Accounting for Income Taxes Overview
ASC 740 pertains to accounting and reporting for income taxes in the
financial statements under GAAP.
Income Taxes
ASC 740 is concerned solely with accounting and reporting for all taxes
based on net income. The standard encompasses all federal, state, local
and foreign income taxes. ASC 740 does not apply to franchise taxes
based on capital, sales based taxes, payroll taxes, or other non-net
income based taxes.
Balance Sheet Approach
ASC 740 is based on a balance sheet approach to accounting for income
taxes on past and current income reported in the financial statements.
Essentially the Company reports two components of income tax expense
on its worldwide income in its financial statements:
1) Income taxes currently payable or refundable, often referred to as
the current payable or receivable, is the amount of income tax
expected to be incurred related to the company’s income tax returns
for the reporting period. The related income statement impact is
referred to as the current expense or current benefit accordingly.
2) Deferred tax assets and deferred tax liabilities, are the anticipated
future tax consequences arising from activity in past or current
reporting periods. Deferred tax assets and liabilities represent basis
differences between the book value and tax value of the underlying
items. The related income statement impact is referred to as the
deferred tax benefit or deferred tax expense accordingly.
Effective Tax Rate
The Company’s effective tax rate equals its income tax expense divided
by GAAP pre-tax income. The effective rate typically varies from the
statutory rate imposed by the U.S. government.
The Company is required to include a reconciliation of the items that
cause the effective rate to differ from the statutory rate.
Basic Reporting and Disclosure
The total of current and deferred tax expense is the income tax reported in
the income statement of the financial statements.
© 2015 Tax Prodigy, LLC. This publication contains general information only and is not, by means of this
publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or
services. This publication does not substitute for such professional advice or services, nor should it be used as
a basis for any decision or action that may affect your business. Before making any decision or taking any
action that may affect your business, you should consult a qualified advisor. TAX PRODIGY, LLC shall not be
responsible for any loss sustained by any person who relies on this publication.
1
Public companies are required to disclose the amount of current and
deferred tax expense by significant tax jurisdiction in the footnotes to the
financial statements. Additionally, filers are required to disclose the nature
and value of the deferred tax assets and liabilities. Additional disclosure
items can be found in the Disclosure section.
Application to Different Entity Types
ASC 740 applies to all types of legal entities, including not-for-profit
entities. However, from a practical perspective under U.S. tax law,
business income taxes primarily relate to corporations as other entity
types typically do not incur income tax liabilities at the entity level. Entities
such as partnerships, LLCs, and S Corporations are pass-through entities
where the owners of the entities, rather than the entities themselves, are
taxed on their share of the income earned by the entity.
U.S. Corporate Income Tax Overview
The U.S. corporate income tax system taxes U.S. companies, including
their foreign branches1 , on worldwide income regardless of whether the
foreign branches have repatriated the earnings. Generally, a U.S.
corporation will not pay U.S. income tax associated with the income of its
foreign subsidiaries until the foreign subsidiary makes a distribution, is sold
or is dissolved. However, exceptions to this general rule exist whereby
U.S. tax will be imposed on some or all of the earnings of a U.S.
corporation’s foreign subsidiaries prior to these events.
Tax Rate
The top corporate tax rate is 35% for entities earning greater than
$18,333,333 million in taxable income.
Consolidated Returns
Corporate entities that are more than 80%, directly or indirectly, owned by
a common parent may elect to file a consolidated return with the parent
company. This allows members of the consolidated group to offset
income of entities against losses at other entities.
See Typical Temporary
Differences
Temporary Differences
U.S. tax law requires adjustments to GAAP income which give rise to
basis differences between GAAP and tax. Rather than altering the ultimate
1 From a U.S. income tax perspective, a branch is indistinguishable from its parent company
whereas a subsidiary is a separate legal entity. The foreign operations of a U.S. entity would
constitute a foreign branch. This is distinguished from a foreign subsidiary, a separate foreign
entity owned by the U.S. company and doing business in a foreign county.
© 2015 Tax Prodigy, LLC. This publication contains general information only and is not, by means of this
publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or
services. This publication does not substitute for such professional advice or services, nor should it be used as
a basis for any decision or action that may affect your business. Before making any decision or taking any
action that may affect your business, you should consult a qualified advisor. TAX PRODIGY, LLC shall not be
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2
deductibility or taxability of the accounting item, these adjustments impact
the period in which the item is taken into account in the tax return when
compared to GAAP net income.
Typically, temporary items resulting from these types of adjustments have
offsetting current and deferred tax consequences resulting in no impact to
the entity’s effective tax rate.
Accounting Methods
There is often more than one allowable accounting method for a particular
item under U.S. tax. Typically, accounting methods for U.S. tax purposes
are established through elections made on a entity’s initial income tax
return. Methods can only be changed by filing for an automatic method
change or with permission from the IRS, depending on the type of
method change the taxpayer is seeking.
See Typical Permanent
Differences
Permanent Differences
ASC 740 does not define the term permanent differences. However, in
practice the term is commonly used to describe differences that do not
give rise to tax impacts in subsequent reporting periods. There are
generally two types of permanent items.
First, certain items that are accounted for as income or expenses for
GAAP purposes will never be reflected in the entity’s U.S. income tax
return. These permanent differences are typically calculated based on the
detail support for general ledger accounts included in the entity’s income
statement.
