Common Traps for Tax Related Restatements and Material Weaknesses December 16, 2011

1. Presenter: Wayne Hoeing, JD, CPA Partner, Clifton Gunderson, LLP Common Traps for Tax Related Restatements and Material WeaknessesDecember 16, 2011

2. Overview Since the passage of Sarbanes-Oxley, tax issues continue to be a major cause of material weaknesses and restatements 27% of US GAAP failures related to tax accruals and deferrals according to a recent survey by Audit Analytics (404 Dashboard Year 6 Update, October 2010) For further reading, see Deloitte’s 2011 publication, “Material weakness and restatements, Is tax still in the hot seat?”

3. Top Tax Material Weaknesses • Inadequate staffing and technical expertise within the company • Ineffective review and approval practices relating to tax • Inadequate processes to effectively reconcile tax accounts • Lack of documentation regarding tax provision • Improper treatment/recording of tax expense and accruals

4. Situations Creating Tax Risks • Poor communication/data sharing • Business combinations • Net operating losses and tax credits • Stock-based compensation • State taxes • Foreign taxes • Valuation allowances

5. Basics of ASC 740(formerly FAS 109) • Current income tax provision (benefit) • Deferred income tax provision (benefit) • Identify book-tax temporary differences • Identify NOL and tax credit carryforwards • Determine the tax rate to measure assets/liabilities • Consider the need for a valuation allowance • Presentation and disclosure

6. Calculating Current Income Taxes • Calculate current income tax using the “regular” tax system after adjusting book income for temporary and permanent differences • Alternative minimum tax (AMT) systems must be considered • Multistate and international tax calculations required for material jurisdictions

7. Nondeductible expenses Life insurance premiums Nondeductible goodwill Penalties and fines Political contributions 50% of meals, entertainment Club dues Lease inclusion amount Certain related-party interest Obligations under buy-sells Examples of Permanent Differences • Tax-exempt revenues • State, municipal interest • Life insurance proceeds • Domestic dividends

8. Examples of Temporary Differences • Book & tax depreciation differences • Bad debt reserves • Inventory uniform capitalization • Estimated warranty reserves • Bonus accruals not paid within 2 ½ months • Deferred revenue book-tax differences (tax rules generally provide for lesser deferral than GAAP) • Stock compensation expense

9. Deferred Tax Items – Documentation and Reversals • General considerations • Prepare rollforward of gross temporary differences • Compute tax effect based on expected rate upon reversal • Classify based on related asset/liability • Be mindful of deferred items reflected in OCI • Scheduling reversal patterns generally not necessary • Situations that may require scheduling • Phased changes in enacted tax law • Future utilization of NOL carryforwards • Considering the need for a valuation allowance

10. Communication/Data SharingCommon Traps • Failure to maintain pre-tax financial data in a manner consistent with the legal entity structure (resulting in re-work before tax calculations can be performed) • Failure to plan for adequate time to complete tax provision calculations, often due to poor data flow • Failure to properly consider the impact of “top-side” entries on different taxing jurisdictions • Lack of, or late involvement of, tax professionals in key corporate initiatives (debt restructuring, acquisitions, etc.) • Failure of tax professionals to communicate key tax matters (i.e., 382 ownership change triggers, upcoming expirations of NOLs and tax credits, recent tax law changes impacting the company, etc.)

11. Business Combinations -Tax Accounting Considerations • Taxable vs. tax-free • Goodwill • Acquisition method (under ASC 805-740; formerly FAS 141(R)) • Tax effect of differences between income tax and financial reporting basis should be recognized as deferred items as of the acquisition date • Adjustments to Tax VA’s or Acquired Uncertain Tax Positions after the one-year measurement period are now generally recorded to tax expense (Pre 2009 all adjustments were recorded to goodwill)

12. Business CombinationsCommon Traps • Failure to properly compute and record deferred tax items as part of purchase accounting (book and tax basis differences of assets and liabilities) • Failure to consider carryover tax basis of assets in nontaxable business combinations which resulted in step-up/down for financial reporting basis • Failure to consider the different characterization of goodwill and the resulting deferred tax implications (component one vs. component two goodwill)

13. Net Operating Losses –Common Traps • Failure to consider IRC Section 382 limitations on ability to utilize NOLs (i.e., change of ownership provisions) • Failure to properly consider reversal periods and potential expiration due to statutes of limitations • Failure to calculate different NOL’s under the different tax systems (regular and AMT, states) • Failure to consider different NOL carryforward rules in different jurisdictions

14. Stock CompensationTax Accounting Considerations • Only awards ordinarily resulting in a tax deduction create a temporary difference • Grant of NQSO results in DTA based on book compensation recorded • Grant of ISO or ESPP does not result in a DTA because tax deduction is not certain • Disqualifying disposition of ISO or ESPP results in a permanent tax benefit in the income statement based on lesser of the deduction or cumulative book compensation expense

