XYZ Productions has determined that it is eligible for a federal research and development credit for 2016 in the amount of $826,000. This amount will be claimed on the 2016 federal income tax return. However, due to the IRS scrutiny over R&D credits, XYZ Productions has determined that this credit is an uncertain tax position and based on the criteria of ASC 740-10 has determined that a reserve should be recorded as a FIN 48 liability. XYZ Productions has a FIN 48 liability as of December 31, 2015 for previous uncertain tax positions for R&D credit equal to 20% of the $410,000 R&D credit claimed on the 2012 federal income tax return and 20% of the $440,000 R&D credit claimed on the 2013 federal income tax returns. No R&D credits were claimed in 2014 or 2015.

XYZ Productions 2012 tax return was audited during 2016 and settled on August 12, 2016. The only audit issue was related to the R&D credit claimed on the 2012 return. The IRS disallowed $102,500 of the $410,000 credit claimed. XYZ Productions paid the IRS the $102,500 on August 12, 2016. The 2012 tax year was closed by the statute of limitations on September 15, 2016. Tax years 2013 and forward remain open for IRS audit.

Based on the results of the IRS audit, XYZ Productions has re-evaluated the measurement of its required FIN 48 liability. Taking into consideration the issues related to the challenges the IRS made to specific R&D expenditures, XYZ Productions now believes it is appropriate to change its reserve for the 2013 R&D credit to 25% and to record a reserve for the 2016 R&D credit of 25%. The only activity during 2016 in the FIN 48 Liability account (Account # 2105) was to increase the reserve by $20,500 for 2012 to record an additional reserve for the IRS assessment and to reflect the payment of $102,500 to the IRS in settlement of the 2012 audit.

While XYZ Productions does not believe it would be subject to any potential penalties related to this position, the company will treat any future interest or penalties related to uncertain tax positions as a component of tax expense. Ignore calculation of interest expense for purposes of calculating the FIN 48 Liability.

Info from financial statements:

Balalnce Sheet:

12/31/2015 12/31/2016

FIN 48 Liability

(170,000)

(88,000)

Income Statement:

Income tax expense - FIN 48

0

20,500

Question:

Calculate the 2016 FIN 48 tax expense and show all the calculations for the reserve at 12/31/15 and 12/31/16.