Second, certain special tax deductions will never be reflected in the
entity’s GAAP income.
Permanent items do not have direct deferred tax consequences and
therefore impact the effective tax rate of the company.
Taxable Income
Corporate taxable income is reported on IRS form 1120. For companies
with greater than $10 million in assets, Schedule M-3 is used to report the
permanent and temporary items that reconcile GAAP income with taxable
income.
© 2015 Tax Prodigy, LLC. This publication contains general information only and is not, by means of this
publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or
services. This publication does not substitute for such professional advice or services, nor should it be used as
a basis for any decision or action that may affect your business. Before making any decision or taking any
action that may affect your business, you should consult a qualified advisor. TAX PRODIGY, LLC shall not be
responsible for any loss sustained by any person who relies on this publication.
3
Typical Temporary Differences
Type
GAAP
Tax
Payroll Accruals
Compensation expense related
to bonuses, vacation,
commissions, etc., are accrued
under the matching principle in
the period the services are
provided.
Generally, a taxpayer may elect a
method to deduct accrued payroll
related expenses to the extent
that they are fixed and
determinable and paid within 2
1/2 months after year end. (Reg.
§1.404(b)-1T, Q&A-2)
Amounts paid
within 2 1/2
months of year
end*
DTA
Current
Other Accruals
Expense related to professional
fees, advertising, insurance,
rent, payroll taxes, etc., are
accrued under the matching
principle in the period the
services are provided.
Generally, a taxpayer may elect a
method to deduct accrued
expenses only to the extent that
they are fixed and determinable
and paid by the earlier of
a) the filing of the return or
b) 8 1/2 months after year end.
(Reg. §1.461-5(b)(1))
Amounts paid
within 8 1/2
months of year
end*
DTA
Current/
Noncurrent
depending on
type of accrual
Reserves
Reserves related to bad debt,
inventory values, litigation,
losses, etc., are accrued in the
period in which the loss
becomes probable and
estimable
Expenses related to reserves are
typically not deductible until they
become fixed and determinable
and are paid.
Amount of
reserve not
recorded to the
income
statement,
typically zero*
DTA
Current/
Noncurrent
depending on
type of accrual
Prepaid expenses such as
insurance, advertising, rent,
maintenance, etc., are recorded
as assets when the cash is paid
and expensed over the period in
which the underlying service is
performed or benefit is received.
A taxpayer may elect either of 2
methods:
1) deduct prepaid expenses that
are expected to be provided
within 3 1/2 months after year
end (Reg. §1.461-4(d)(6)(ii)) or
2) deduct prepaid amounts that
create a right or benefit that
does not exceed the earlier of:
12 months after the first
•
date on which you
receive the benefit or
right; or
The end of the tax year
•
following the tax year in
which payment is made.
(Reg. §1.263(a)-4(f))
Prepaid
Expenses
In the case of bad debt reserves,
taxpayers may elect a specific
charge off method where they
deduct the loss on bad debts in
the period in which the debt
becomes worthless.
Adjustment
The amount of
services not
provided within 3
1/2 months of
year end or 12
months of year
end depending
on the method*
Classification
DTL
Current
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advice or services. This publication does not substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your
business. Before making any decision or taking any action that may affect your business, you should consult a qualified advisor. The author of this publication shall not be
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Typical Temporary Differences
Type
GAAP
Tax
Adjustment
Classification
Unearned/
Deferred Income
Unearned/Deferred income is
recorded when a company has
received cash from a customer
but has not had a triggering
event for revenue recognition.
Typical revenue recognition
issues arise from lack of
completion of contract,
provision of services, delivery of
product, transfer risk of loss,
etc.
A taxpayer may elect a method to
exclude certain advance
payments until the following year
in which any remaining unearned/
deferred revenue amount will be
recognized as taxable income.
(Rev. Proc 2004-34)
Amount of
advance payment
expected to be
earned within 1
year*
Two
Components:
Current/
Noncurrent
DTA based on
Balance Sheet
Fixed Assets
Fixed assets are depreciated on
a straight line basis over their
useful lives.
Fixed assets are depreciated on
an accelerated basis often over
different useful lives. Congress
occasionally enacts “bonus”
depreciation provisions allowing
50% or 100% of the depreciation
to be taken in the first year of
service.
Add back GAAP
depreciation
expense and
deduct tax
depreciation
expense
Typically DTL
Noncurrent
Intangible Assets
Intangible assets are amortized
over the appropriate life under
GAAP.
Intangibles often have different
lives or bases for tax purposes.
Intangibles are amortized over
180 months/15 years for start-up
costs (§195) and 15 years for
most acquired intangibles (§197).
Certain GAAP intangibles may not
be amortizable at all for tax
purposes.
Add back GAAP
amortization
expense and
deduct tax
amortization
expense
DTA or DTL
Noncurrent
Tax accounting
method changes
N/A
Accounting method changes
include a cumulative “catch up”
adjustment for the difference
between the old accounting
method and the new method
(§481 adjustment).
To the extent the
adjustment is a
benefit, it is taken
into account as a
deduction in the
tax year of the
method change.
If not, it is taken
into account as
an add back over
a 4 year period.
