STATE AND LOCAL INCOME TAX PROVISIONS TECHNICAL SUPPLEMENT Teresa M. Dieguez, CPA Vice President of Corporate Tax Wynn Resorts Limited Las Vegas, NV teresa.dieguez@wynnresorts.com Smitha Hahn, CPA Senior Manager Ernst & Young LLP Detroit, MI smitha.hahn@ey.com The guidance for accounting for income taxes in ASC 740 applies to all federal, foreign, state, and local (including franchise) taxes based on income. That is, any tax levied by a governmental taxing authority on a company based on the company s income is subject to the provisions of ASC 740. In addition to income taxes attributable to the company s stand-alone operations, ASC 740 requires recognition of the current and future income tax consequences of all entities included in the reporting entity s financial statements. Thus, consolidated subsidiaries, investees accounted for under the equity method, and entities that are combined due to common control are subject to the provisions of ASC 740. The guidance for accounting for income taxes in ASC 740 is applicable to all financial statements prepared in accordance with generally accepted accounting principles in the United States, including foreign entities. This appendix addresses state income tax guidance provided in ASC 740. This approach considers the effect of state and local taxes, net of any federal benefit, on an entity s temporary differences. As discussed below, there are unique issues related to state and local income taxes. Current provision considerations State taxes based on the greater of franchise tax or income tax Excerpts from Accounting Standards Codification Income Taxes Overall Scope and Scope Exception 740-10-15-4 The guidance in this Topic does not apply to the following transactions and activities: a. A franchise tax to the extent it is based on capital and there is no additional tax based on income. If there is an additional tax based on income, that excess is considered an income tax and is subject to the guidance in this Topic. See Example 17 (paragraph 740-10-55-139) for an example of the determination of whether a franchise tax is an income tax.
Implementation Guidance and Illustrations 740-10-55-139 The guidance in paragraph 740-10-55-26 addressing when a tax is an income tax is illustrated using the following historical example. 740-10-55-140 In August 1991, a state amended its franchise tax statute to include a tax on income apportioned to the state based on the federal tax return. The new tax was effective January 1, 1992. The amount of franchise tax on each corporation was set at the greater of 0.25 percent of the corporation's net taxable capital and 4.5 percent of the corporation's net taxable earned surplus. Net taxable earned surplus was a term defined by the tax statute for federal taxable income. 740-10-55-141 In this Example, the total computed tax is an income tax only to the extent that the tax exceeds the capital-based tax in a given year. 740-10-55-142 A deferred tax liability is required to be recognized under this Subtopic for the amount by which the income-based tax payable on net reversing temporary differences in each future year exceeds the capital-based tax computed for each future year based on the level of capital that exists as of the end of the year for which deferred taxes are being computed. 740-10-55-143 The portion of the current tax liability based on income is required to be accrued with a charge to income during the period in which the income is earned. The portion of the deferred tax liability related to temporary differences is required to be recognized as of the date of the statement of financial position for temporary differences that exist as of the date of the statement of financial position. 740-10-55-144 Because the state tax is an income tax only to the extent that the tax exceeds the capital-based tax in a given year, under the requirements of this Subtopic, deferred taxes are recognized for temporary differences that will reverse in future years for which annual taxable income is expected to exceed 5.5% (.25% of net taxable capital/4.5% of taxable income) of expected net taxable capital. In measuring deferred taxes, see paragraph 740-10-55-138 to determine whether a detailed analysis of the net reversals of temporary differences in each future year is
warranted. While the tax statutes of states differ, the accounting described above would be appropriate if the tax structure of another state was essentially the same as in this Example. Franchise taxes are often referred to as privilege taxes because the tax is levied on all entities granted authority by the state to conduct business within its jurisdiction (i.e., the state allows the company to have the privilege of operating within the state). An example of a state franchise tax is included in ASC 740-10-55-139 through ASC 740-10-55-144. In this example, the amount of franchise tax owed by a corporation was the greater of (A) 0.25 percent of the corporation s net taxable capital, as defined, or (B) 4.5 percent of the corporation s net taxable earned surplus. Net taxable earned surplus was a term defined by the tax statute and is based on federal taxable income. Additionally, the total computed tax is an income tax only to the extent that the tax exceeds the capital-based tax in a given year (ASC 740-10-55-141). We believe a franchise tax with essentially the same tax structure as the example above should be considered to be comprised of two elements under ASC 740, a franchise tax and an income tax. To the extent the tax is based on net taxable capital, it is a franchise tax that should be accrued in the year to which the privilege relates. If there is additional tax due based on income, that excess is considered to be an income tax that should be accrued in