The disclosure of material items in the financial statements of a public company is of high
importance since the knowledge of the same (i.e., material items) may influence the decisions
that are made by the user of the financial statements, such as investors, creditors, etc. The
inclusion of material items can aid the decisions and judgment of the users (IFRS, 2021). The
ASC 740-10 (uncertain tax positions) plays a key role in the disclosure process. ASC 740-10
gives guidance to recognize and measure tax positions that are taken or expected to be taken
for the purpose of tax returns that may directly or indirectly impact the reported amounts in
the financial statements. Additionally, it also provides accounting-related guidance for the
specific income tax effects relating to individuals tax positions that fail to meet the threshold
requirements for any component of the tax position benefit to be recognized in the firm’s
financial statements (Deloitte., n.d.).
Business entities have several options that they might consider if they intend to rectify their
tax position without booking a reserve. For dealing with an uncertain tax position due to an
error in the previous year, firms may decide to rectify the same in the current financial year
without booking a reserve. Similarly, in the case of the Retroactive Application of New Tax
Laws, companies may decide to adopt the changes in taxation instead of booking a reserve.
Based on such specific legislation, a higher tax burden can be imposed on a client for the
income that has been earned by it for its prior transactions. Firms with uncertain tax positions
also have the option to settle the matter with the taxation authorities. In such a situation, there
would be no need for businesses to create reserves in the financial statements of the business.
According to US income tax rules 15.3, after business entities have identified their uncertain
tax position, they must ascertain when the tax return benefits must be recognized for the
purpose of financial reporting (PWC, n.d). The firm can consider to recognize the tax benefits
pertaining to its uncertain tax position in case there is a high probability that the same position
is likely to be sustained after assessment and examination. Hence there exist a host of options
that public companies may choose for dealing with uncertain tax positions instead of creating
a reserve in their financial statements.
The tax law is not all black and white and there are a lot of grey areas in the law. It causes
companies to take positions that may, or may not, be sustained if audited by the IRS. It is
important to disclose material items in the financial statements because that information helps
investors to make informed and rational investment decisions.
Our course scenario with XYZ company is a great example of uncertainty in income taxes
and how it affects financial statements. As we know, the company is under the IRS audit for
per diem travel expenses. XYZ, Inc. took a deduction on the tax return and it reduced the
company’s taxable income. Now, if the IRS disallows the deduction, it means XYZ
understated its taxable income by $5 million and, therefore, also understated its income tax
expense by $1,050,000. From a financial reporting perspective, the company must consider
this uncertainty. However, the question is how much of that uncertainty XYZ should
recognize in the financial statements. ASC 740-10 provides guidance on how to account for
tax uncertainty in the financial statements. It requires that each tax position meet a more-
likely-than-not (MLTN) test and that the tax benefits be correspondingly reduced if the result
is not certain. A more-likely-than-not means a likelihood more than 50%. If there is a greater
than 50% chance that the company’s tax position (per diem deduction) will be sustained, then
XYZ will recognize the tax benefits. Otherwise, the company cannot recognize a benefit for
the uncertain tax position. The next question is: how much of that tax benefit does XYZ get to
recognize in its financial statements? It is the largest amount of benefit that is cumulatively
greater than 50%. XYZ will disclose the components of income tax provision either on the
face of the statements of operations or in a note to the financial statements.
IRC § 6501 discusses limitations on assessment and collection. Per § 6501(a), the amount of
any tax imposed shall be assessed within 3 years after the return was filed (whether such
return was filed on or after the date prescribed). However, the statute of limitation is doubled
(6 years) if:
a taxpayer omits from gross income an amount in excess of 25 percent of the amount of gross
income stated in the return (§ 6501(e)(A)(i));
such amount is attributable to one or more assets with respect to which information is
required to be reported under section 6038D (§ 6501(e)(A)(ii)(I));
such amount is in excess of $5,000 (§ 6501(e)(A)(ii)(II)).
Additionally, per § 6501(c), the tax may be assessed, or a proceeding in court for collection of
such tax may be begun without assessment, at any time for:
A false or fraudulent return was filed with the intent to evade tax.
A wilful attempt to evade tax.
No tax return filed.
Last week I received a phone call from a new client desperately looking for a tax accountant
to help him file corporate tax returns (1120) for 2019-2022. I was surprised that the IRS has
not issued any notices to them regarding non-filing. The statute of limitation expired for them
to receive a refund for 2019 while they owe for all other years. Given the amount of their
gross sales ($8 million), I will not be surprised if they get audited by the IRS after all. b
The federal securities laws of the United States require public companies to disclose
information that is relevant to investors and potential investors. An important part of this
standard is determining if the information is "material", that is if knowing this information
would substantially change the investment decisions made by the recipient of the information.
FASB Accounting Standards Codification (ASC) Subtopic 740-10 provides guidelines for the
way uncertain tax positions are to be disclosed. ASC 740-10 reporting allows financial
statement users to assess a company's willingness to take risks, specifically related to tax
liability.