Depends on
adjustment
This publication contains general information only and is not, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional
advice or services. This publication does not substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your
business. Before making any decision or taking any action that may affect your business, you should consult a qualified advisor. The author of this publication shall not be
responsible for any loss sustained by any person who relies on this publication.
5
Typical Temporary Differences
Type
Unrealized
gains/losses on
investments
GAAP
Tax
Unrealized gains and losses on
trading securities are accounted
for in operating income.
Unrealized gains and losses on
Available For Sale (AFS)
securities are accounted for in
the other comprehensive
income (OCI).
Uniform Inventory
Capitalization
(UNICAP)
N/A
Adjustment
Classification
Unrealized gains and losses on
investments do not constitute
taxable transactions. Instead a
gain or loss will become a taxable
event on the date the underlying
asset is disposed. The tax gain
or loss will typically be calculated
based on the amount realized at
disposition compared to the
historic cost basis.
Prior to disposal,
reverse unrealized
gains or losses
included in the
income
statement. Upon
disposal, account
for taxable gain or
loss.
Varies
Taxpayers are typically required to
capitalize additional indirect and
mixed service costs, that are not
part of cost of goods sold (COGs)
for GAAP purposes, in inventory
for tax purposes (§263A)
Compare
beginning
capitalized
amount to ending
capitalized
amount
DTA
Current
* Many temporary items are balance sheet driven calculations that
are calculated by comparing the prior year (PY) gross deferred
balance to the current year (CY) gross deferred balance in the
following manner:
The Adjustments column in the table represents the information that
is
GL Balance
Less: Adjustment
Gross Deferred
Activity
PY
CY
125.0 200.0
(45.0) (55.0)
80.0 145.0
65.0
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advice or services. This publication does not substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your
business. Before making any decision or taking any action that may affect your business, you should consult a qualified advisor. The author of this publication shall not be
responsible for any loss sustained by any person who relies on this publication.
6
Typical Permanent Differences
Permanent Item
Code
Description
Meals and
Entertainment
§274(n)
50% limitation on the deduction of business
related meals and entertainment.
Skybox
§274(l)
Expense for skybox license is nondeductible.
Political contributions
§162(e)(1)
Political contributions are nondeductible for tax
purposes.
Fines and penalties
§162(f)
Fines and penalties imposed by a government
for violation of the law are nondeductible for tax
purposes.
$1 million limit on
performance based
compensation
§162(m)
Non-performance based compensation, paid to
the top 5 executives in a public company, in
excess of $1 million is nondeductible.
Tax exempt interest
§103
State and Municipal interest is excludible from
taxable income.
Transaction Costs
§263(a)
Certain transaction costs paid to facilitate the
acquisition of a corporation are nondeductible.
Parachute payments
§280G
Certain compensation payments made to
executives in conjunction with a change in
control of the company and in excess of a base
amount are nondeductible.
Domestic production
activities deduction
§199
Domestic manufacturers are eligible for a
deduction equal to the lesser of:
1. 9% of their qualified production activities
income
2. 9% of taxable income before §199 and after
net operating loss or,
3. 50% of W-2 wages.
Percentage Depletion
§613
Deduction in excess of basis related to extraction
activities such as mining, gas and oil drilling.
Incentive Stock Options
(ISOs)
Compensation expense associated with ISOs
under ASC 718 is non-deductible
© 2015 Tax Prodigy, LLC. This publication contains general information only and is not, by means of this
publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or
services. This publication does not substitute for such professional advice or services, nor should it be used as
a basis for any decision or action that may affect your business. Before making any decision or taking any
action that may affect your business, you should consult a qualified advisor. TAX PRODIGY, LLC shall not be
responsible for any loss sustained by any person who relies on this publication.
7
Net Operating Losses
If a company’s deductions exceed its income in a given year, it reports a
net operating loss (NOL) for U.S. income tax purposes. An NOL may be
carried back two years or forward twenty years to offset taxable income in
those years. If an NOL is carried back, the company will record a current
receivable equal to the expected tax refund. To the extent that the NOL
will be carried forward, the tax benefit associated with the NOL is
accounted for as a DTA which is reversed as it utilized. NOLs do not
typically have an impact on the effective tax rate.
Capital Loss Carryforwards
To the extent that a company incurs a loss on the sale of a capital asset,
the loss can only be offset by capital gains under U.S. tax law.
Consequently, a company without sufficient capital gains to utilize a
capital loss will record a DTA related to its capital loss carryforward. The
capital loss can be carried back three years or forward five years. The DTA
from a capital loss carryforward is reversed as it utilized. Capital loss
carryforwards do not typically have an impact on the effective tax rate.
General Business Credits
Under U.S. law, there are many general business credits available to
qualifying taxpayers that can be used to offset their federal income tax
liability. The credits are accounted for as permanent items that reduce
income tax expense, and have a corresponding impact on the rate. If the
company is reporting net income, this will be a reduction to the rate;
however, if the company has a loss, it will report a higher rate (i.e., a
higher benefit associated with current year income). To the extent a credit is not utilized in the year it is claimed, it can be
carried forward 20 years. Any credit carryforward is recorded as a DTA
which will be reversed in the period in which the credit is utilized.