the year the income was earned. The income-based franchise tax should be included in a company s estimated annual effective tax rate for purposes of applying ASC 740-270 to interim financial statements. Revised Texas franchise tax On 18 May 2006, Texas revised its franchise tax (the Revised Tax). The Revised Tax created a new franchise tax. The new franchise tax replaces the taxable capital and earned surplus components with a tax based on taxable margin. Taxable margin is defined as the entities total revenues less (at the election of the taxpayer) the greater of cost of goods sold or compensation (compensation would include wages and cash compensation as well as benefits). However, the entity s taxable margin would be capped at 70% of the entity s total revenues. The Revised Tax also provides for the carryforward of prior tax credits, subject to limitations, as well as a temporary tax credit. We believe the Revised Tax, while based on an entity s margins (as discussed above), is nonetheless, a tax based substantially on income, and as such is subject to the provisions of ASC 740. Accordingly, the signing into law of the Revised Tax bill represented a change in tax law and the corresponding financial statement impact should be recognized in the period the law is enacted (i.e., 18 May 2006), despite an effective date of 1 January 2008. Additionally, companies with qualifying tax credit carryforwards would continue to analyze the realizability of those credits to determine the need for a valuation allowance as required by ASC 740. Shortly after the Revised Tax was enacted, the FASB declined to add to its agenda a project to provide guidance relating to the accounting implications of the Revised Tax, principally whether or not it should be accounted for under ASC 740. In their deliberations, the FASB staff noted that the tax is based substantially on a measure of income and as a result believes it is subject to ASC 740.
Since the Revised Tax does not provide for the carryforward of business operating losses, a temporary credit was included using as the basis for the credit, the net operating losses for Texas tax purposes, to be reported on the entity s franchise tax report due prior to 1 January 2008. However, one of the significant areas of uncertainty in the Revised Tax was how the temporary tax credit should be calculated. Since that time, the Texas State Comptroller s Office has issued a margin tax calculator that is intended to assist constituents in calculating the franchise tax due. In the instructions to the calculator the following computational guidance regarding the temporary credit is included: In addition, a corporation may take a credit based on business losses accrued under Tax Code Section 171.110(e) that were not expired or exhausted on a report due prior to January 1, 2008. The credit is 10 percent of the business losses multiplied by the appropriate margins tax rate and expires September 1, 2016. Texas Tax Code 171.111. We believe the instructions, as issued by the Comptroller s Office, provide sufficient clarification such that the appropriate temporary credit that exists as of the enactment date (based on losses, for Texas tax purposes, that were incurred as of the enactment date) can now be calculated for financial reporting purposes. The impact of the Texas tax losses post the enactment date on the temporary credit calculation should be reflected as they occur versus the anticipated in the calculation of the credit on enactment. State taxes based on items other than income Some state/local taxing authorities compute taxes due from business operations based on income plus or minus payroll, capital expenditures, net capital, and/or other items. Based on an actual company s operating results, the income tax component of the state/local taxation scheme may not be applicable (e.g., when the company is in a loss position) or may be the most significant component of the total state/local tax liability. In determining whether these taxation schemes are income taxes or other taxes (e.g., payroll, sales/use, or franchise), entities should consider the current and future impact of the various components of the state/local tax scheme. In addition, companies should note that the ASC Master Glossary defines income tax expense (benefit) as the sum of current tax expense (or benefit) (that is, the amount of income taxes paid or payable (or refundable) for a year as determined by applying the provisions of the enacted tax law to the taxable income or excess of deductions over revenues for that year) and deferred tax expense (or benefit) (that is, the change during the year (or since the acquisition date for acquired temporary differences) in an entity s deferred tax liabilities and assets). Further, public companies should consider Rule 5-03(b)(11) of Regulation S-X, which requires public companies to include only taxes based on income under the caption income tax expense. In other words, taxes based on net capital are generally regarded as franchise taxes and recognized in the period the entity has the privilege to operate in the taxing authority s jurisdiction. Likewise, taxes based on payroll or capital expenditures are generally regarded as payroll or use taxes and recognized in the period those costs are incurred. Conversely, taxes based on income should be recognized in the period in which the income is reported for financial reporting purposes (including the recognition of deferred tax assets and liabilities). Deferred taxes are recognized based on the incremental effect caused by reversals of temporary differences in future years for which annual taxable income is expected to exceed the other components (based on the existing relative significance) of the taxation scheme.
