Successful FIN 48 Implementation for Tax Exempt Organizations

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                       A Principled Approach for FIN 48
                       Implementation for Tax Exempt
                       Organizations

                       Prepared by:
                       James P. Sweeney
                       Managing Director
                       Exempt Organization Technical Tax Services
                       RSM McGladrey, Inc.
                       james.sweeney@rsmi.com
                       703.336.6514




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The Financial Accounting Standards Board (FASB) recently               being realized upon ultimate settlement with the taxing authorities.
required tax exempt organizations to implement FASB                    Therefore, the goal of FIN 48 is to first identify the more likely than
Interpretation No. 48 (FIN 48) for years ending after Sept. 15,        not recognition threshold taken by the auditee, pertaining to a tax
2009. RSM McGladrey was put to the test 17 months ago to               position and then determine the amount of tax benefit to be
address FIN 48 for its exempt organization clients that were           recognized in the financial statements. This process measures
required to implement the FIN because of the existence of              the impact of that uncertainty on the organization’s financial
publicly traded bond issues and developed at that time, “The RSM       statements and the effect on its accounts (e.g., current, non-
McGladrey Principled Approach” to FIN 48 implementation.               current or deferred tax accounts).

With the FASB’s recent announcement, guidance suggests that a          The uncertainty will be measured by the auditee by determining a
“principled approach is the approach” to FIN 48 implementation.        risk factor associated with the more likely than not tax position.
As a firm, we were pleased that the FASB acknowledged that this        These risk factors will be measured by a percentage analysis
was really the only approach to FIN 48 implementation for tax          related to the probability of success in defending the position. The
exempt organizations. We provide this white paper to share with        two-step process is further explained later in this document.
you “The RSM McGladrey Principled Approach” to FIN 48
implementations for exempt organization management teams.              Tax positions that previously failed to meet the MLTN recognition
This approach states that at a very minimum, the following needs       threshold should be recognized in the first subsequent financial
to be addressed by exempt organization accounting teams in             reporting period in which the requirement is met. Previously
implementing the FIN. This paper takes an “auditor” approach to        recognized tax positions that no longer meet the threshold should
the explanations, in that, this is what an auditor of the financial    not be recognized in the first subsequent financial reporting period
statements would expect management to address regarding FIN            in which it is no longer met. Lastly, in prior periods, MLTN tax
48.                                                                    positions that are uncertain or tax positions that are less than
                                                                       MLTN should be derecognized in the first financial reporting
A general explanation of FIN 48                                        period in which these issues are identified.
FIN 48 clarifies the need to properly account for and disclose
uncertainty in income taxes recognized in a tax exempt                 Application of FIN 48 to tax exempt organizations
organization’s financial statements in accordance with FASB            The application of FIN 48 will be most prevalent for tax exempt
Statement No. 109, Accounting for Income Taxes, as amended.            organizations in the following audit engagements:
FIN 48 prescribes a comprehensive model for recognizing,
measuring, presenting and disclosing tax positions taken or            Current and new clients for an accounting firm – FIN 48
expected to be taken on a tax return in the financial statements.      implementation year
This includes decisions to classify a transaction or entity as tax          •    In the implementation year, a permanent difference
exempt. FIN 48 requires the auditor to examine and record the                    may result from analysis of tax positions that were
uncertainty that a tax position will be sustained if examined by the             taken in all open tax years (open under the statute of
taxing authorities in the financial statements. The evaluation of a              limitations for audit by the taxing authorities) and which
tax position in accordance with this Interpretation is a two-step                fail the MLTN standard. This may occur for less than
process.                                                                         MLTN positions that were taken in the past, on filed tax
                                                                                 returns under taxpayer advocacy standards that were
The first step is recognition; the tax exempt organization                       in place in those prior periods (i.e., over one-third
determines whether it is more likely than not that a tax position                realistic possibility of the position being sustained but
will be sustained upon examination by the taxing authorities,                    less than 51 percent). It will also include MLTN tax
including resolution of any related appeals or litigation processes,             positions that are determined to be less than 100
based on the technical merits of the position. In evaluating                     percent sustainable based on its technical merits
whether a tax position has met the more likely than not (MLTN –                  under the measurement step in FIN 48. This includes
over 50 percent) recognition threshold, the tax exempt                           clients and new clients that are stand alone tax exempt
organization should presume that the position will be examined by                organizations and clients and new clients in complex
the appropriate taxing authorities and that the taxing authorities               structures where financial reporting is on a
are in possession of all relevant information pertaining to that tax             consolidated basis.
position.
                                                                            •     Tax return positions taken by current clients and new
The second step is measurement; a tax position taken by a tax                     clients preparing their own income tax returns for open
exempt organization that meets the MLTN recognition threshold is                  tax years (open under the statute of limitations for
measured to determine the amount of the benefit to recognize in                   audit by the taxing authorities) which the firm believes
the financial statements. The tax position is measured at the                     fail the MLTN standard and those MLTN tax positions
largest amount of benefit that is greater than 50 percent likely of               that fail the 100 percent sustainable measurement step



