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The initial recognition of a liability for unrecognized tax benefits is a component of the tax expense for the current period subject to the ordinary intraperiod allocation process (see TX 12). As such, the tax expense associated with recording a liability for an unrecognized tax benefit may have initially been recorded in any of the components of income (e.g., continuing operations, discontinued operations, other comprehensive income) or equity. If the liability for unrecognized tax benefits is subsequently remeasured, an entity should record the remeasurement in continuing operations. This conclusion is based on the principle in ASC 740-10-45-20 under which the tax effects of any changes to the beginning of the year valuation allowance (as a result of a change in judgment) is generally recorded in continuing operations. Therefore, by analogy, the tax effects of a change in the opening balance of unrecognized tax benefits (including unrecognized tax benefits related to prior-period discontinued operations) should be recorded in current-period income/loss from continuing operations.
However, there are certain exceptions. Pursuant to ASC 740-20-45-3, we believe “backwards tracing” for the tax effects of the equity items listed in ASC 740-20-45-11(c) and (f) also includes both favorable and unfavorable adjustments resulting from changes in the assessment of uncertain tax positions.
We also believe that an alternative treatment could be supported by analogy to ASC 205. For example, consider remeasurements of a liability for unrecognized tax benefits when the original liability’s tax expense was recorded in discontinued operations. ASC 205-20-45-4 requires that subsequent adjustments to contingencies recorded as part of prior-year discontinued operations be classified as discontinued operations in the period in which the subsequent adjustment is made. Although tax uncertainties are subject to ASC 740 and not ASC 450, we believe it is reasonable to interpret tax uncertainties as contingencies under ASC 205-20-45-4. Therefore, subsequent resolution would be reflected in that year’s financial statements as discontinued operations even in the absence of current-period pretax income or loss from discontinued operations (i.e., the income statement line item “income or loss from discontinued operations” would show a tax benefit, but no pretax income or loss).
We believe both alternatives are acceptable. The alternative selected, however, is an accounting policy and should therefore be applied consistently.
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