Example illustration Jurisdiction M s business tax is based on income for the period plus payroll costs less construction expenditures. In many situations, the payroll and construction expenditures components may be more significant than the income component. Although Jurisdiction M s tax law clearly states the tax is not an income tax, the starting point for the tax is income for the period and therefore meets ASC 740 s definition of a tax on income. Some diversity in practice arises because companies may show losses for both financial reporting and US federal income tax purposes and still have a tax liability for Jurisdiction M s business tax due to the payroll component of the base computation. Thus, some companies have elected to classify this tax (a) as income tax expense, (b) partially as income tax expense and partially as general expense, or (c) as general expense. However, we believe interperiod tax allocation is required for the Jurisdiction M business tax that is, the income tax portion of the tax should be reported as a component of income tax expense while the payroll cost and construction expenditures are treated as payroll taxes and use taxes, respectively, and typically reported as a general expense. Temporary differences related to state income taxes ASC 740-10-55 addresses temporary differences related to state and local income taxes and their interaction with federal temporary differences. Excerpts from Accounting Standards Codification Income Taxes Overall Implementation Guidance and Illustrations 740-10-55-20 State income taxes are deductible for US federal income tax purposes and therefore a deferred state income tax liability or asset gives rise to a temporary difference for purposes of determining a deferred US federal income tax asset or liability, respectively. The pattern of deductible or taxable amounts in future years for temporary differences related to deferred state income tax liabilities or assets should be determined by estimates of the amount of those state income taxes that are expected to become payable or recoverable for particular future years and, therefore, deductible or taxable for US federal tax purposes in those particular future years. 740-10-55-25 If deferred tax assets or liabilities for a state or local tax jurisdiction are significant, this Subtopic requires a separate deferred tax computation when there are significant differences between the tax laws of that and other tax jurisdictions that apply to the entity. In the United States, however, many state or local income taxes are based on US federal taxable income, and aggregate computations of deferred tax assets and liabilities for at least some of those state or local tax jurisdictions might be
acceptable. In assessing whether an aggregate calculation is appropriate, matters such as differences in tax rates or the loss carryback and carryforward periods in those state or local tax jurisdictions should be considered. Also, the provisions of paragraph 740-10-45-6 about offset of deferred tax liabilities and assets of different tax jurisdictions should be considered. In assessing the significance of deferred tax expense for a state or local tax jurisdiction, it is appropriate to consider the deferred tax consequences that those deferred state or local tax assets or liabilities have on other tax jurisdictions, for example, on deferred federal income taxes. When deferred tax assets and liabilities attributable to state or local tax jurisdictions are significant, a separate deferred tax computation may be required when there are significant differences between the tax laws of that state or local tax jurisdiction and other tax jurisdictions applicable to the company (i.e., the US federal and other state or local tax jurisdiction). For example, many states have limited carryback and carryforward provisions, which could result in limited asset recognition under the liability method. In assessing whether an aggregate calculation is appropriate, matters such as differences in tax rates or the loss carryback and carryforward periods in those state or local tax jurisdictions should be considered (ASC 740-10- 55-25). State applied vs. enacted tax rates ASC 740 requires the use of currently enacted tax rates in computing deferred taxes. However, when considering state and local income taxes, companies must consider the federal tax benefits, if any, related to those state and local taxes and adjust the enacted tax rates by the expected federal benefit. That is, if the enacted income tax rate for a given state is 10% and the company anticipates receiving a federal tax deduction in the period that tax liability becomes payable to the state taxing authority, and the company s federal tax rate is 35%, the company would compute its state deferred taxes using 6.5% (or 10% x (1-0.35)). Despite the computation of the state tax, public entities are required by Regulation S-X to separately disclose the state