A Guide to FASB Updates to Income Tax Disclosure Requirements

How are the FASB income tax disclosure requirements changing?

Before ASU 2023-09, investors relied 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.

FASB previously stated that it received requests from investors for more transparency about income tax information. The purpose of the ASU is to enhance the transparency and usefulness of income tax disclosures by targeting two main areas:

1. Rate reconciliation
2. Income taxes paid

With these changes, FASB aims to “allow investors to better assess, in their capital allocation decisions, how an entity’s worldwide operations and related tax risks and tax planning and operational opportunities affect its income tax rate and prospects for future cash flows.”

ASU 2023-09 dramatically impacts income tax disclosures with several changes intended to address investor calls for more information about income taxes. Those changes include:

• Enhanced disclosures around rate reconciliations
• Disclosure of income taxes paid
• Adding income tax expense as a disclosure
• Disaggregation between domestic and foreign taxes of income (or loss) from continuing operations before income tax expense (or benefit)
• Disaggregating by federal (national), state, and foreign taxes the income tax expense (or benefit) from continuing operations
• Eliminating unrecognized tax benefits (UTB) disclosure around the nature and estimate of the range of the reasonably possible change in the UTB balance in the next 12 months
• Eliminating the cumulative amount of each nonrecognized deferred tax liability
• Disclosure of states contributing to the majority of state tax expense

The first two changes are the main components of ASU 2023-09 and the areas that will require significant changes to your current process for calculating income tax provisions and preparing disclosures.

Enhanced disclosures around rate reconciliations

In general, the amendments require public business entities (a term that replaces “public entity”) to make certain mandatory disclosures in financial statements. Public business entities (PBEs) are required to 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),” as noted in the FASB ASU.

PBEs must now perform a tax rate reconciliation for both:

1. The expected tax to the total income tax provision, where expected tax is calculated as the statutory rate multiplied by GAAP pretax income
2. The statutory rate to the effective tax rate

Rate reconciliation categories

The ASU adds ASC 740-10-50-12A, which requires PBEs to annually disaggregate the income tax rate reconciliation among the following eight categories by both percentages and reporting currency amounts:

1. Tax credits
2. Foreign tax effects
3. Effect of changes in tax laws or rates enacted in the current period
4. Effects of cross-border tax laws
5. Changes in valuation allowances
6. Nontaxable or nondeductible items
7. Changes in unrecognized tax benefits
8. State and local income tax, net of federal (national) income tax effect

Individual reconciling items that meet the 5% quantitative threshold

Separate disclosure is required for any of the following reconciling items that meet the 5% quantitative threshold:

• Cross-border tax laws
• Tax credits
• Foreign tax effects
• Nontaxable or nondeductible items

If the reconciling item does not fall within any of the above categories but meets the conditions for disaggregation based on the 5% threshold, it must be disaggregated by nature.

Companies should present all reconciling items on a gross basis, except for unrecognized tax benefits, certain cross-border tax effects, and the related tax credits, which the company can choose to present net. The new disclosure requirements must be applied retrospectively for all periods presented.

Finally, the ASU adds ASC 740-10-50-12C, which requires entities to “provide an explanation, if not otherwise evident, of individual reconciling items required by paragraph 740-10-50-12A, such as the nature, effect, and underlying causes of the reconciling items and the judgment used in categorizing the reconciling items.”

Updated disclosure of income taxes paid

Under the ASU, entities’ required disclosures on income taxes paid changed. The year-to-date amount of income taxes paid (net of refunds received) must be disaggregated by federal, state, and foreign taxes on an annual basis. The amount of income taxes paid (net of refunds received) must also be disaggregated by individual jurisdictions in which income taxes paid (net of refunds received) is equal to or greater than 5% of total income taxes paid (net of refunds received), on an annual basis.

The amendments apply to all entities subject to the income tax disclosure requirements. The updated tax disclosure requirements will change the provision process, including tie-outs. Disclosures will become more burdensome, and the ASU complicates the already complex tax provision process. Tax professionals will need to calculate updated mandatory disclosures in financial statements for the current year, while staying up to date on the in-depth technical and accounting rules under ASC 740.

Disaggregation of federal and domestic income tax expense

The ASU amends ASC 740-10-50-12 to require public business entities to disclose a reconciliation “between the amount of reported income tax expense (or benefit) from continuing operations and the amount computed by multiplying the income (or loss) from continuing operations before income taxes by the applicable statutory federal (national) income tax rate of the jurisdiction (country) of domicile.”

Public entities not domiciled in the U.S. must use the federal (national) income tax rate in the company’s jurisdiction of domicile for the rate reconciliation. The ASU prohibits companies from using different income tax rates for subsidiaries or segments. Companies that use an income tax rate in the reconciliation other than the U.S. income tax rate must disclose the rate they use and their basis for using it.

Eliminated disclosure of unrecognized tax benefits and deferred tax liabilities

FASB income tax disclosure requirements in the ASU eliminate the unrecognized tax benefits disclosure requiring the nature and estimate of the range of reasonably possible change in the unrecognized tax benefits balance in the next 12 months.

The ASU also removed the requirement to disclose the cumulative amount of each type of temporary difference when a deferred tax liability (DTL) is not recognized due to exceptions to comprehensive recognition of deferred taxes related to subsidiaries and corporate joint ventures.

Qualitative disclosure of states contributing to majority of state tax expense

The ASU also requires entities to provide qualitative disclosures about which states contribute to the majority of the reconciling item for state and local income taxes.

This was one of the more contentious aspects of FASB’s updates because, although the existing ASUs never prescribed the use of blended rates, most preparers use a blended rate in practice.

Are blended state rates over?

The ASU requires PBEs to separately identify the states that account for more than 50% of the state and local income tax category. This makes the use of a blended state rate significantly more difficult for both current and deferred state tax expense calculations.

Theoretically, using a blended rate should yield the same mathematical results as using a state-by-state approach. However, it sometimes doesn’t, due to variables such as net operating losses (NOLs), state tax credits, or areas where states have decoupled from federal law. Maintaining, supporting, and disclosing the blended rate is often more work than simply preparing the calculations without using a blended rate.