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           in FIN 48. This includes clients and new clients that        the organization is intact. The auditor should consider two
           are stand alone tax exempt organizations and clients         questions:
           and new clients in complex structures where financial              •    Could the current (and planned future) activities of the
           reporting is on a consolidated basis.                                   exempt organization result in continued tax exempt
                                                                                   treatment by the taxing authorities?
Current clients of an accounting firm – FIN 48 post-
implementation years                                                         •     Are the current activities of the exempt organization
     •      Tax return positions taken by current clients preparing                similar in nature with the activities disclosed to the
            their own income tax returns for open years (open                      taxing authorities on its originally filed application for
            under that statute of limitations for audit by the taxing              recognition of exempt status and which formed the
            authorities) which the firm believes fail the MLTN                     basis of the taxing authority’s favorable determination
            standard and the 100 percent sustainable MLTN                          as to that organization’s tax exempt status? One
            standard (under the measurement step in FIN 48).                       extreme example: the activity that formed the basis for
            This includes clients which are stand alone tax exempt                 recognizing tax exemption by the taxing authority was
            organizations and clients in complex structures where                  the activity of operating an orphanage, yet the entity is
            financial reporting is on a consolidated basis.                        substantially operating as a credit counseling
                                                                                   organization.
New clients of an accounting firm – FIN 48 post-implementation
years                                                                   The auditor should NOT default to the belief that even though
     •     Uncertain tax positions may exist for new clients which      there has not been a tax audit of the organization, that the
           have historically taken positions that fail the MLTN         organization’s tax exempt status would be honored in the event a
           standard, resulting in a permanent difference for all        tax audit did occur. Current activities may be outside the scope of
           open years (open under the statute of limitations for        activities that formed the basis for the recognized exemption from
           audit by the taxing authorities) in the year it becomes a    tax for the organization.
           new client of the firm.
                                                                        Under this universal tax issue, there are overarching tax positions
     •     Uncertain tax positions may exist for new clients which      that require consideration as to their certainty. Overarching tax
           have historically taken tax positions that are MLTN tax      positions, due to their uncertainty, which could threaten the
           positions, and which fail the 100 percent sustainable        exempt status or the continued exempt status of a tax exempt
           measurement step under FIN 48.                               organization are provided for in a list presented later in this
                                                                        document.
     •     Uncertain tax positions may exist for new clients on a
           continuing basis which have profitable taxable               Universal tax issue: Unrelated business income tax
           subsidiaries that generate material book/tax temporary       Tax exempt organizations which operate unrelated trade or
           differences requiring deferred tax accounts to be            businesses, must also file an income tax return, Form 990-T –
           adjusted annually at the subsidiary level and reported       Exempt Organization Business Income Tax Return (and proxy tax
           on the consolidated financial statements.                    under section 6033(e)).