Many credits disallow the deduction of the expenses that give rise to the
credit i.e. the taxpayer will get a credit for the items in lieu of the
deduction. The disallowance of the expense is a permanent item that
increases the effective tax rate. The most common general business credit relates to research and
experimental activities under §41. There are several methods available for
calculating the amount of the credit based on a company’s incremental
spending increases. If the taxpayer does not elect the reduced credit
under §280C, the gross amount of the credit is added back as permanent
item. The credit itself also constitutes a permanent item that reduces the
© 2015 Tax Prodigy, LLC. This publication contains general information only and is not, by means of this
publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or
services. This publication does not substitute for such professional advice or services, nor should it be used as
a basis for any decision or action that may affect your business. Before making any decision or taking any
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responsible for any loss sustained by any person who relies on this publication.
8
effective rate. Alternative Minimum Taxes
The alternative minimum tax (AMT) is a parallel corporate tax imposed at a
20% rate on a company’s alternative minimum taxable income (AMTI).
AMTI disallows certain items that are allowed for regular tax purposes,
such as percentage depletion and certain accelerated depreciation.
A company’s federal income taxes currently payable is the greater of its
regular income tax liability or its tentative AMT liability. The amount of
tentative AMT in excess of regular tax in a particular year is carried forward
indefinitely as a credit. The AMT credit is recorded as a DTA. The AMT
credit is utilized, and the related DTA is reduced, in years in which a
company’s regular tax exceeds its tentative AMT. Net Operating Losses
Due to the differences between the regular U.S. income tax and the AMT,
a company will typically have a different NOL for AMT purposes than for
regular tax purposes. Unlike the regular tax system, the AMT system only allows a taxpayer to
utilize net operating losses to offset 90% of its AMTI. Therefore,
companies that incur losses and become taxable in subsequent years are
often subject to the AMT due to the limitation on the utilization of net
operating losses. Tax Accounting Considerations
Typically, neither the impact of an AMT liability nor the utilization of an AMT
credit will have an impact on the effective rate of a company unless the
company is expected to perpetually be subject to the AMT (i.e., it will
never be in a position to utilize its AMT credits).
No deferred taxes are recorded with respect to basis differences between
the AMT system and the regular U.S. tax or between the regular NOL and
the AMT NOL.
Valuation Allowances
Since companies are often subject to the AMT when they move from
losses to taxability, it is not uncommon for these companies to have
valuation allowances associated with their deferred tax assets. This
situation may result in a undesirable situation where a company will record
income tax expense as a result of recording valuation allowance against
its AMT credit carryforward.
© 2015 Tax Prodigy, LLC. This publication contains general information only and is not, by means of this
publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or
services. This publication does not substitute for such professional advice or services, nor should it be used as
a basis for any decision or action that may affect your business. Before making any decision or taking any
action that may affect your business, you should consult a qualified advisor. TAX PRODIGY, LLC shall not be
responsible for any loss sustained by any person who relies on this publication.
9
Share-Based Compensation
ASC 718 governs the accounting for share-based compensation. The
standard requires companies to recognize compensation expense related
to their equity awards on an award-by-award basis. The expense is
recorded over the vesting period in which the award is earned and offset
by a credit to additional paid-in capital (APIC).
Hypothetical APIC Pool
Since share-based compensation is based on the equity of the company
itself, the income tax accounting also has implications to APIC.
The income tax accounting consequences often depend on whether or
not a company has a hypothetical APIC pool (APIC pool). The APIC pool
represents the cumulative excess benefits, or windfall benefits, of the
company. An excess benefit is the amount the realized tax benefit
associated with an award exceeds the tax benefit associated with the
GAAP compensation expense. To the extent the company has a
cumulative shortfall rather than an APIC pool, the income tax accounting
will often differ.
Methods for Calculating the Hypothetical APIC Pool
There are two methods for calculating the APIC pool: the short-cut
method and the long-form method. The short-cut method was allowable
only for determining the historical APIC pool as of the adoption of ASC
718. The long-form method was also available for calculating the historical
APIC pool but is required for all activity after adoption.
General Accounting by Award Type
See Share-Based
Compensation and
Terminology
The tax accounting for share-based payments differs depending on the
ultimate tax consequence of the reward to the company. Awards such as
non-qualified stock options (NQSOs) and restricted stock units (RSUs)
that ordinarily result in deductions to the company, are accounted for as
temporary items. Conversely, incentive stock options (ISOs), which
provide favorable tax treatment to employees and no deduction to the
employer are treated as permanent items.
Regardless of the award type, excess deductions are recorded as a credit
to APIC rather than current expense. This is an exception to the general
rule that the amount recorded to income taxes payable is an equal offset
to the current expense.
© 2015 Tax Prodigy, LLC. This publication contains general information only and is not, by means of this
publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or
services. This publication does not substitute for such professional advice or services, nor should it be used as
a basis for any decision or action that may affect your business. Before making any decision or taking any
action that may affect your business, you should consult a qualified advisor. TAX PRODIGY, LLC shall not be
responsible for any loss sustained by any person who relies on this publication.
10
Share-Based Compensation
Award
Non-Qualfied
Stock Option
(NQSO)
Description
The employee is granted
the option to purchase a
certain number of shares of
stock, at the exercise price,
after a vesting date. NQSOs
are typically subject to a
condition of continued
employment.
GAAP Expense
The Company calculates the intrinsic
value of the options on the grant date
using an option pricing model.
