Question

ABC Co. took four tax deductions on their 2016 tax return that have issues that could result in some or all of the deductions being disallowed if ABC’s 2016 tax return is audited. ABC believes the deductions are justifiable but knows that tax law related to each item is unclear. Information about each deduction follows:

1)         Amount of deduction $500,000

            ABC’s probability full deduction will be allowed 60%

            ABC’s estimate of potential deduction being allowed

                        500,000                       60%

                        400,000                       30%

                        250,000                       10%

2)         Amount of deduction $800,000

            ABC’s probability full deduction will be allowed 40%

            ABC’s estimate of potential deduction being allowed

                        800,000                       40%

                        650,000                       30%

                        500,000                       20%

                        400,000                       10%

3)         Amount of deduction $300,000

            ABC’s probability full deduction will be allowed 30%

            ABC’s estimate of potential deduction being allowed

                        300,000                       30%

                        250,000                       15%

                        200,000                       40%

                        125,000                       15%

4)         Amount of deduction $900,000

            ABC’s probability full deduction will be allowed 45%

            ABC’s estimate of potential deduction being allowed

                        900,000                       45%

                        800,000                       40%

                        650,000                       15%

ABC’s 2016 tax rate was 25%. ABC is a calendar-year company. During 2017, ABC Co. received notification that its 2016 tax return was being audited. At December 31, 2017, the IRS had verbally communicated their findings on deductions 1 – 3. Their findings were as follows:

Deduction 1                          $120,000 disallowed

Deduction 2                          no disallowance

Deduction 3                          $80,000 disallowed

Deduction 4 was still under examination at December 31, 2017. Prior to December 31, 2017, ABC and the IRS formalized their agreement on deductions 2 and 3 by signing IRS Form 906, “Closing Agreement on Final Determination Covering Specific Matters.” ABC is disputing the IRS’ findings related to deduction 1.

1.         What amount if any liability should ABC recognize at December 31, 2016 related to the tax effects of these four deductions? (ignore possible interest and penalties)

2.         Can ABC assert an “effective settlement” for any of the deductions taken on the 2016 tax return at December 31, 2017?

3.         What amount of liability should ABC report at December 31, 2017 related to the 2016 deductions assuming ABC has not changed its assessment of deduction 1 or 4?

Answer 1

Above Question relates to the ASC 740-10 -Accounting for Uncertainty of Income Taxes

To determine this liability we need to see cumulatively at what amount outcomes is greater than 50%.

Solution-1.$ 87500 Liability shall be recongnized as on 31st Dec'2016

No.	Deduction	Deduction under ASC 704	Cumulative >50 %	Difference Taxable
1	500000	500000	60%	-
2	800000	650000	70%	(150,000)
3	300000	200000	85%	(100,000)
4	900000	800000	85%	(100,000)
Difference is liable for Tax				(350,000)
Deferred Tax Liabilities@25%				(87,500)

Solution 2.Yes for Deduction 2 and 3 as IRS has formalized the agreement on 31st Dec'17

Solution3 .Considering shall record the liability for Deduction 1 and 4 as this are not being finalized by IRS.ABC should create Liability for Deduction 4 for $25,000.However for Deduction 1 , ABC report can either creates contingent liabilities or deferred tax liabilities(More likey than not losing the case for Disallowance for $120000) for $30000(120000*25%).