Tax positions can be effectively settled upon examination by a taxing authority, which may impact an entity’s reassessment of whether the tax position should be recognized or not. Settlement is assessed on a position-by-position basis. To be considered “effectively settled,” the conditions in ASC 740-10-25-10
must be met.
As required by paragraph 740-10-25-8(b)
, an entity shall recognize the benefit of a tax position when it is effectively settled. An entity shall evaluate all of the following conditions when determining effective settlement:
a. The taxing authority has completed its examination procedures including all appeals and administrative reviews that the taxing authority is required and expected to perform for the tax position.
b. The entity does not intend to appeal or litigate any aspect of the tax position included in the completed examination.
c. It is remote that the taxing authority would examine or reexamine any aspect of the tax position. In making this assessment management shall consider the taxing authority’s policy on reopening closed examinations and the specific facts and circumstances of the tax position. Management shall presume the relevant taxing authority has full knowledge of all relevant information in making the assessment on whether the taxing authority would reopen a previously closed examination.
In analyzing whether a tax position meets the three conditions of ASC 740-10-25-10
and can therefore be considered effectively settled, certain key considerations should be noted.
Tax position is not specifically examined
As stated in ASC 740-10-25-11
, a tax position does not need to be specifically reviewed or examined by the taxing authority during the examination of a tax year in order for it to be considered effectively settled through examination.
In cases in which the position has not been specifically reviewed or examined by the taxing authority, additional judgment may be necessary to conclude whether the likelihood that the taxing authority would subsequently examine the position is remote. It is also important to remember that this conclusion must be reached under the presumption that the taxing authority has full knowledge of all relevant information.
Completion of examination and other procedures
If a position is challenged, the resolution process in many jurisdictions can potentially involve several stages and various government departments, each of which might be empowered to overturn or modify another department’s ruling. A previously unrecognized tax benefit can be recognized when an entity is able to conclude that a tax position is “effectively settled.” Under the US federal income tax system, Form 870, Waiver of Restrictions on Assessment and Collection of Deficiency in Tax and Acceptance of Overassessment, is used upon completion of an IRS examination to indicate the taxpayer’s agreement with the revenue agent’s proposed adjustments and agreement to pay any deficiency. The Revenue Agent’s Report (RAR) accompanies the Form 870. By signing the Form 870, the taxpayer waives the right to a notice of deficiency and thus permits the IRS to assess the tax immediately. In effect, this represents the closing of the IRS examination upon acceptance by the IRS. Generally, the IRS will only re-open a closed case if (1) there is evidence of fraud, malfeasance, collusion, concealment, or misrepresentation of a material fact, (2) the closed case involves a clearly defined, substantial error based on an established service position existing at the time of the examination, or (3) other circumstances exist that indicate that a failure to re-open the case would be a serious administrative omission.
We generally expect the closing of an IRS examination to constitute effective settlement of a position taken in the examined year when not being appealed, other than cases involving continued governmental review (e.g., Joint Committee) or years in which there was no tax payable (e.g., NOL years).
When evaluating whether the taxing authority has “completed its examination procedures” (as discussed in ASC 740-10-25-10
(a)), NOLs and tax credit carryforwards need to be evaluated differently. To illustrate, assume that a US entity generated an NOL carryforward of $500 on its tax return for a particular year, but only $400 of that amount was recognizable in the financial statements because of an uncertain tax position that totaled $100. The uncertain position is not examined by the IRS in the subsequent examination, and the examination is later closed.
In this case, it is unlikely that the entity would be in a position to conclude that the unrecognized benefit of $100 was effectively settled upon closure of the examination for the year in which the NOL first arose. This is because the IRS not only has the ability to examine or reexamine the positions that led to the generation of the NOL and tax credit carryforwards, but in many cases will examine or re-examine those positions when they are utilized on a future year’s tax return. The IRS can perform the re-examination even if the statute of limitations for the year of generation has since expired. Other jurisdictions may have the same or a similar ability based in tax law, regulations, or judicial doctrine.
Assessing whether an appeal is effectively settled
Entities that file an appeal similarly need to assess when the appeal is effectively settled. At the conclusion of an appeal, the IRS appeals division issues a Form 870-AD, Offer to Waive Restrictions on Assessment and Collection of Tax Deficiency and to Accept Overassessment. Form 870-AD is used almost exclusively by the appeals division and differs from Form 870. Specifically, Form 870-AD states that the case will not be reopened by the IRS unless, among other things, there was “fraud, malfeasance, concealment or misrepresentation of a material fact,” “an important mistake in mathematical calculation,” or “excessive tentative allowance of a carryback.”
We generally believe sign-off on Form 870-AD constitutes effective settlement. Even if the tax position had not been examined, the likelihood that the IRS would challenge a position after receiving a Form 870-AD would generally be remote. The instructions for Form 870-AD indicate that by signing, the taxpayer is agreeing not to re-open the referenced tax years and the IRS will only re-open the tax years in very limited circumstances.
requires the continuous re-evaluation of tax positions that were previously determined to be “effectively settled.” An entity should re-evaluate a tax position that was effectively settled if it believes that a taxing authority may examine or re-examine the tax position, or if the entity intends to appeal or litigate any aspect of the tax position. Under these circumstances, the criteria in ASC 740-10-25-10
would no longer be met and the tax position would no longer be considered effectively settled.
acknowledges that an entity may obtain information during an examination that would enable it to change its assessment of the technical merits of a tax position or of similar tax positions taken in other periods. However, the fact that a position has been effectively settled for a given year should not be used as a basis for concluding that similar tax positions taken in future years can be recognized. The fact that a position was effectively settled for a particular year does not in and of itself constitute “new information” that would allow the entity to recognize the benefit from similar positions taken in subsequent years. See TX 220.127.116.11
for additional information.