ASC 740 NOLs and Credits
August 23, 2022
ASC 740 governs how companies recognize the effects of income taxes on their financial statements under U.S. GAAP. This applies only to taxes based on income—not sales, payroll, or property taxes—per ASC 740-10.
Net operating losses (NOLs) and credits impact the ASC 740 provision for income tax required by U.S. GAAP. Like most tax provision subjects, handling NOLs and credits correctly requires both tax and accounting expertise.
NOL and credit carryforwards create deferred tax assets subject to valuation allowances. Manually tracking NOL and credit carryforwards, expiration dates, and valuation allowances can consume considerable time and lead to errors. The frequent carryforward and carryback period changes for NOLs can prove particularly burdensome.
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How do NOLs affect the ASC 740 income tax provision?
Current year NOLs reduce the ASC 740 deferred tax provision by the tax benefit of the NOL amount that the company will more likely than not realize. Create a deferred tax asset for the tax benefit of the entire NOL with a valuation allowance for any portion that fails the more likely than not test.
The NOL for a given year equals allowable deductions minus gross income for federal income tax purposes. Ignore any NOLs from other years and any taxable income limitation on the dividends received deduction when calculating the NOL.
Companies must separately track NOLs for each year one occurs to correctly calculate valuation allowances and to carry the NOLs to other years. For federal NOLs generated in tax years ending before January 1, 2018, carry back to two prior years and then forward for up to twenty subsequent years. Any NOLs created for tax years ending between December 31, 2017, and before January 1, 2021, carry back five years and carry forward indefinitely until used. Finally, NOLs arising from tax years ending after December 31, 2020, cannot be carried back but instead carry forward indefinitely until used and can only be used to offset up to 80% of taxable income.
Carrybacks and carryforwards affect the ASC 740 current tax provision when utilized – subject to certain exceptions.
ASC 740 requires companies to disclose the amounts and expiration dates of all NOL carryforwards.
NOLs do not impact the ASC740 effective tax rate [ETR] calculation.
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How do corporations account for tax credits under ASC 740?
Tax credits reduce the ASC 740 current tax provision to the extent they offset the current year’s tax liability. Credits grant a dollar-for-dollar reduction in tax liability, so the tax benefit equals the amount of the credit.
Current federal tax law generally does not offer refundable income tax credits to corporations. Any excess tax credit over current year liability generates a deferred tax asset and reduces the ASC 740 deferred tax provision. A valuation allowance applies to the deferred tax asset for any portion that fails to meet the more likely than not standard for realization.
Unused credits generally carry back one year and carry forward 20 years, though certain small businesses can carry general business credits back five years and forward 25 years. Foreign tax credits have a 10-year carry forward. ASC 740 does not specifically address how to account for the tax benefit of a tax credit carryforward or carryback. Some practitioners apply the rules for NOLs and recognize the tax benefit of a credit in the year in which the activity that gives rise to the credit occurs. The amount utilized is recognized as a current benefit and the carryforward amount is recognized as a deferred benefit.
Unlike NOLs, under ASC 740 tax credits affect the ASC 740 ETR for the amount of credit generated by current year activity regardless of carryback or carryforward. Credits reduce the ETR for companies with taxable income. However, credits increase the ETR for companies reporting an NOL – the credit increases the benefit associated with current year income.
Like NOLs, under ASC 740 companies must disclose the amounts and expiration dates of all tax credit carryforwards.
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