ASC 740-10 specifically refers to GAAP-basis financial statements, non-cash basis, and only
relates to income tax positions. Although it specifically relates to public companies, the
principles are important for privately held companies to consider as well. These uncertain tax
positions often relate to differences between reporting for financial statements that is different
than the income tax reporting. Examples include the financial statement reporting 100% of
meal expenses, but deducting only 50% on the tax return; and timing differences of claiming
income in December instead of January (or vice versa). A very important evaluation is
determining if the tax implications of these positions are material and if they are "more-likely-
than-not" to occur. Materiality can be judged by the substantial omission’s standard in IRS
statute of limitations guidelines, that is 25% of gross revenues.
In the absence of booking tax liability reserves in the financial statements, either as current or
deferred tax assets or liabilities, a company can also disclose these positions using Schedule
UTP with income tax Form 1120.
In most cases, IRS has a statute of limitations of 3 years to review or audit most tax returns.
The 3-year clock begins on the later of the tax return due date, or filing date. If there is
evidence of substantial omissions of income, the statute of limitations is 6 years. In the event
a taxpayer is suspected of committing fraud in a wilful attempt to evade tax, there is no end
date to the statute of limitations.
Disclosure of material items in public company financial statements is essential for
transparency, providing investors with information, and compliance with accounting rules and
regulations (CFI, 2022). Public corporations must give accurate financial information to
stakeholders. Material items may need to be more accurate and provide correct information
about a company's financial performance, weakening investor confidence and credibility.
ASC 740-10, Accounting for Income Taxes (previously FIN 48), addresses financial
accounting and reporting of uncertain tax positions. Public corporations must examine
uncertain tax positions in earlier years' tax returns and establish reserves in their financial
statements for future tax costs. ASC 740-10's primary goal is to assess and disclose uncertain
tax position liabilities and advantages (Bloomberg Tax, 2022) correctly and honestly.
If the possibility of sustaining an uncertain tax situation is substantial, clients may recognize
it without booking a reserve. The client feels the position will be upheld following review. No
reserve is needed, but the uncertain tax position and its potential financial statement impact
must be noted in the footnotes (Bradley & Spreeuwenberg, 2017).
The client may de-recognize a position if new information changes its evaluation. A reserve
may not be needed if further supporting evidence or tax regulations change. Footnotes should
note this shift.
Clients may update prior tax returns if they discover errors or inconsistencies that affect an
uncertain tax position. By amending the return, a reserve may be unnecessary. The customer
must report the amendment's financial impact.
Clients should consider the statute of limitations when taking uncertain tax positions. The
client may decide to register a reserve or pursue other options after the statute of limitations
expires. However, stakeholders must be informed of the uncertainty through footnotes.
References
Bloomberg Tax. (2022). How ASC 740 impacts uncertain tax positions. Bloomberg.
Retrieved from https://pro.bloombergtax.com/brief/asc-740-uncertain-tax-positions/
Bradley, I. & Spreeuwenberg, B. (2017). Dealing with uncertain tax positions in your
financial statements. Deloitte. Retrieved from https://www2.deloitte.com/nz/en/pages/tax-
alerts/articles/dealing-with-uncertain-tax-positions-in-your-financial-statements.html
CFI Team. (2022). Full Disclosure Principle. CFI. Retrieved from
https://corporatefinanceinstitute.com/resources/accounting/full-disclosure-principle/
IRS. Uncertain Tax Positions-Schedule UTP.
https://www.irs.gov/businesses/corporations/uncertain-tax-positions-schedule-utp
Lyon, D., Haskell, L. (2023). ASC 740 Frequently Asked Questions. TaxOps.
https://taxops.com/wp-content/uploads/2021/04/ASC-740-FAQs.pdf
Munter, P. (2022). Assessing Materiality: Focusing on the Reasonable Investor When
Evaluating Errors. Securities Exchange Commission.
https://www.sec.gov/news/statement/munter-statement-assessing-materiality-030922
Swenson, M. (2020). Understanding the mechanics of FASB ASC Subtopic 740-10. The Tax
Adviser. https://www.thetaxadviser.com/issues/2020/jan/fasb-asc-subtopic-740-10.html
ASC 740-10
IRC § 6501
Swenson, M. (2020). Understanding the mechanics of FASB ASC Subtopic 740-10. The Tax
Adviser. Retrieved from https://www.thetaxadviser.com/issues/2020/jan/fasb-asc-subtopic-
740-10.html
15.3 recognition of benefits from uncertain tax positions. PWC. (n.d.).
https://viewpoint.pwc.com/dt/us/en/pwc/accounting_guides/income_taxes/income_taxes__16
_US/chapter_15_accountin_US/153_recognition_US.html
Investor perspective: Disclosures in financial statements to ... - IFRS. (2021).
https://www.ifrs.org/content/dam/ifrs/resources-for/investors/investor-perspectives/investor-
perspectives-sept-2021.pdf
ASC 740 income taxes. Deloitte. (n.d.).
https://dart.deloitte.com/USDART/home/codification/expenses/asc740