The value is recorded as compensation
expense over the vesting period with an
offsetting credit to APIC.
In anticipation of the future deduction, a
DTA is recognized related to the
compensation expense.
Restricted
Stock Unit
(RSU)
Incentive Stock
Option (ISO)
Exercise/Vest
Upon exercise, the company receives a tax deduction
equal to the difference between the fair value of the
exercised awards and the exercise price of the awards
on the exercise date.
The DTA associated with the exercised options is
reversed. Any excess benefit is recorded as a credit to
APIC. Any shortfall is recorded as a debit to APIC to the
extent of the APIC pool. Any remaining shortfall is
recorded to income tax expense.
Shares of stock are
awarded to the employee at
a future date if certain
vesting requirements, such
as continued employment
and/or achievement of
performance goals, are
satisfied.
The value of the award as of the grant
date is recorded as compensation
expense over the vesting period with an
offsetting credit to APIC.
In anticipation of the future deduction, a
DTA is recognized related to the
compensation expense.
The DTA associated with the restricted shares is
reversed upon vest. Any excess benefit is recorded as a
credit to APIC. Any shortfall is recorded as a debit to
APIC to the extent of the APIC pool. Any remaining
shortfall is recorded to income tax expense.
The employee is granted
the option to purchase a
certain number of shares of
stock, at the exercise price,
after a vesting date. ISOs
are typically subject to a
condition of continued
employment. An option
must meet certain statutory
requirements to be
considered an ISO and
qualify for preferential
treatment.
The Company calculates the intrinsic
value of the options on the grant date
using an option pricing model.
Upon exercise, the Company receives no deduction if
the employee complies with the requisite holding
periods.
The value is recorded as compensation
expense over the vesting period with an
offsetting credit to APIC.
If the employee does not meet the requisite holding
period for preferential treatment (a disqualifying
disposition), the company receives a tax deduction equal
to the difference between the fair value of the exercised
awards and the exercise price of the awards on the
exercise date.
Since ISOs do not result in deductions,
no DTA is recorded i.e. the
compensation expense is treated as a
permanent item.
Upon vest, the Company receives a tax deduction equal
to the fair value of the awards
The benefit is recorded as a permanent item to the
extent of the tax expense previously recorded for the
award. Any excess benefit is recorded as a credit to
APIC.
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Share-Based Compensation Terminology
Term
Definition
Grant Date
Date on which the award is granted to the
employee and typically the day the vesting
period begins.
Vesting/Service
Period
Period over which the award is earned and
becomes available for exercise by the employee.
• Options typically vest in tranches over 3 or 4
years with a multiple year exercise period.
• RSUs typically all vest on the same date after a
3 or 4 year period. This is often referred to as a
“cliff vest.”
Vest Date
The date the award is available for exercise, in
the case of options, or the restrictions lapse,
in the case of RSUs.
Exercise Date
The date an option is exercised.
Exercise/Strike
Price
The price, established at the grant date, at
which the option is exercisable.
Expiration of Un-Exercised Awards
If awards expire un-exercised, the accounting depends on whether the
expired awards have vested. If an unvested award expires, the associated
compensation cost is reversed and the related DTA is written off as
permanent item to income tax expense. For vested awards, the
compensation cost is not reversed but the DTA is written off to APIC to
the extent of the APIC pool, with any remaining amount written off as a
permanent item to income tax expense.
Net Operating Losses
ASC 718-740-25-10 provides that the excess tax benefit and the credit to
APIC should not be recorded until the deduction reduces income taxes
payable. To the extent the excess deduction associated with an award
results in an NOL or increases an NOL, there is no reduction to the
income taxes payable associated with the deduction, and consequently
no credit to APIC, until the NOL is utilized.
© 2015 Tax Prodigy, LLC. This publication contains general information only and is not, by means of this
publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or
services. This publication does not substitute for such professional advice or services, nor should it be used as
a basis for any decision or action that may affect your business. Before making any decision or taking any
action that may affect your business, you should consult a qualified advisor. TAX PRODIGY, LLC shall not be
responsible for any loss sustained by any person who relies on this publication.
12
Since the credit to APIC is suspended, the offsetting debit that one would
expect to be recorded to the NOL will be excluded from the gross NOL
DTA. This results in the unintuitive situation where the gross NOL DTA will
differ from the gross NOL in the tax returns by the cumulative amount of
excess deductions.
The excess deductions to be recorded to APIC are suspended and
tracked separately. There are two approaches to identifying the period in
which excess deductions result in a reduction to income taxes payable
and the corresponding credit is recorded to APIC: the tax ordering rules
and the “with or without” approach.
Tax Ordering Rules
Under the tax ordering rules approach, the benefit would be realized in the
period in which the specific NOL that includes the excess deduction is
utilized for tax purposes under the rationale that the NOL utilization has
caused a reduction to income taxes payable. Generally the excess tax
benefit is considered to be the last component of the NOL utilized in a
particular year.
“With and Without” Approach
Under the “with and without” approach, the current income taxes payable
including the excess deductions (“with”) is compared to the current
income taxes payable excluding the excess deductions (“without”). A
credit to APIC is recorded to the extent that the income taxes payable
under the “with” calculation is less than the “without” calculation.