Income tax returns                                                      A tax exempt organization may take many tax positions related to
Income tax returns are those returns that were filed, or may be         taxable income flows that it generates and reports as taxable
required to be filed with local, state, federal and international       income, or does not report as taxable income. There are
taxing authorities. For tax exempt organizations, the situation is      overarching tax positions taken by exempt organizations in this
unique in that an organization’s main federal reporting                 arena which would require measurement as to their certainty.
requirement in the United States comes in the form of an                FIN 48 provides that the exempt organization’s management
information return and NOT an income tax return. This return is         consider the income tax positions it takes on returns filed (or not
Form 990 – Return of Organization Exempt from Income Tax.               filed) to the taxing authorities. As stated earlier, all tax exempt
For tax exempt organizations, there are two universal tax issues        organizations (which do not qualify for the deferral in
that the auditor must consider when performing audit procedures         implementation of FIN 48 to years beginning after Dec. 15, 2007)
under FIN 48. These issues are exemption/exempt status and              must now disclose in footnotes to its financial statements
unrelated business income tax.                                          presented in accordance with GAAP, whether uncertain tax
                                                                        positions, based on the technical merits of the position, create a
Universal tax issue: Exempt status                                      material tax liability or tax asset. Determining whether a tax
The first universal tax issue that applies to an exempt                 liability or tax asset is material for financial statement reporting
organization filing Form 990 is the issue that the tax exemption for    purposes is a matter of judgment.




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As stated earlier, for an organization’s first year of implementation   Example 1:
of FIN 48, a complete and thorough analysis of all tax positions is     New client to the firm or current client preparing its own income
required for the current tax year and all open tax years under          tax returns: An exempt organization has been allocating certain
applicable tax statutes (no statute of limitations period exists for    expenses to offset its unrelated business income that are not
the tax exemption issue). This thorough analysis is also required       proximately and primarily related to the income producing activity
for new clients acquired by the firm in FIN 48 post-implementation      itself, but has been taking a MLTN position (at 100 percent
years.                                                                  sustainability level) regarding the issue. The tax benefit that has
                                                                        resulted in this “uncertain” allocation methodology (only in prior
Statute of limitations for open tax years                               open year returns filed) totals $1,000,000. As stated, the client is
Generally, the statute of limitations is three years for filed income   preparing its own income tax returns.
tax and information returns unless the tax position is to not file a
return. Therefore technically the statute of limitations does not       The following matrix is constructed under the measurement
begin to run on the un-filed return and could be considered open        second step in FIN 48.
forever (in practice, most taxing jurisdictions require the prior
three years returns to be filed if it is determined that there was a     Possible Estimated        Probability of            Cumulative
                                                                        (realized) Outcomes         Occurring               Probability of
filing requirement, but this could be expanded to the prior six
                                                                            (tax benefit)                                    Occurring
years depending on the jurisdiction and other factors). In addition,
                                                                              $1,000,000                 5%                      5%
if a tax position could result in a material omission of gross                 $800,000                 25%                     30%
income (over 25 percent), the statute of limitations is six years. If          $600,000                 25%                     55%
a tax position could be construed to be fraudulent or an effort at             $500,000                 25%                     80%
tax evasion, the statute of limitations could be considered to be              $400,000                 20%                    100%
open forever.
                                                                        The measurement matrix analysis above yields the result that
In subsequent years after the adoption of FIN 48, only those new        since $600,000 is the largest amount of tax benefit that has a
events that occur during that subsequent year or law changes that       cumulative probability of greater than 50 percent likelihood of
make prior tax positions inapplicable would likely need to be           being realized (although a MLTN position) upon examination and
reviewed. Of course, this only applies to those clients that the firm   settlement, the tax exempt organization would be required under
performed the initial open tax year analysis under FIN 48 and           FIN 48 to de-recognize previous tax benefits recognized in the
should not be the case for new clients acquired in FIN 48-post          amount of $400,000 in the financial statements. If in this example,
implementation years. In cases where a new client is acquired by        this tax benefit was being claimed on only a current year return,
the firm in FIN 48-post implementation years, a complete open tax       the tax exempt organization should only recognize $600,000 of
year analysis is required.                                              tax benefit on that current year’s financial statements (current
                                                                        client/or FIN 48-post implementation year for a new client).
A two-fold approach
A FIN 48 analysis involves a two-step process; the first is to          Example 2:
determine whether a tax position will (recognized) or will not          Dec. 31, 2005: A tax exempt organization over allocated
(derecognized) be sustained based on an examination by the              $1,000,000 of expenses to offset unrelated business income
taxing authorities of the tax position if the authorities are in        during this open year that could be examined by the taxing
possession of all relevant facts pertaining to the tax position. The    authorities even though it considers that this position meets the
assumption under FIN 48 is that the tax position WILL BE                MLTN level at a 100 percent level of assurance (based on prior
examined by the taxing authorities. If a tax position fails to reach    accounting firm recommendations). It used a GAAP allocation
the MLTN threshold, it is not recognized. If the MLTN threshold is      methodology; the tax rate is 40 percent (federal and state). The
met, the second step is measurement: what tax benefit would be          tax expense for those periods totaled $600,000 related to other
realized (or liability required to be paid) related to the MLTN tax     net taxable income as reported on the income tax return.
position. This process is based on judgment, at various
probabilities of sustainability beginning with complete success (at     Dec. 31, 2007: Upon adoption of FIN 48, the tax exempt
100 percent sustainability) working down a matrix of probabilities      organization evaluated the GAAP deductions claimed on the prior
that would then cumulatively result in a more than 50 percent           filed open year income tax return and determined that this method
likelihood that the tax position would be sustained upon                of allocation of expenses, does not meet the MLTN standard as
examination.                                                            recognized in those prior open periods. This was determined
                                                                        because it is materially different than allowable tax allocation
The following two examples show how this measurement is                 methodologies (the firm analyzes this tax position and declares
performed.                                                              that it is not only uncertain, but it fails the MLTN standard
                                                                        recognition threshold) therefore the $400,000 in additional tax
                                                                        benefit (related to the $1,000,000 in expenses that should have



