Your Nonprofit Organization May Need to Worry about FIN 48

Financial Interpretation Number 48, Accounting for Uncertainty in Income Taxes (FIN 48) was issued by the Financial Accounting Standards Board (FASB) in June 2006 to help organizations understand how they should account for uncertainties in recognizing income tax on financial statements. FASB took this action to correct ambiguities caused by the fact that there was no specific guidance on this issue in its previous Statement 109.

Just because your nonprofit is considered tax exempt doesn't automatically exempt it from FIN 48. Depending on how you operate, you may need to comply with the rule.

Who does it apply to?

Because FIN 48 deals with income tax, most nonprofits assume that it applies only to for-profit businesses that generate income. But if your organization earns unrelated business income (UBI) — income from operations that are regularly carried out but not substantially related to your exempt purpose — that income may be subject to local, state, federal and foreign income taxes and FIN 48 generally applies.

For example, an art museum might operate a café to generate income. Selling refreshments to museum patrons and the public isn’t related to the museum’s primary mission. The museum, therefore, has UBI and needs to think about FIN 48.

You might also become subject to FIN 48 if you’re involved in a joint venture with an organization that isn’t tax exempt. Or you could be subject if your organization’s tax exempt status is under investigation, because, for example, it has engaged in political activities that aren’t allowed of nonprofits.

Clarifying uncertainty

Even though UBI generally results from activities that are regularly conducted and not substantially related to an organization's exempt purpose, the IRS makes several exceptions. You’re not subject to federal unrelated business income tax if:

• Your gross UBI is less than $1,000,
• The business is conducted solely by volunteers,
• Most of the merchandise you’re selling has been donated, such as thrift shop merchandise, or
• The business is run mainly for the convenience of your organization’s members, such as a school cafeteria.

This is where the “uncertainty” part of “Accounting for Uncertainty in Income Taxes” comes in. If a school cafeteria regularly sells lunch to office workers in the neighborhood in addition to its students and faculty, its income may or may not be unrelated. The school may feel it’s well within the rules, but the rules aren’t precise about how many students versus nonstudents the cafeteria can serve. The taxability of this income, therefore, is open to interpretation.

Recognize and measure

If you’re uncertain about any of your nonprofit’s income, your financial statements need to reflect this. FIN 48 mandates a two-step process:

1. Recognition. You must determine how confident you are that you can recognize a particular tax position — that, for example, the income you receive is tax exempt — and that this position ultimately will be upheld by the IRS. You should apply a "more likely than not" standard, meaning that you’re more than 50% certain that your position would be sustained in the event of examination by taxing authorities. If your organization suspects it won’t meet the more-likely-than-not standard, it must treat the income as taxable on its financial statements.
2. Measurement. If you believe your organization is more likely than not to prevail, you move on to the measurement step. According to FASB, that means determining "the largest amount of tax benefit that is greater than 50% likely of being realized upon ultimate settlement with a taxing authority”. So if you’re more than 50% sure that 90% of income from, for example, a cafeteria is exempt, you must recognize only 10% of the income as UBI on your financial statements.

Disclosures

FIN 48 also contains additional required disclosures.  A summary of these follow:

• The organization’s policy for presenting interest and penalties related to income taxes,
• A tabular reconciliation of the total amounts of unrecognized tax benefits at the beginning and end of the period, with specific minimum information,
• The total amount of unrecognized tax benefits as a result of a lapse of the applicable statute of limitations,
• The total amounts of interest and penalties recognized in the statement of operations and the total amounts of interest and penalties recognized in the statement of financial position,
• Specific information about positions for which it is reasonably possible that the total amounts of unrecognized tax benefits will significantly increase or decrease within 12 months of the reporting date, and
• A description of tax years that remain subject to examination by major tax jurisdictions.

Taking action

Nothing about FIN 48 is straightforward, and the above is only a brief overview of a very complex accounting issue. For these reasons, you should work with a tax expert to review your operations and determine whether it applies to you. If it does, you’ll need to implement FIN 48’s guidelines beginning with the first fiscal year beginning after Dec. 15, 2006.