income tax expense exclusive of the federal tax benefit when reconciling the components of income tax expense as well as the income tax rate. In addition, the guidance for accounting of income taxes in ASC 740 does not permit netting of deferred tax assets and liabilities related to different tax jurisdictions (e.g., federal and state) in the statement of financial position. In addition to the impact of federal tax benefits attributable to state and local income taxes, companies with operations in multiple state and local taxing jurisdictions must also consider the various allocation methodologies under state income tax laws and regulations. Estimating deferred state income taxes In some jurisdictions, state and local taxes are based on US federal taxable income, and aggregate computations of deferred tax assets and liabilities for at least some of those state or local tax jurisdictions might be acceptable. In assessing whether an aggregate calculation is appropriate, matters such as differences in tax rates or the loss carryback and carryforward periods should be considered. In addition, in assessing the significance of deferred tax expense with respect to state or local taxes, consideration should be given to the deferred tax
consequences that those deferred state or local tax assets or liabilities have on other tax jurisdictions, for example, on the computation of deferred federal income taxes. Consideration must also be given to the prohibition against offsetting deferred tax liabilities and assets attributable to different tax jurisdictions under ASC 740-10-45-6. Companies with a majority of their taxable income allocated to a few states ordinarily should be able to analyze the tax effects in those states, and estimate an overall provision for remaining operations. Income apportionment Many states require apportionment of federal taxable income to the states in which companies operate in based on various factors. Taxable income is typically apportioned based on sales, payroll costs, and assets located in each state. Because not all state and local taxing authorities require or permit the same allocation methodologies, a portion of a company s income may be taxable in more than one jurisdiction or may not be subject to taxation in any jurisdiction. ASC 740 does not specifically address the apportionment of income for future years when temporary differences will reverse. One approach would be to estimate future allocations to states based on historical relationships. Franchise tax effect on deferred state income taxes ASC 740 does not require specific accounting for deferred state income taxes. The guidance for the accounting of income taxes in ASC 740 requires recognition of a current tax asset or liability for the estimated taxes payable or refundable on tax returns for the current year and a deferred tax asset or liability for the estimated future tax effects attributable to temporary differences and carryforwards that are measured at the enacted tax rates. Accordingly, under ASC 740, deferred taxes are recognized for temporary differences that will reverse in future years for which annual taxable income is expected to exceed the capital-based tax computation based on the level of existing capital at year-end. ASC 740-10-55-138 and its discussion of graduated tax rates, should be considered when determining whether a detailed analysis of the net reversals of temporary differences in each future year (i.e., scheduling) is warranted. In most cases ASC 740 does not require temporary difference to be scheduled. Valuation allowances Excerpts from Accounting Standards Codification Income Taxes Overall Initial Measurement 740-10-30-17
All available evidence, both positive and negative, shall be considered to determine whether, based on the weight of that evidence, a valuation allowance for deferred tax assets is needed. Information about an entity s current financial position and its results of operations for the current and preceding years ordinarily is readily available. That historical information is supplemented by all currently available information about future years. Sometimes, however, historical information may not be available (for example, start-up operations) or it may not be as relevant (for example, if there has been a significant, recent change in circumstances) and special attention is required. 740-10-30-18 Future realization of the tax benefit of an existing deductible temporary difference or carryforward ultimately depends on the existence of sufficient taxable income of the appropriate character (for example, ordinary income or capital gain) within the carryback, carryforward period available under the tax law. The following four possible sources of taxable income may be available under the tax law to realize a tax benefit for deductible temporary differences and carryforwards: a. Future reversals of existing taxable temporary differences. b. Future taxable income exclusive of reversing temporary differences and carryforwards. c. Taxable income in prior carryback year(s) if carryback is permitted under the tax law. d. Tax-planning strategies (see paragraph 740-10-30-19) that would, if necessary, be implemented to, for example: 1. Accelerate taxable amounts to utilize expiring carryforwards. 