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not been expensed against UBI at a 40 percent tax rate), taken in        temporary difference is the difference between the book values in
the prior open tax year, is unwarranted). The organization does          the statement of financial position (balance sheet) and the tax
not expect to pay any tax liability associated with this measured        basis of an item as determined by applying FIN 48. A liability
difference taken on this prior open year tax return within the next      recognized as a result of applying this interpretation must not be
year (or operating cycle).                                               classified as a deferred tax liability unless it arises from a taxable
                                                                         temporary difference (FIN 48, paragraph 18).
In this situation, since the position is identified in the recognition
threshold phase to fail to be considered MLTN, there is no need          Examining prior year errors in the application of the tax law,
for step two (measurement). Therefore the tax exempt                     results in a permanent difference, and if temporary differences do
organization should derecognize the tax benefits from the prior          not exist for the tax exempt organization, then theoretically, no
open year period for the difference between the recognized tax           deferred tax accounts should exist on a current year financial
benefits and the tax benefit which would be expected to be               statement, as SFAS No. 109 looks to temporary differences and
allowed by the taxing authorities due to this over allocation of         their impact on the deferred tax accounts. Deferred tax accounts
costs to the unrelated business income flow. The organization            most likely would exist in the case of a profitable taxable
should also accrue penalties and interest, as of the balance sheet       subsidiary, wholly owned by a tax exempt organization, and
date, associated with the expected amount of tax it would be             reported as a part of the consolidated financial statements.
required to pay due to this uncertain tax position. Since the
liability is not expected to be incurred within the next operating       Universal tax issues and overarching tax
cycle of the tax exempt organization, it would be classified as a        positions which may be uncertain applicable to
noncurrent liability, with the expected penalties and interest
related to it.                                                           tax exempt organizations
                                                                         FIN 48 only applies to “income tax positions” taken by tax exempt
Expiration of the statute of limitations for a tax position              organizations that are uncertain. As such, excise taxes are not
If the omission from gross income is 25 percent or less, the             considered, and therefore, potential “intermediate sanctions”
statute of limitations on a tax position would be three years.           penalties that could be assessed against the recipient of an
Therefore, at the end of the statute of limitations, the                 excess benefit or against the persons who approved such a
derecognized position presented above would then be                      financial arrangement are not taken into account. In addition,
recognized, as the taxing authority could not adjust that tax            sales and use taxes and payroll taxes are also not within the
liability in the event of an examination. If the omission from gross     scope of FIN 48, as well as real estate taxes.
income is over 25 percent, the statute of limitations should be
considered open for six years.                                           Universal tax issue: Exemption
                                                                         This example pertains to a situation where the tax exempt entity is
                                                                         considered exempt from tax. The uncertain aspect regarding this
Classification issues
                                                                         tax issue is the uncertainty that may exist as a result of the
The amount of benefit recognized in the statement of financial
                                                                         exempt organization possibly being considered a taxable entity
position (balance sheet) and the amount taken, or expected to be
                                                                         paying income tax on its net income from general operations, and
taken, on the tax return may be different. These differences
                                                                         not just from unrelated trade or business operations.
represent unrecognized tax benefits. The unrecognized tax
benefits and the related interest and penalties will generally result
                                                                         Overarching tax positions which may be uncertain and taken by a
in the recognition of a liability under FIN 48. Alternatively, the
                                                                         client that could yield a material amount of tax under this universal
amount of net operating loss carry forward or amount of
                                                                         tax issue and the measurement requirement under FIN 48 include
refundable tax may be reduced.
                                                                         the uncertainty associated with a MLTN tax position taken by an
                                                                         organization:
A tax exempt organization that has a liability for unrecognized tax
benefits, and presents a classified statement of financial position,
                                                                              •     That it is tax exempt without corresponding proof of
must classify this liability separately from other tax balances
                                                                                    recognition of tax exemption from federal and state
based on the expected timing of the cash flows. The classification
                                                                                    taxing authorities and there is material net income
of the deferred liability as either current or non-current would be
                                                                                    generated by the entity. The measurement of this tax
based on that one year or an operating cycle criterion that is used
                                                                                    position certainty is less than the 100 percent
for classifying other liabilities. The liability (or reduction of
                                                                                    sustainability level.
amounts refundable) must not be combined with deferred tax
                                                                              •     That egregiously high compensation paid to insiders,
liabilities or assets (FIN 48, paragraph 17).
                                                                                    which could result in revocation of exempt status
                                                                                    (outside the scope of intermediate sanctions excise tax
In addition, the tax position recognized as a result of applying this
                                                                                    penalties), does not jeopardize tax exemption. The
interpretation may also affect the tax basis or liabilities and
thereby create temporary differences. A taxable and deductible



