More changes may be on the way for the now infamous FIN 48, the guidelines for reporting uncertain tax positions. For the better part of three years, FIN 48 has seen a series of delays and adjustments that have sometimes had financial departments scrambling to understand the nuances.

A firm deadline for compliance was set last year, calling for all entities to adopt the standard as of the fiscal year beginning after December 31, 2008. However, as we approach the traditional tax season for that period, the IRS is already proposing changes to FIN 48 (for next year at the earliest). FIN 48 has been criticized in the past for its complexity and most notably its lack of clarity when it comes to pass-through and tax-exempt nonprofit entities. Given the deadline, private entities will have to get moving on FIN 48 compliance and stay attuned to the proposed adjustments.

The information reported under FIN 48 is meant to assist in the examination of tax returns by bringing to light areas of interest or magnitude that warrant further inquiry. The IRS is developing a schedule to be filed with corporate returns for taxpayers with assets greater than $10 million, which would require filers to provide a concise description of each uncertain tax position for which they or a related entity has recorded a reserve in financial statements; and the maximum amount of potential federal tax liability attributable to each uncertain tax position.

In addition to positions disclosed by taxpayers under FIN 48, the IRS changes would require that taxpayers disclose positions where no tax reserve was recorded because either it expects to litigate the position or it has determined that the IRS has an administrative practice or precedent not to examine the position.

The IRS proposal asks for descriptions of any uncertain tax positions to contain:

1. The Code sections potentially implicated by the position
2. A description of the taxable year or years to which the position relates
3. A statement that the position involves an item of income, gain, loss, deduction, or credit against tax
4. A statement that the position involves a permanent inclusion or exclusion of any item, the timing of that item, or both
5. A statement whether the position involves a determination of the value of any property or right
6. A statement whether the position involves a computation of basis.

Under the proposal, the IRS would also require that taxpayers indicate for each uncertain tax position the entire amount of federal income tax that would be due if the position were disallowed.

While the changes would not take effect during this filing season, the IRS is looking to expedite the process by requesting public comments by March 29, 2010. At that point, another chapter in the book on FIN 48 will go to press, and CPAs and finance departments will shift gears to keep pace.

As my MFA Partner Jim Guarino mentioned in a November 2009 blog post on Roth IRA conversions, starting this year all taxpayers — regardless of income levels — can now convert a traditional IRA to a Roth IRA. This change applies to 2010 and beyond but carries a special tax incentive for 2010 conversions; the income tax due on the 2010 conversion can be spread equally over the following two tax years (2011 and 2012).

I’d like to follow on Jim’s blog post and offer some additional food for thought on the subject of Roth IRA conversions. In particular, I’d like to share a little known Roth conversion strategy that is worthy of consideration. In essence, it’s a strategy that involves converting a traditional IRA to multiple Roth IRAs, each with a single, distinct asset class. By implementing this type of strategy, investors allow themselves the time and the opportunity to assess the performance of each Roth IRA separately before committing to making the conversion permanent.

Under current Roth IRA conversion rules, investors can “undo” conversions any time before the tax filing deadline for the conversion year. This is what’s known as a “Roth recharacterization.” Understand though, that recharacterization is an “all or nothing” decision. The IRA owner cannot “cherry pick” and recharacterize only those Roth IRA assets that declined in value. If one elects to recharacterize, the entire Roth IRA must be recharacterized, hence the reason for creating a number of Roth IRAs, each with a single, distinct asset class.

Putting a Roth Segregation Strategy Into Play

To put a Roth segregation strategy into play, investors simply convert the portion of the traditional IRA they wish to convert into multiple Roth IRAs, each of which holds a different asset class (bonds, U.S. equities, international equities, real assets, private equity, etc.). The idea behind this allocation strategy is to isolate (or segregate) the returns from each asset class, as they will likely all perform differently, and then keep the best performers as Roth IRAs and recharacterize the losers back to traditional IRAs. It doesn’t change the fact that certain investments lost money, but at least no taxes are due on the Roths that declined in value. Investors will only owe taxes on the Roth IRAs left converted and will have eliminated paying taxes on the Roth amounts that were recharacterized.

To illustrate, let’s consider the following scenario.

Barbara has a single, $100,000 traditional IRA. She would like to convert the entire $100,000 into four Roth IRAs, each invested in a different asset class. In order to do so, she splits her $100,000 into four separate IRAs based on these distinct asset classes. She then converts those four IRAs into four separate Roth IRAs. Once that’s done, it’s time to sit back and watch how they perform.

Prior to April 15^th of the following year (or October 15^th if an extension is filed), Barbara will assess which Roth IRAs performed well and which declined in value. Let’s say two declined substantially. Barbara can “undo” those two Roth IRAs by recharacterizing them back to traditional IRAs. By doing so, Barbara will not have to pay taxes on the total $100,000 she initially converted; instead, she will only pay taxes on the two remaining Roth IRAs.

Now, the story doesn’t end there. Barbara can take advantage of the decline in value to once again convert those recharacterized IRAs back to Roth IRAs, but now at lower values and thus lower taxes. The only stipulation is that she wait 30 days after the recharacterization or one year after the initial conversion, whichever is later. By continuing to use this segregated conversion approach, Barbara has in effect adopted a strategy that minimizes conversion taxes within the larger goal of ultimately converting her traditional IRA to Roths.

This strategy combined with the ability to recharacterize may be beneficial in other areas. For example, anticipated tax law changes, changes in one’s financial situation or other planning considerations may prompt an IRA owner to consider recharacterizing a portion of their Roth IRA before the deadline. An all-or-nothing recharacterization scenario can leave one handcuffed, whereas the flexibility and hindsight offered by this strategy could prove to be invaluable. The new Roths don’t have to be segregated by asset class, either. One holding private equity in an IRA might hedge their conversion approach by segregating unit holdings into multiple IRAs, and then monitoring valuation changes near the tax filing deadline. Beyond the tax benefits is the ability to far more easily benchmark the performance of your various investment holdings within IRAs — tough to do in the all too common “pooled” IRA approach.

Although this strategy is straightforward, it does require the insight of a financial planner with extensive tax experience to ensure conversion taxes are minimized without impeding on the overall conversion strategy and financial plan.  Be sure to contact a skilled practitioner for guidance.

I wanted to bring to our readers’ attention changes to some fees for nonprofits, as the IRS updated amounts for various exempt organizations’ user fees.  While many of the fee changes will not raise eyebrows, some are noteworthy and apply to common requests such as letter rulings.  Adjustments include:

- Changed $900 to $2,250 in section 6.06(3) (Approval of qualified 501(c)(25) subsidiary)

- Changed $8,700 to $10,000 in section 6.06(4) (All other letter rulings)

- Updated user fee amounts for section 6.07 (Determinations letters and requests for group exemption letters) and section 6.08 (“Determinations Office” summary list).

Full detail can be found by linking to the IRS Bulletin.