2. Change the character of taxable or deductible amounts from ordinary income or loss to capital gain or loss. 3. Switch from tax-exempt to taxable investments. Evidence available about each of those possible sources of taxable income will vary for different tax jurisdictions and, possibly, from year to year. To the extent evidence about one or more sources of taxable income is sufficient to support a conclusion that a valuation allowance is not necessary, other sources need not be considered. Consideration of each source is required, however, to determine the amount of the valuation allowance that is recognized for deferred tax assets. 740-10-30-19 In some circumstances, there are actions (including elections for tax purposes) that: a. Are prudent and feasible. b. An entity ordinarily might not take, but would take to prevent an operating loss or tax credit carryforward from expiring unused. c. Would result in realization of deferred tax assets.
This Subtopic refers to those actions as tax-planning strategies. An entity shall consider tax-planning strategies in determining the amount of valuation allowance required. Significant expenses to implement a tax-planning strategy or any significant losses that would be recognized if that strategy were implemented (net of any recognizable tax benefits associated with those expenses or losses) shall be included in the valuation allowance. See paragraphs 740-10-55-39 through 55-48 for additional guidance. Implementation of the tax-planning strategy shall be primarily within the control of management but need not be within the unilateral control of management. Under ASC 740-10-25-29, a deferred tax asset is recognized for deductible temporary differences and operating loss and tax credit carryforwards. Deferred tax assets are measured using the applicable enacted tax rate and provisions of the enacted tax law. Generally, deferred tax assets are recorded when the event giving rise to the tax benefit has been recognized in the company s financial statements (i.e., the tax benefit exists). The existence of deductible temporary differences, operating loss carryforwards, and tax credit carryforwards is generally fairly straightforward based on the application of tax law. However, in some cases, the existence of tax benefits may be subject to significant judgment requiring careful consideration of the facts and circumstances (e.g., tax benefits based on complex provisions of tax law or tax positions subject to a high likelihood of challenge by the Internal Revenue Service). Valuation allowances do not deal with existence; instead, valuation allowances under ASC 740 address the realizability of an asset. A valuation allowance is recognized if, based on the weight of available evidence, it is morelikely-than-not (likelihood of more than 50 percent) that some portion, or all, of the deferred tax asset will not be realized (ASC 740-10-30-5(e)). It is important to emphasize that the evaluation regarding realizability of deferred tax assets is made on a gross as opposed to a net basis. In other words, all companies with significant deductible temporary differences and operating loss and tax credit carryforwards are required to evaluate the realizability of their deferred tax assets, not only those companies in a net deferred tax asset position. Future realization of deferred tax assets ultimately depends on the existence of sufficient taxable income of the appropriate character in either the carryback or carryforward period under the tax law. Determining whether a valuation allowance for deferred tax assets is necessary often requires an extensive analysis of positive and negative evidence regarding realization of the deferred tax assets and inherent in that, an assessment of the likelihood of sufficient future taxable income. This analysis typically includes scheduling reversals of temporary differences, evaluating expectations of future profitability, determining refund potential in the event of NOL carrybacks, and evaluating potential tax-planning strategies. Companies with deferred tax assets should carefully consider whether a valuation allowance is necessary. For companies that historically have been profitable and expect that trend to continue, the judgment required to conclude the future realization of deferred tax assets is more-likely-than-not to occur is generally not difficult. However, the assessment is more difficult when there is negative evidence, which generally is the case for unprofitable companies,