15. Stock Compensation -Common Traps • Failure to properly track Additional Paid In Capital (APIC) pool • Failure to remove deferred tax asset upon expiration of unexercised stock options (ie. upon termination of employment) • Failure to distinguish between ISO’s and NQSO’s when tracking expense for financial reporting purposes

16. Multistate Taxation - Common Traps • Failure to consider different state tax treatment of certain items (i.e., depreciation addbacks, bad debts, charitable contributions, capital gains & losses, etc.) • Failure to address state nexus issues as the company grows or operations change • Use of blended vs. actual tax rates to calculate deferred tax balances • Failure to timely consider changes in tax rates

17. International Taxation - Common Traps • Communication barriers! • Failure to engage competent local tax specialists to prepare foreign tax provisions • Failure of parent to understand key aspects of local country tax system in order to provide adequate oversight • Failure to comply with tax holiday requirements • Inadequate transfer pricing documentation

18. Valuation Allowances –Common Traps • Failure to adequately consider all available evidence (positive and negative) to determine when a company should provide for a valuation allowance against its deferred tax assets • Attempting to identify a mathematical formula to determine when to release a valuation allowance • Improperly considering reversals of DTLs on indefinite lived asset as a source of future income (so called “naked credits” issue) • Failure to consider reversal patterns of temporary differences in assessing need for a VA

19. Valuation Allowance –Tax Accounting Considerations • Negative evidence • Cumulative losses in recent years • History of carryforwards expiring unused • Future losses expected by presently profitable entity • Future effects of contingencies, uncertainties • Statutory limits on future realization of tax benefits • Positive evidence • Existing contracts or sales backlog • Appreciated asset value over tax basis • Strong earnings history • Exclusive of current loss • Along with evidence that loss is nonrecurring

20. Valuation Allowance –Tax Accounting Considerations • Sources of Taxable Income (ASC 740-10-30-18) • Reversals of taxable temporary differences • Future taxable income exclusive of reversals and carryforwards • Taxable income in prior carryback years • Qualifying tax planning strategies

21. Uncertain Tax Positions – IRS Trap for Everyone! • FIN 48 required a reserve to be recorded for an uncertain tax position unless it met the “more likely than not”(MLTN) criteria that the tax position will be upheld upon examination • IRS Schedule UTP is now required for corporations issuing audited financial statements with at least one tax position that must be reported for GAAP purposes

22. UTP Guidelines for Evaluating Tax Positions • Assumed examination by taxing authority • Must assume that examination will occur • Must assume examiner has all relevant information • Each position judged on its technical merits • Positions evaluated independently of each other • Application of authoritative tax laws • Specific facts and circumstances of tax position • Considers administrative practices and precedents

23. Presentation and Disclosure • Accounting policies • Deferred tax assets and liabilities • Income tax expense • Net operating loss and tax credit carryforwards • Other disclosures

24. Balance Sheet Presentation • Income taxes currently payable (refundable) • Deferred income tax assets and liabilities • Associated with particular assets and liabilities • Not associated with particular assets and liabilities • Reduction of assets by valuation allowances • Liability for unrecognized tax positions • No right of offset between tax jurisdictions

25. Income Statement Presentation • Current income tax expense (benefit) • Deferred income tax expense (benefit) • Generally equal to change in deferred income tax assets and liabilities • Return to provision true-up items for temporary differences should not impact overall tax expense

26. Tax Footnotes • What they will tell you: • Is income taxed in jurisdictions other than the U.S.? • Are some available tax credits being recognized? • Are there tax attributes that may expire unused? • Have tax positions been claimed on returns that may not be sustained on audit? • What they will not tell you: • What jurisdictions and at what rate of tax? • Are all available credits claimed and/or recognized? • What are the unrecognized tax benefits by jurisdiction?

27. Reporting Trends • Disclosures relating to unrecognized tax benefits have been notably vague, query whether introduction of Schedule UTP will impact how companies approach uncertain tax positions going forward • Nonpublic companies must disclose the types of significant temporary differences but don’t have to quantify the tax effects of each • Per recent AICPA Accounting Trends & Techniques, examples of rate reconciling items included: • State taxes, net of federal benefits • Non-deductible stock-based compensation expense • R&D tax credits • Current year FIN 48 changes (increase or decrease) • Valuation allowance (increase or decrease) • US domestic manufacturing deduction • Foreign tax rate differential • Nondeductible expense • Goodwill impairment (where DTA not previously established, circa 2008-09)

28. Conclusion and Wrap-Up Questions? Wayne Hoeing – 317-569-6266 wayne.hoeing@cliftoncpa.com