Essentially, the tax benefit from the suspended APIC credits is utilized only
after the NOLs included in the DTA are utilized.
Disclosure Considerations
The footnote disclosure of the amount of NOLs should reflect the entire
NOL regardless of excess deductions. Additionally the Company must
disclose the amount of benefit that would be credited to APIC upon
utilization of the NOL.
Valuation Allowances
Regardless of subsequent fluctuations in value of the underlaying stock,
no subsequent adjustments are made to the total compensation expense
associated with a particular award. Furthermore, the existence of
underwater options (i.e., options where the exercise price exceeds the fair
value) is not negative evidence in considering the need for a valuation
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13
allowance. However, it the DTA is material to the financial statements, it
should be disclosed. 2
2 ASC 718-740-30-2
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State Taxes
Federal Deduction
State income taxes are deductible for federal income tax purposes.
Consequently, in order to arrive at an appropriate federal current income
taxes payable, the state income tax deduction must be calculated. Furthermore, deferred taxes are calculated at the combined federal and
state rate, net of the federal benefit from the deduction of state taxes.
Similarly, the effective tax rate impact of state income taxes is reported net
of the federal benefit.
Filing Groups/Separate Company States
Certain states do not allow taxpayers to file consolidated tax returns.
Consequently, many companies are required to file a separate return for
each entity that is conducting business in a particular state. Some states allow entities to file combined returns or unitary returns.
These filing groups in these returns may be based on different principles
than the federal consolidated return rules. Therefore, there are situations
where a state combined return may include entities not included in the
federal group or exclude entities that are included in the federal
consolidated return.
State Taxable Income
See Typical State
Modifications
Though most states use federal taxable income as the starting point for
calculating state taxable income, state income tax law often differs from
U.S. tax law in significant areas. The states make modifications, referred
to as additions and subtractions, to account for certain differences
between federal and state tax law.
Allocation and Apportionment
Certain types of income, such as portfolio interest and dividend income,
may be directly allocated to a particular state. Income that is not directly
allocated to a state is apportioned based on an apportionment
percentage. The apportionment percentage is a ratio of certain in-state apportionment
factors to the total amounts for those same factors. Typically
apportionment factors include sales, property, and payroll. The specific
items included in the factors and the relative weight given to each varies
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from state to state.
In recent years there has been a general shift for states to move towards a
single sales factor apportionment method or increase the weight of the
sales factor relative to the other factors.
State Income Tax Rates
State income tax rates, among the states that impose in an income tax,
vary significantly. The top marginal rates are typically in the 6% to 9%
range.
State Net Operating Losses and Credits
State NOLs are accounted for as deferred tax assets, similar to federal
NOLs. However, they often differ in the period of carryforward or
carryback (if any) and whether the carryforward is based on modified state
income prior to apportionment or after apportionment. Due to budget
issues, some states have enacted laws suspending or limiting the use of
NOLs.
Many states allow taxpayers to offset their state liability with credits. The
credits tend to relate to research and experimental expenditures, job
creation initiatives, and certain industries in the state. State NOLs and credits are recorded net of the federal benefit since they
represent a reduction in state income taxes and therefore an increase in
future federal income. Enacted State Law and Rates
Companies may encounter state tax law changes that impact the income
tax provision. ASC 740 requires companies to account for income tax rate
and law changes in the period in which the law is enacted. A state tax rate change will often require a company to “re-price” its DTAs
and DTLs resulting in a deferred impact to the effective rate. Disclosure Note
If a law change occurs before the end of a reporting period but prior to the
release of the financial statements, the Company would be required to
complete its income tax provisions based on the law as of the balance
sheet date, but should disclose any material impact of subsequent
changes in law.
ASC 740 requires companies to calculate income tax provisions for each
jurisdiction in which it is subject to tax. However, due to apportionment
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and state rates being much lower than the federal rate, state income
taxes tend to be relatively small compared to the federal income tax
liability. Therefore, situations arise where a company will use a blended
state rate to account for all or a portion of its state income tax provision.
The decision to use a blended rate should be evaluated as facts change.
Disclosure Considerations
Typically the rate reconciliation disclosure presents state income taxes net
of the federal benefit. Alternatively, the components of expense may
show the state current and deferred expense on a gross basis and the
federal current and deferred expense net of the state tax.
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Typical State Modifications
Modification
Description
Perm/
Temp
State Taxes
Many states do not allow the deduction of state taxes
other than those imposed by the state itself or its own
political subdivisions.
Tax-exempt interest
Unlike the federal government, most states impose
income tax on all interest income with the exception
of interest earned on obligations of the taxing state
itself or its own political subdivisions.
Permanent
Bonus depreciation
Many states do not follow the federal rules under
§168(k) for bonus depreciation. The states employ
various approaches to making the modification.
Typical approaches include the following:
1) require the taxpayer to adjust income to reflect
only the amount of depreciation that would have
been allowed in the absence of bonus
depreciation, or
2) account for the bonus amount over a period of
time, typically 5 years.
Temporary
Domestic
production
activities deduction
Certain states do not allow the domestic production
activities deduction.
Permanent
Percentage
Depletion
Certain states do not allow a deduction for
percentage depletion.
Permanent
Foreign Dividends
States will often allow a subtraction for actual and
deemed foreign dividends (Subpart F).