marginally profitable companies, or companies experiencing a high degree of volatility in earnings. Sources of taxable income The four sources of taxable income to be considered in determining whether a valuation allowance is required include (from least to most subjective): a. Taxable income in prior carryback years, if carryback is permitted under the tax law; b. Future reversals of existing taxable temporary differences (i.e., offset gross deferred tax assets against gross deferred tax liabilities); c. Tax planning strategies; and d. Future taxable income exclusive of reversing temporary differences and carryforwards. ASC 740-10-30-17 requires an assessment of all available evidence, both positive and negative, to determine the amount of any required valuation allowance. In general terms, positive evidence refers to factors affecting the predictability of one or more of the four sources of taxable income described above, including qualitative information about those sources, particularly with regard to future taxable income. For example, what has been the company s experience with respect to achieving its forecasted results over various periods? If a single source of taxable income (e.g., future reversal of existing taxable temporary differences) is sufficient to eliminate the need for a valuation allowance, other sources do not need to be considered. However, before determining if a valuation allowance is necessary, consideration of each source of taxable income is required. For example, if a company has existing taxable temporary differences greater than its deductible temporary differences and loss carryforwards, and the general reversal patterns are such that offset would be expected under the tax law, there is no need to consider other sources of taxable income in concluding that a valuation allowance is not necessary. Alternatively, if taxable income from carryback and reversal of existing temporary differences is insufficient in eliminating the need for a valuation allowance, tax planning strategies and future taxable income must be considered. A company cannot choose to simply ignore one or more of its available sources of taxable income in assessing its valuation allowance. In determining the need for a valuation allowance, we believe a company should consider the four sources of taxable income in order of the least subjective to the most subjective. That order is: carrybacks, reversals of existing temporary differences, tax planning strategies and, lastly, future taxable income exclusive of reversals of existing temporary differences. In that way, subjective assumptions about future taxable income will be necessary only if the more objectively determinable sources of taxable income are inadequate to reduce the potential balance in the valuation allowance to zero. However, in cases where deferred tax assets are significant (e.g., a company with few taxable temporary differences and limited carryback ability), future taxable income will need to be considered. In such cases, forecasts, projections, or other types of forward-looking analyses might be required. State and local income taxes and valuation allowance
As discussed above, the computation of state deferred taxes considers expected federal tax effects, if any. However, ASC 740 does not permit netting of deferred tax assets and liabilities related to different jurisdictions. An interesting issue arises if a valuation allowance is necessary for a state deferred tax asset that is not more-likely-than-not to be realized. The issue is whether a state deferred tax asset should be assessed for realizability before or after the related federal deferred tax liability is recognized. That is, when a state deferred tax asset is not realizable and a valuation allowance is required, does an entity first record a valuation allowance associated with the state deferred tax asset resulting in the entity not recording the related federal deferred tax liability or does an entity first record a federal deferred tax liability and then record a valuation allowance based on the deferred tax asset after considering the federal deferred tax liability? Many have not objected to either of these views so long as the selected view has been applied on a consistent basis. Uncertain tax positions The guidance for accounting for uncertainty in income taxes in ASC 740 applies to all tax positions related to income taxes subject to ASC 740, including tax positions considered to be routine as well as those with a high degree of uncertainty. The guidance for accounting for uncertainty in income taxes in ASC 740 is also applicable to pass-through entities, non-taxable entities, and entities whose tax liability is subject to a 100-percent credit for dividends paid (e.g., real estate investment companies and registered investment companies). ASC 450 is not applicable to income taxes. The provision in ASC 740 for the accounting for uncertainty in income taxes utilizes a two-step approach for evaluating tax positions. Recognition (Step 1) occurs when an entity concludes that a tax