When it comes to corporate tax accounting, calculating the provision for income taxes under ASC 740 can present a technical challenge. ASC 740 governs how companies recognize the effects of income taxes on their financial statements under U.S. GAAP. It mandates a balance sheet approach and requires the netting of all deferred tax assets and liabilities. ASC 740 also provides guidance on complicated tax topics like uncertain tax benefits and reporting and disclosure requirements, including the rate reconciliation.
Since the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU) in December 2023, corporate tax professionals need to understand how to accurately complete related disclosure requirements.
Read on to learn more about these FASB disclosure requirements, including how they impact the tax provision process.
What are the new FASB improvements to income tax disclosures?
ASC 740 applies only to taxes based on income, not sales, payroll, or property taxes. But public companies must perform a tax rate reconciliation for either the expected tax – based on the statutory rate multiplied by GAAP pretax income – to the income tax provision, or the statutory rate to the effective tax rate.
FASB’s amendments in its 2023 update are intended to “enhance the transparency and decision usefulness of income tax disclosures through improvements to the rate reconciliation and income taxes paid disclosures,” the board noted in its final Accounting Standards Update.
In general, the amendments will require public business entities (a term that replaces “public entity”) to make certain mandatory disclosures in financial statements. To do this, these public business entities will annually disclose specific categories in their rate reconciliation and share “additional information for reconciling items that meet a quantitative threshold (if the effect of those reconciling items is equal to or greater than 5% of the amount computed by multiplying pretax income [or loss] by the applicable statutory tax rate),” the board noted.
Amendments also require entities to disclose new information about the amount of income taxes paid on an annual basis.
These amendments apply to all entities that are subject to income taxes.
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What are the new FASB income tax disclosure requirements?
After noting that it received requests from investors for more transparency about income tax information, FASB explained in its ASU that the amendments “allow investors to better assess, in their capital allocation decisions, how an entity’s worldwide operations and related tax risk and tax planning and operational opportunities affect its income tax rate and prospects for future cash flows.”
Under the update, entities’ required disclosure on income taxes paid would change. Income taxes paid (net of refunds received) will be disaggregated by federal, state, and foreign taxes on an annual basis. And the amount of income taxes paid (net of refunds received) will be disaggregated by individual jurisdictions in which income taxes paid (net of refunds received) would be equal to or greater than 5% of total income taxes paid (net of refunds received), on an annual basis.
Additionally, amendments in the update require that all entities disclose:
- Income (or loss) from continuing operations before income tax expense (or benefit) disaggregated between domestic and foreign
- Income tax expense (or benefit) from continuing operations disaggregated by federal, state, and foreign
FASB income tax disclosure requirements also eliminate the unrecognized tax benefits disclosure around the nature and range estimate of the reasonably possible change in the unrecognized tax benefits balance in the next 12 months. The Accounting Standards Update also eliminated the requirement to disclose the cumulative amount of each type of temporary difference when a deferred tax liability isn’t recognized due to exceptions for subsidiaries and corporate joint ventures.
How are FASB disclosure rules changing?
Currently, investors rely on the rate reconciliation table and other disclosures, including total income taxes paid in the statement of cash flows, to evaluate income tax risks and opportunities. With the ASU, tax professionals will need to produce enhanced disclosure around rate reconciliation and more narrative analysis about changes to these figures. These enhancements require public business entities to specifically disclose the following categories:
- State and local income tax and net of federal income tax effect
- Foreign tax effects
- Effect of changes in tax laws or rates enacted in the current period
- Effects of cross-border tax laws
- Tax credits
- Changes in valuation allowances
- Nontaxable or nondeductible items
- Changes in unrecognized tax benefits
Separate disclosure is required for any of the following reconciling items that meet the 5% quantitative threshold:
- If the reconciling item is within the effect of cross-border tax laws, tax credits, and nontaxable or nondeductible categories, it must be disaggregated by nature.
- If the reconciling item is within the foreign tax effects category, it must be disaggregated by jurisdiction and by nature.
- If the reconciling item does not fall within any of the categories listed above, it must be disaggregated by nature.
Amendments will also require public business entities to provide a qualitative description of the state and local jurisdictions that make up the majority (greater than 50%) of the effect of the state and local income tax category.
How will the updated income tax disclosure requirements change the provision process?
Tax professionals will need to calculate updated mandatory disclosures in financial statements for the current year and prior two years, while staying up to date on the in-depth technical and accounting rules under ASC 740. With the updated FASB disclosure requirements, disclosures will become more burdensome and add complexity to the already complicated tax provision process. For instance, tax professionals will find that tie-outs and rate reconciliation will be impacted by new requirements.
In addition, this ASU includes amendments from FASB’s 2019 revised proposed update, which seek to improve disclosure effectiveness in two ways:
- Adding disclosures of pretax income (or loss) and income tax expense (or benefit) to be consistent with U.S. Securities and Exchange Commission (SEC) Regulation S-X 210.4-08(h), Rules of General Application – General Notes to Financial Statements: Income Tax Expense.
- Removing disclosures that no longer are considered cost beneficial or relevant.
When will the FASB disclosure updates go into effect?
For public business entities, the amendments in this update are effective for annual periods beginning after Dec. 15, 2024. For entities other than public business entities, the amendments are effective for annual periods beginning after Dec. 15, 2025.
Early adoption is permitted for annual financial statements that have not yet been issued or made available for issuance. The amendments in this update should be applied on a prospective basis. Retrospective application is permitted.
Automate your tax provision process
The FASB Accounting Standards Update dramatically impacts ASC 740 reporting and disclosure requirements. Download Your Guide to Proposed FASB Changes to ASC 740 for the latest developments regarding FASB’s proposed updates and how these changes will affect the tax provision process.
FASB’s ASC 740 updates have changed disclosure requirements, and additional calculations are necessary. And for professionals who use Excel sheets to calculate their ASC 740 income tax provision, the prior year’s formulas won’t automatically apply, which could lead to calculation errors. That said, automation can resolve these types of process issues. Learn how tax professionals can use ASC 740 tax provision software to manage controls and efficiencies better than in Excel.
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