Uncertain Tax Position Disclosures: Is Your Organization in Compliance?
As a not-for-profit, tax-exempt organization, you might think the subject of “uncertain tax positions” (UTPs) doesn't apply to you. Think again. Some of the basics of your operations, including your tax-exempt status, could create uncertain tax positions that trigger critical reporting obligations.
FIN 48 in a Nutshell
For several years now, the Financial Accounting Standards Board (FASB) has required taxpayers that prepare their financial statements according to Generally Accepted Accounting Principles (GAAP) to adhere to Accounting Standards Codification Topic 740, Income Taxes, Subtopic 740-10—more commonly known as FIN 48. Under FIN 48, taxpayers must disclose in their financial statements information on uncertain tax positions (UTPs).
While FIN 48 applies only to positions related to income taxes, the practices of some not-for-profits could trigger the disclosure requirement. To determine whether your organization has UTPs under FIN 48, you must engage in a two-step process.
Step 1: Recognition - First, identify the tax positions and determine whether, based on their technical merits, it's more more than 50 percent likely that the positions will be sustained upon examination by taxing authorities. Assume that your organization will be audited by authorities who have all relevant information on the position.
Step 2: Measurement - For each position that fails to meet the more-likely-than-not threshold, measure the amount of potential tax liability, including taxes, interest, and penalties. If the aggregate amount of all UTPs is material (that is, the omission or misstatement of the amount could influence the economic decision of users taken on the basis of the financial statements), it must be disclosed in the financial statement footnotes (and, in turn, on Schedule D of IRS Form 990). Where financial statements are consolidated, FIN 48 applies to each of the consolidated entities, and the UTPs are aggregated for the consolidated group to see if disclosure is required.
The Exemption Issue
You may be surprised by the assertion that a tax-exempt organization could have an uncertain tax position. But uncertainty may exist. For example, if your nonprofit generates substantial net income from unrelated business operations, rather than only from operations related to its exempt purpose, it might be considered a taxable entity. Your organization's exempt status also could be threatened, and thus uncertain, if:
1. Insiders receive excessively high compensation or buy undervalued assets from the organization;
2. Management focuses substantial attention on generating unrelated business income;
3. The not-for-profit organization engages in substantial lobbying activities; or
4. The organization's current activities are unrelated to the activities originally disclosed to tax authorities as the basis of the exemption.
Don't assume that, because your not-for-profit has never been audited, its exempt status would necessarily be upheld in an audit. The above factors and others could cost you the exemption.
Unrelated Business Income
Unrelated business income also can create uncertain tax positions. Nonprofits may take numerous tax positions on its taxable income — including what is and isn't taxable income. Uncertain tax positions regarding unrelated business income also could include:
- Allocation of expenses against unrelated business income.
- Not filing income tax returns in a state, local or foreign jurisdiction for unrelated business activities conducted in that jurisdiction.
- Apportionment of income earned in other jurisdictions.
- Deeming an activity that repeatedly generates net operating losses (NOLs) a business activity, and using the NOLs to offset unrelated business income.
The critical question is whether the organization is recognizing too much tax benefit as a result of the tax positions it takes on tax returns for unrelated business income.
FIN 48 and the IRS
With the IRS requiring the reporting of your FIN 48 footnotes on Schedule D of Form 990, you can expect that any UTPs will be targeted in an audit. Your financial adviser can help ensure you have the appropriate documentation to withstand the scrutiny of these positions.