In June 2006, the Financial Accounting Standards Board ("FASB") issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes ("FIN 48"). The purpose of FIN 48 is to clarify how to account for uncertainty in income taxes reported in financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. FIN 48 is intended to eliminate inconsistent and diverse practices in accounting for income taxes. FIN 48, which generally goes in effect for fiscal years beginning after December 15, 2006, will impact all businesses with certified, audited financial statements with respect to all tax positions as to which there is any material uncertainty. The requirements of FIN 48 apply to business enterprises, not-for-profit organizations, pass-through entities and other entities whose tax liability is subject to 100 percent credit for dividends paid.

FIN 48 provides a two-step approach for evaluating tax positions. It sets forth standards for determining: (1) whether an enterprise may recognize the effect of a tax position in its financial statements; and (2) if the tax position can be recognized, how to measure the amount of benefit to be recognized in the enterprise's financial statements.

Tax Positions

FIN 48 applies to "tax positions," a term that is broadly defined. The term includes not only tax savings strategies, but also decisions not to file a tax return (e.g., due to lack of nexus), apportionment and allocation determinations, decisions that an organization is tax-exempt, decisions that income is tax-exempt or subject to nonrecognition treatment, decisions as to the timing or characterization of income or deduction items, and decisions as to whether income is reportable by one taxpayer as opposed to another (e.g., transfer pricing).

Recognition Threshold

In order to be able to recognize a tax benefit in an enterprise's financial statements, it must be more-likely-than-not (a likelihood of more than 50 percent) that, based on its technical merits, the tax position would be sustained upon challenge by the relevant taxing authorities (the "Recognition Threshold"). In evaluating whether the tax position has met the more-likely-than-not Recognition Threshold, the enterprise must presume that the tax position will be challenged by all taxing authorities having jurisdiction, including foreign countries, and that those authorities have full knowledge of all relevant information. The technical merits of the tax position must derive from authorities in relevant tax law and their applicability to the facts and circumstances of the tax position. FIN 48 provides that, for purposes of evaluating the technical merits, relevant tax law includes authorities such as statutes, cases, regulations, legislative intent and past administrative practices and precedents of relevant taxing authorities. Significantly, relevant tax law also includes judicial doctrines, such as the business purpose and economic substance doctrines, that may permit a taxing authority to challenge a position notwithstanding that all statutory requirements are literally satisfied. Therefore, in order to determine whether a tax position is more-likely-than-not to survive a challenge by taxing authorities, an enterprise must know, or be advised with regard to, the relevant tax law and apply the relevant tax law to the particular facts and circumstances of the tax position.

FIN 48 requires that enterprises continue to evaluate tax positions recognized in prior periods. If a previously recognized tax position can no longer meet the more-likely-than-not Recognition Threshold, the tax position must be derecognized in the period the Recognition Threshold can no longer be met. The decision to recognize a tax position must be based on the facts, circumstances and the relevant tax law at the time the tax position is recognized. A previously recognized tax position may no longer meet the more-likely-than-not threshold in a subsequent period due to changes in relevant tax law, such as court decisions and administrative developments, or evaluation of new information. However, subsequent determinations of whether a tax position is more-likely-than-not to survive a challenge by tax authorities should not be based on a new evaluation of information that was available in previous periods. FIN 48 prohibits merely reducing the amount of the tax benefit to take into account the reduced likelihood of success (i.e., using a valuation allowance) as a substitute for derecognition in circumstances where a previously recognized tax position no longer meets the more-likely-than-not threshold.

Measurement of the Tax Benefit

If a tax position meets the more-likely-than-not threshold, the second step under FIN 48 is to measure the amount of the tax benefit to be recognized in the financial statements. A tax position that satisfies the more-likely-than-not threshold is measured as the largest amount of tax benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement with a taxing authority that has full knowledge of all relevant information. This measurement will require the evaluation of all facts, circumstances and information available as of the reporting date of the enterprise's most recent financial statements to determine the amount and probability of the outcome that could be realized upon settlement. In determining the appropriate amount of tax benefit to be taken into account, the enterprise may consider its settlement experience in similar matters with the relevant taxing authority. New information or changes in tax law or interpretations thereof arising in a subsequent period that affect the tax position but do not cause it to fail the more-likely-than-not recognition standard may lead to changes in measurement that require adjustments to the enterprise's financial statements in that period.