Permanent
Intercompany
Transactions
States will often eliminate the impacts of transactions
with other companies controlled by the same parent
Permanent
N/A
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Uncertain Tax Positions
Tax Positions
For the purposes of ASC 740, a tax position is any position in a previously
filed tax return or a position expected to be taken in a future tax return.
The term tax position also encompasses, but is not limited to:
a. A decision not to file a tax return
b. An allocation or a shift of income between jurisdictions
c. The characterization of income or a decision to exclude
reporting income in a tax return
d. A decision to classify a transaction, entity, or other position in a
tax return as tax-exempt
e. The characterization of an entity’s status, including its status as
a pass-through entity or a tax-exempt not-for-profit entity.
Unit of Account
For each tax position, the company must identify the unit of account for
determining what constitutes an individual tax position and the rationale
for the conclusion. The determination is a matter of judgment based on all
available evidence including the manner in which the entity prepares and
supports its income tax return and the approach the entity anticipates the
taxing authority will take during an examination.
Recognition
The first step is to evaluate whether it is more likely than not (greater than
a 50% chance) that the position would be sustained by the taxing
authority solely on its technical merits. The recognition test assumes that
the tax authority will examine the uncertain tax position and has full
knowledge of all relevant facts. No consideration is given to offsetting or
aggregating tax positions in negotiations with the tax authority.
In evaluating the technical merits of a particular tax position, a company
may only consider past examination activity to the extent that the item
was explicitly agreed to by the taxing authority. If the recognition test is not satisfied, no benefit is recognized for the
uncertain position.
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Measurement To the extent the more-likely-than-not recognition threshold is met, the
amount of benefit recognized is the amount that is more likely than not
(greater than 50% chance) to be sustained upon examination, including all
appeals or negotiations.
This analysis for the measurement test often depends on whether the
position is an “all or nothing” position. An “all or nothing” position is a
position where success on the technical merits (i.e. satisfaction of the
recognition test) essentially means the entire benefit will be realized as the
appropriate measurement amount.
A position that is not “all or nothing” allows for many possible resolutions
to the underlying technical issue. For these positions, professional
judgement is necessary for determining the measurement amount.
In applying the recognition and measurement tests, all information
available on the reporting date should be considered, including the
company’s willingness to settle or litigate a position with the taxing
authority.
New Information
ASC 740-10-25-8 If the more-likely-than-not recognition threshold is not
met in the period for which a tax position is taken or expected to be taken,
an entity shall recognize the benefit of the tax position in the first interim
period that meets any one of the following conditions:
a. The more-likely-than-not recognition threshold is met by the
reporting date.
b. The tax position is effectively settled through examination,
negotiation or litigation.
c. The statute of limitations for the relevant taxing authority to
examine and challenge the tax position has expired.
All new information, including changes in tax laws, regulations, court
cases, and examination activity, should be evaluated for any impact on the
recognition or measurement of tax positions.
A previously recognized tax position that subsequently fails to meet the
more-likely-than-not recognition standard is derecognized in the first
interim period in which the recognition threshold is no longer met.
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Facts and circumstances that occur after the reporting date but before the
release of the financial statements should not be considered.
Effectively Settled
ASC 740-10-25-9 A tax position could be effectively settled upon
examination by a taxing authority. Assessing whether a tax position is
effectively settled is a matter of judgment because examinations occur in
a variety of ways. In determining whether a tax position is effectively
settled, an entity shall make the assessment on a position-by-position
basis, but an entity could conclude that all positions in a particular tax
year are effectively settled.
ASC 740-10-25-10 As required by paragraph 740-10-25-8(b) an entity
shall recognize the benefit of a tax position when it is effectively settled.
An entity shall evaluate all of the following conditions when determining
effective settlement:
a. The taxing authority has completed its examination procedures
including all appeals and administrative reviews that the taxing authority is
required and expected to perform for the tax position.
b. The entity does not intend to appeal or litigate any aspect of the tax
position included in the completed examination.
c. It is remote that the taxing authority would examine or reexamine any
aspect of the tax position. In making this assessment management shall
consider the taxing authority’s policy on reopening closed examinations
and the specific facts and circumstances of the tax position. Management
shall presume the relevant taxing authority has full knowledge of all
relevant information in making the assessment on whether the taxing
authority would reopen a previously closed examination.
ASC 740-10-25-11 In the tax years under examination, a tax position
does not need to be specifically reviewed or examined by the taxing
authority to be considered effectively settled through examination.
Effective settlement of a position subject to an examination does not
result in effective settlement of similar or identical tax positions in periods
that have not been examined.
ASC 740-10-25-12 An entity may obtain information during the
examination process that enables that entity to change its assessment of
the technical merits of a tax position or of similar tax positions taken in
other periods. However, the effectively settled conditions in paragraph
740-10-25-10 do not provide any basis for the entity to change its
assessment of the technical merits of any tax position in other periods.
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Accounting
Typically, for each uncertain tax position that is not fully recognized:
• Record the unrecognized tax benefit as a non-current liability with
an offsetting debit to non-current income tax expense.
• A gross state liability associated with a U.S. federal position is
also recorded as a non-current liability with an offsetting debit to
non-current income tax expense.
• If the uncertainty relates to the timing of the deduction, not the
deductibility itself, a DTA related to the position should be recorded
with an offsetting credit to deferred income tax expense.
