It is not often that I get to (or even want to) write about the tax disclosures contained in the notes to financial statements. However, this recent CFO article highlighted a recent study by professors at Ohio State University and the University of Washington that companies should consider when drafting those disclosures.
The study’s findings…
Using a “novel dataset of IRS downloads…from EDGAR,” the study analyzed the timing and frequency with which the IRS reviewed Form 10-Ks from 2003 to 2011. The goal of the study was to determine the extent to which the IRS monitors public company filings.
The professors identified “several interesting patterns.” In addition to observing “large dips” in IRS attention during the lunch hour, which appears not to have surprised them, they noted that:
- IRS attention is strongly driven by such company characteristics as size, foreign profitability and the existence of net operating losses.
- The IRS is predictably interested in evidence of tax avoidance, including cash effective tax rates and the number of subsidiaries in tax havens.
- FIN 48 disclosures regarding uncertain tax benefits seem to attract a lot of IRS attention.
This last finding may support long-standing concerns among some companies and their advisors about IRS use of FIN 48 tax note disclosures as a roadmap for future tax disputes. FIN 48 requires certain qualitative and quantitative disclosures regarding, among other things, the total amounts of unrecognized tax benefits that are reasonably possible to significantly increase or decrease within the next 12 months. In such cases, the company must disclose:
- The nature of the uncertainty,
- The nature of the event that could occur in the next 12 months that would cause the change, and
- An estimate of the range of the reasonably possible change (or a statement that an estimate of the range cannot be made).
In some cases, a company may be required by GAAP to book a reserve for possible future adverse determinations by the IRS with regard to an uncertain tax position.
Though this should not come as a shock to anyone, it is interesting that the IRS seems, according to this study, to be proactively attentive to companies with significant FIN 48 disclosures. Of course, there is a limit to what you can do about that since FIN 48’s disclosure requirements are pretty specific.
Nevertheless, as with all disclosure, a certain amount of judgment and subjectivity can be brought to bear. It is useful, therefore, to keep this study in the back of your mind the next time you are deciding what to say and what not to say in the tax note to your financial statements.