying FIN 48 and preparing related financial accounting workpapers can generally be structured to merely document the conclusions reached with respect to recognition and measurement, and to include only the critical facts and legal authorities supporting the accounting conclusions. The FIN 48 workpapers generally would not disclose the company’s detailed evaluation of competing factual and legal arguments or its subjective analysis of alternative settlement strategies.

By separating the legal analysis of uncertain tax positions from the accounting compliance process, a company’s FIN 48 workpapers will contain less damaging information, and the company’s more comprehensive and privileged legal analysis of its uncertain tax positions should be outside the scope of any request for production of the company’s FIN 48 or other financial accounting workpapers.


A private company should carefully plan the preparation and content of its FIN 48 workpapers to minimize the damage to the company if the IRS or other tax authority obtains discovery of the workpapers. One way to support this objective is to fully separate the process of analyzing the technical merits of uncertain tax positions and the likely settlement scenarios (legal analysis) from the process of documenting the company’s compliance with FIN 48 (accounting analysis). Under this bifurcated approach, the FIN 48 documentation may be less likely to create a roadmap for the IRS and other affected tax authorities.

For more information on this subject, contact Jim Browne (contact information listed in the side bar at left)

1Accounting Standards Update 2009-06 (Sep. 2, 2009), available at FIN 48 is now codified at Accounting Standards Codification (ASC) § 740-10.

2 Textron v. United States, __ F.3d __ (1st Cir. 2009). See also United States v. El Paso Co., 682 F.2d 530 (5th Cir. 1982).