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       measurement of this tax position certainty is less than                   issue. The measurement of this tax position certainty is
       the 100 percent sustainability level.                                     less than the 100 percent sustainability level.
   •   That egregiously undervalued asset sales by the tax                 •     Where the tax law has changed to disallow tax
       exempt organization to insiders (outside the scope of                     exemption to the organization or substantially revises
       intermediate sanctions excise tax penalties), does not                    the allowed activities that will continue to receive
       jeopardize tax exemption. The measurement of this tax                     favorable tax exempt status (proposed legislation is
       position certainty is less than the 100 percent                           not to be considered), and client management believes
       sustainability level.                                                     that the tax law change does not jeopardize its current
   •   That treats an income flow as exempt from tax, when it                    tax exemption. The measurement of this tax position
       should be subject to tax, and such income represents                      certainty is less than the 100 percent sustainability
       a substantial gross income flow to the organization                       level.
       (substantial unrelated gross income generating activity             •     An organization other than IRC section 501(c)(3) or
       could jeopardize tax exempt status). The                                  IRC section 501(c)(4) believes that unreasonably high
       measurement of this tax position certainty is less than                   compensatory arrangements/unreasonably low asset
       the 100 percent sustainability level.                                     sales with individuals do not result in prohibited private
   •   That its management time and focus is substantial in                      inurement which could jeopardize tax exemption. [In
       generating unrelated business income, as opposed to                       instances where the statute requires that no private
       management time and focus on accomplishment of the                        inurement to individuals is allowed, where private
       organization’s tax exempt purpose, and this fact does                     inurement exists, revocation of exemption by the
       not jeopardize tax exemption. The measurement of                          taxing authorities could be the result. The excise tax
       this tax position certainty is less than the 100 percent                  provisions under intermediate sanctions only apply to
       sustainability level.                                                     501(c)(3) and (c)(4) organizations, and the U.S. taxing
   •   That a transfer of substantial assets to a for-profit joint               authority use these intermediate sanctions as
       venture, where the tax exempt organization may not                        something intermediate to revocation of tax exempt
       control the activities of the joint venture, does not                     status (except in egregious situations). This tax
       jeopardize tax exemption. The measurement of this tax                     position uncertainty applies to IRC 501(c)(6)
       position certainty is less than the 100 percent                           [associations and business leagues], (c)(7)
       sustainability level.                                                     [social/country clubs] and (c)(9) [VEBAs] to name a
   •   That control of the exempt organization’s activities by a                 few, and would apply to unreasonably high
       for-profit subsidiary or co-joint venturer, does not                      compensatory arrangements and unreasonably
       jeopardize tax exemption. The measurement of this tax                     undervalued asset sales to individuals that result in
       position certainty is less than the 100 percent                           prohibited private inurement]. The uncertain tax
       sustainability level.                                                     position taken by the client is that private inurement
   •   That hyperlinks on its Web site to political campaign                     does NOT exist which could jeopardize tax exempt
       intervention activity Web sites (outside the scope of                     status. The measurement of this tax position certainty
       allowable lobbying activities) does not jeopardize tax                    is less than the 100 percent sustainability level.
       exemption. Also that the measurement of this tax                    •     That current substantial activities of the organization
       position certainty is less than the 100 percent                           that are not related to activities disclosed to the tax
       sustainability level.                                                     authorities that formed the basis of the taxing
   •   That substantial lobbying activities where the                            authority’s recognition of tax exemption (and no proof
       organization does not have an IRC section 501(h)                          exists of subsequent approval or disclosure having
       election in place, do not jeopardize tax exemption. The                   been made from/to the taxing authorities regarding the
       measurement of this tax position certainty is less than                   change in activities, or material change in operations),
       the 100 percent sustainability level.                                     do not jeopardize tax exemption. The measurement of
   •   In deciding to not file required income tax returns in a                  this tax position certainty is less than the 100 percent
       local, state or foreign jurisdiction, and such                            sustainability level.
       jurisdiction(s) do (does) not recognize tax exempt                  •     That current activities of the organization, which confer
       status for United States federal income tax purposes                      more than incidental private benefit, do not jeopardize
       (this position is uncertain in that the client is concluding              tax exemption. The measurement of this tax position
       that returns are not required to be filed and if requisite                certainty is less than the 100 percent sustainability
       returns were filed, the result may yield a material                       level.
       amount of income tax, interest and penalties to the
       organization). This tax position uncertainty is                Under the overarching tax positions above, each has their specific
       considered a state/foreign jurisdiction tax exemption          subsets of further considerations that will require review.