Transition — Effect of Past Positions

FIN 48 provides that upon its adoption by an enterprise, it must be applied to all tax positions of the enterprise, both current tax positions and those taken in prior periods that have continuing effects, and only tax positions that meet the more-likely-than-not threshold at the effective date may be recognized or continue to be recognized upon its adoption. Therefore, in the year in which an enterprise's financial statements are first prepared under FIN 48, all of the enterprise's tax positions, both current and previously taken, will need to be evaluated to see if they meet the minimum threshold for recognition under FIN 48 and, if they do meet the minimum threshold, to determine the measurement of the benefit to be recorded. Any differences in the amounts recognized in the financial statements prior to the adoption of FIN 48 and the amount recognized after its adoption will be reported as a cumulative-effect adjustment to the entity's beginning retain earnings.

Legal Tax Opinions

While FIN 48 does not expressly require a legal tax opinion in order to recognize a tax benefit with regard to uncertain income tax positions in an enterprise's financial statements, a legal tax opinion from an independent tax attorney provides excellent external evidence that the enterprise's tax position meets the minimum threshold to be recognized in its financial statements. Tax laws are very complex and change often. As a result, evaluating the likelihood of whether a given tax position could withstand a challenge by a taxing authority and measuring the likely benefit to be obtained from that position require knowledge of the relevant tax laws and experience in applying them to a wide variety of facts, transactions and circumstances. Therefore, by obtaining a legal tax opinion from an attorney with knowledge of, and experience in dealing with, the relevant tax laws, an enterprise will have confidence in its tax positions recognized in its financial statements.

IRS Initiative to Address Certain Implications of FIN 48

In an effort to assist certain taxpayers that issue certified financial statements in accordance with Generally Accepted Accounting Principles in implementing FIN 48, the IRS has announced a new initiative, the Expedited Resolution of Uncertain Tax Positions — LMSB Initiative to Address Certain Implications of FIN 48 (the "Initiative"), that provides for expedited processing of examinations and accelerated resolution of important issues relative to FIN 48's implementation. The Initiative is primarily intended for taxpayers that will issue financial statements for financial accounting years ending on or before March 31, 2007. To participate in the Initiative, a taxpayer must submit a request for resolution of issues no later than 45 days prior to the taxpayer's financial statement year-end date. The Initiative cannot be used to resolve any issues or transactions that are the subject of, or that the IRS had designated for, litigation, any issues or transactions for which fraud penalties have been imposed on the taxpayer or for which the taxpayer is under a tax-related criminal investigation.

Taxpayers participating in the Initiative are required to act with complete transparency and be committed to timely issue resolution. Taxpayers will be required to provide the IRS with all pertinent facts and documents regarding the issues or transactions including documents setting forth all relevant legal authorities, both in support of and contrary to the taxpayer's position, documents relating to the taxpayer's risk assessment of the issues or transactions and where the issues or transactions were, or will be, reported on the taxpayer's tax returns. Taxpayers must provide the IRS with access to taxpayer's personnel or representatives with knowledge regarding the facts of the issues or transactions and taxpayers must signed a declaration declaring, under penalty of perjury, that the information provided in the request is true, correct and complete to the best of their knowledge and belief.

At the beginning of the process, the IRS and the taxpayer will agree upon a timeline for processing the taxpayer's request and for issuing a closing agreement. Under the Initiative, the IRS agrees to employ its best efforts to resolve the matter prior to the end of the taxpayer's current financial statement accounting year. Upon the IRS's completion of processing the taxpayer's request, the IRS will issue the taxpayer a closing agreement.

Buchanan Ingersoll & Rooney PC attorneys have extensive experience in virtually all areas of tax law, giving us the capability to evaluate tax positions arising from a wide variety of transactions, arrangements and structures. Our attorneys are experienced in representing clients before the IRS and state and local tax authorities and in preparing ruling requests on behalf of our clients. Our attorneys, some of whom are also certified public accountants, have experience with both federal and state and local tax laws and have provided tax opinions to our clients on a wide array of tax issues.

To discuss FIN 48 or the IRS's Initiative or to request our assistance in evaluating uncertain income tax positions or determining whether to request participation in the IRS's Initiative, please contact us.

TAX ADVICE DISCLAIMER: Any federal tax advice contained in this communication (including attachments) was not intended or written to be used, and it may not be used, by you for the purpose of (1) avoiding any penalty that may be imposed by the Internal Revenue Service or (2) promoting, marketing or recommending to another party any transaction or matter addressed herein. If you would like such advice, please contact us.