position, based solely on its technical merits, is more likely than not to be sustained upon examination. Measurement (Step 2) is only addressed if Step 1 has been satisfied (i.e., the position is more likely than not to be sustained). Under Step 2, the tax benefit is measured as the largest amount of benefit, determined on a cumulative probability basis, that is more likely than not to be realized upon ultimate settlement. Those tax positions failing to qualify for initial recognition are recognized in the first subsequent interim period that they meet the more-likely-than-not standard, are resolved through negotiation or litigation with the taxing authority, or on expiration of the statute of limitations. Derecognition of a tax position that was previously recognized would occur when a company subsequently determines that a tax position no longer meets the more-likely-than-not threshold of being sustained. The guidance for accounting for uncertainty in income taxes in ASC 740 specifically prohibits the use of a valuation allowance as a substitute for derecognition of tax positions. State and local law versus higher level law One of the more complicated issues surrounding state and local tax positions relates to the interaction of state and higher level law when there is a perceived conflict. In that regard,
numerous questions have arisen related to both the court of last resort under ASC 740-10-25-7 as well as the effect a decision of the US Supreme Court (USSC) not to hear a case has on the evaluation of the technical merits of a tax position for purposes of applying ASC 740-10-25-7. The highest court that has discretion to hear the case is the Court of last resort as contemplated by ASC 740-10-55-3 when it comes to state tax matters. For questions of constitutionality of enacted state law, the highest court, by default, is the USSC which is the court of last resort on constitutional issues. ASC 740-10-25-6 states, the terms examined and upon examination also include resolution of the related appeals or litigation processes, if any. Once the USSC denies certiorari, the lower court ruling is final and that lower court becomes the court of last resort for the specific taxpayer who applied for certiorari. An entity can factor in a law being overturned (i.e. the state tax law determined to be unconstitutional) as a basis for applying step 1 of the ASC 740-10-25-6 analysis. ASC 740-10- 25-6 states: [a]n entity shall initially recognize the financial statement effects of a tax position when it is more likely than not, based on the technical merits, that the position will be sustained upon examination. The term more likely than not means a likelihood of more than 50 percent; the terms examined and upon examination also include resolution of the related appeals or litigation processes, if any. Since the litigation process would include the ability to appeal whether a tax law is in conflict with higher level law, that appeal and the resultant outcome should be considered in assessing compliance with the more-likely-than-not criterion for initial recognition. In addition, ASC 740-10-55-3 states, [t]he recognition threshold is met when the taxpayer (the reporting entity) concludes that, consistent with paragraphs 740-10-25-6 through 25-7 and 740-10-25-13, it is more likely than not that the taxpayer will sustain the benefit taken or expected to be taken in the tax return in a dispute with the taxing authorities if the taxpayer takes the dispute to the court of last resort. Often, the court of last resort can choose not to hear a specific case without ruling on the issue of law (in the case of the US Supreme Court, many more cases are filed than could ever be granted certiorari (heard). The Supreme Court s website notes, [t]he Justices must exercise considerable discretion in deciding which cases to hear, since more than 7,000 civil and criminal cases are filed in the Supreme Court each year from the various state and federal courts ). In such cases, an entity does not have to factor the likelihood such case would be heard by the court of last resort in applying the ASC 740-10-25-6 initial recognition threshold of more-likelythan-not. ASC 740 does not require an assessment of the likelihood that the court of last resort will ultimately decide the technical merits of the position. The likelihood of an appeal being accepted by the USSC is, however, a component of measurement of a recognized tax position where an entity is required to assess the various outcomes (e.g., litigation and settlement). As a result, the USSC declining to hear related cases and the resultant likelihood that the USSC would hear an entity s specific or a similar case should be considered by entities in measurement of their recognized tax positions. While the USSC s recent denial of certiorari does not necessarily change the ASC 740-10-25-6 conclusion reached in the recognition step, measurement could be significantly affected.