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                                                                                    or business activity by the taxing authorities, and the
                                                                                    client utilizes these NOLs to offset other net taxable
Universal tax issue: Unrelated trade or business income                             unrelated business income flows (because of the
The key aspect regarding this universal tax issue is the                            frequency of losses, the taxing authorities may not
uncertainty that may exist that the exempt organization is                          allow the NOLs to offset other activities generating net
recognizing too much tax benefit as a result of the tax position(s)                 taxable income). The measurement of this tax position
it is taking, or may not be taking on income tax returns.                           certainty is less than the 100 percent sustainability
Overarching tax positions which may be uncertain and taken by a                     level.
client that could yield a material amount of tax under this universal         •     Where there is dual use of facilities and personnel and
tax issue and the measurement requirement under FIN 48 include                      expenses are not allocated on a reasonable basis
the uncertainty associated with a MLTN tax position taken by an                     against an unrelated business income stream. The
organization:                                                                       measurement of this tax position certainty is less than
                                                                                    the 100 percent sustainability level.
     •     In over allocating expenses against unrelated business             •     Where it has net operating losses (NOL) carrying
           income, and that methodology is not based on                             forward into the open years under the statute of
           regulatory requirements that such allocations are                        limitations, and that these NOLs can not be adjusted
           reasonable. The measurement of this tax position                         by the tax authorities downward if not valid. Even
           certainty is less than the 100 percent sustainability                    though the NOL was generated in a closed tax year
           level.                                                                   (although tax could not be assessed for those closed
     •     After an IRS exam closing agreement, that the                            years), the tax position is that the entire NOL is valid
           organization need not follow the reasonable allocations                  and it may not be adjusted downward if examined by
           of expense methodology to offset its unrelated                           the taxing authorities. This would require the auditor to
           business income flows that it agreed to use under a                      analyze the years the NOLs were generated, to ensure
           closing agreement to apply in future tax periods with                    cost allocations in those years are valid and which add
           no material change in facts or the tax law. The                          to the balance of the NOL, even though not generated
           measurement of this tax position certainty is less than                  in “open tax years” required for review under FIN 48.
           the 100 percent sustainability level.                                    The measurement of this tax position certainty is less
     •     Treating an income flow as exempt from tax, when it                      than the 100 percent sustainability level.
           may not be (and it is not a material income flow which             •     That determines investments in pass-through entities,
           could impact the overall tax exemption, but could yield                  and resulting income reported on Schedule K-1, is not
           a material tax liability, requiring FIN 48 disclosure).                  unrelated business income subject to tax when there is
           The measurement of this tax position certainty is less                   a lack of or evidence that identifies the income as UBI
           than the 100 percent sustainability level.                               due to partnership return preparation errors/omissions.
     •     In its decision to not file income tax returns in a local,               And the measurement of this tax position certainty is
           state or foreign jurisdiction for unrelated income tax                   less than the 100 percent sustainability level.
           activities operated in that (those) jurisdiction(s), and if
           those returns are required to be filed, could yield a         Under the overarching tax positions described, each has their
           material tax liability. The measurement of this tax           specific subsets of further considerations that will require review.
           position certainty is less than the 100 percent               The above represent overarching tax positions where uncertainty
           sustainability level.                                         could exist and which are applicable to tax exempt organizations
     •     To not properly report (allocate or apportion) income         for the two universal tax issues: tax exemption and unrelated
           earned in other taxing jurisdictions, but instead             business income tax. These potential uncertain tax positions are a
           allocating and apportioning all income and paying tax         part of the tax exempt organizations uncertain tax positions (UTP)
           on the exempt organization’s home state return, or            checklist to be utilized by any auditor in applying the principles of
           U.S. federal income tax return. This could result in a        FIN 48 to the organization. Measurement will be required if a
           “double tax” issue to be present. This will occur when        client has identified a MLTN tax position. If a tax position is
           home state/U.S. statute of limitations periods have           identified as less than a MLTN tax position, the tax benefit
           expired for years which tax was paid to that home             associated with that position will not be recognized in the financial
           state/U.S., but should have been reported (allocated or       statements and measurement will not be required. Lastly, if a
           apportioned) to other taxing jurisdiction income tax          MLTN tax position certainty is measured at less than a 100
           returns (which would form the basis to claim a tax            percent sustainability level, for prior open tax years, tax benefits
           credit). The measurement of this tax position certainty       recognized in those prior periods would be required to be
           is less than the 100 percent sustainability level.            derecognized in the current period.
     •     That an income producing activity with a long history of
           net operating losses (NOLs) will be considered a trade



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What to do for tax positions that “may be”
considered taxable or not taxable?
For tax positions which do not have a range of analysis like the
above example, but deal with whether the tax position is taxable
or not taxable, and only less than “highly certain,” the probability
that the tax position will be sustained by the taxing authority is
based on a percentage analysis as to probable outcome. The tax
position that exceeds a cumulative probability of outcome of
greater than 50 percent likelihood of being realized upon
examination and settlement is the probable outcome under FIN
48. The following example clarifies management’s approach to a
taxable or not taxable analysis:

A tax exempt organization identifies a tax position that an income
flow it is treating as NOT subject to tax, may be uncertain in this
respect. Management’s approach to measurement of this
uncertainty is as follows:

  Tax        Probability of    Cumulative      Taxable   Non-taxable
Position     Sustainability   Probability of
                              Sustainability
Identified       40%              40%           N/A            --
   Tax
 Position
 Will be
 Treated
    as
 Taxable
Identified       60%              60%            --      Non-taxable
   Tax                                                     treatment
 Position                                                  should be
Will NOT                                                 sustained as
   be                                                    this position
 Treated                                                   meets the
    as                                                   greater than
 Taxable                                                      50%
                                                         likelihood of
                                                         sustainability


Conclusion
This document provides valuable information for management
teams of exempt organizations in implementation of FIN 48. Using
a “principled approach” as suggested by the FASB, will ensure
that items of materiality are at a minimum addressed.




www.rsmmcgladrey.com                                                                8
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