• The DTA should be recorded at the tax rate expected to be in
effect in the period in which the item will reverse rather than the
rate at which the non-current liability is recorded.
• Record a DTA related to the federal benefit associated with any
state non-current liability.
Interaction with Carryforwards
ASC 740-10-25-16 states, “a liability is created (or the amount of a net
operating loss carryforward or amount refundable is reduced) for an
unrecognized tax benefit because it represents an entity's potential future
obligation to the taxing authority for a tax position that was not recognized
A company that has an uncertain tax benefit that would either reduce an
NOL or tax credit carryforward if it was resolved in the taxing authority's
favor would not record a non-current liabilty. Instead, it will reduce the DTA
associated with the carryforward for the uncertain tax benefit.
In this situation, a company would only record a non-current liability in the
case where there would be an economic liability after losing the position.
The DTA related to a particular carryforward represents the amount
estimated to be sustained upon examination.
If the DTA related to the carryforward is utilized prior to the resolution of
the uncertain position, the uncertain tax benefit is recorded as a noncurrent liability.
Process Tip
Track all uncertain tax positions together as non-current payables under
the general rule. Then, separately track the carryforward reductions as
reclassifications from the non-current payable to the deferred items. This
approach facilitates the footnote disclosures for uncertain tax benefits and
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22
simplifies tracking in situations where an attribute gets utilized prior to the
resolution of the uncertain tax benefit.
Interest and penalties
A Company is required to accrue the appropriate interest and penalties
associated with its uncertain tax benefits. The Company makes a policy
election to either include interest and penalties associated with uncertain
tax benefits as part of pre-tax income or as a component of income tax
expense.
• Interest and penalties are expensed on a gross basis in the period in
which they accrue. They are included in the non-current liability
unless they are expected to be paid within 12 months of the balance
sheet date, in which case, they are reported in income taxes
currently payable.
• Record a DTA related to any federal, state or foreign deductibility of
the accrued interest.
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Valuation Allowances A valuation allowance (VA) is recorded against a DTA if it is not more likely
than not that the DTA will be realized. The recognition of a VA has a
negative impact on the effective income tax rate. The analysis should be
performed after consideration of the two-step recognition standard
regarding uncertain tax positions. All available evidence, both positive and
negative, shall be considered to determine whether, based on the weight
of that evidence, a VA for DTAs is needed. A company may reach different
conclusions in different tax jurisdictions with respect to the need for a VA
for the same entity or entities.
Sources of Taxable Income
ASC 740-10-30-18 Future realization of the tax benefit of an existing
deductible temporary difference or carryforward ultimately depends on
the existence of sufficient taxable income of the appropriate character (for
example, ordinary income or capital gain) within the carryback,
carryforward period available under the tax law. The following four
possible sources of taxable income may be available under the tax law to
realize a tax benefit for deductible temporary differences and
carryforwards:
a. Future reversals of existing taxable temporary differences
b. Future taxable income exclusive of reversing temporary
differences and carryforwards
c. Taxable income in prior carryback year(s) if carryback is
permitted under the tax law
d. Tax-planning strategies (see paragraph 740-10-30-19) that
would, if necessary, be implemented to, for example:
1. Accelerate taxable amounts to utilize expiring
carryforwards
2. Change the character of taxable or deductible amounts
from ordinary income or loss to capital gain or loss
3. Switch from tax-exempt to taxable investments.
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Negative Evidence
ASC 740-10-30-21 Forming a conclusion that a valuation allowance is
not needed is difficult when there is negative evidence such as
cumulative losses in recent years. Other examples of negative evidence
include, but are not limited to, the following:
a. A history of operating loss or tax credit carryforwards expiring
unused
b. Losses expected in early future years (by a presently profitable
entity)
Unsettled circumstances that, if unfavorably resolved, would
adversely affect future operations and profit levels on a
continuing basis in future years
c. A carryback, carryforward period that is so brief it would limit
realization of tax benefits if a significant deductible temporary
Positive Evidence
ASC 740-10-30-22 Examples (not prerequisites) of positive evidence
that might support a conclusion that a valuation allowance is not needed
when there is negative evidence include, but are not limited to, the
following:
a. Existing contracts or firm sales backlog that will produce more
than enough taxable income to realize the deferred tax asset
based on existing sales prices and cost structures
b. An excess of appreciated asset value over the tax basis of the
entity's net assets in an amount sufficient to realize the
deferred tax asset
c. A strong earnings history exclusive of the loss that created the
future deductible amount (tax loss carryforward or deductible
temporary difference) coupled with evidence indicating that
the loss (for example, an unusual, infrequent, or extraordinary
item) is an aberration rather than a continuing condition
Weight Given to Positive and Negative Evidence
ASC 740-10-30-23 An entity shall use judgment in considering the
relative impact of negative and positive evidence. The weight given to
the potential effect of negative and positive evidence shall be
commensurate with the extent to which it can be objectively verified. The
more negative evidence that exists, the more positive evidence is
necessary and the more difficult it is to support a conclusion that a
valuation allowance is not needed for some portion or all of the deferred
tax asset. A cumulative loss in recent years is a significant piece of
negative evidence that is difficult to overcome.
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In practice, companies will often record a VA in a period in which they
report a cumulative pretax loss, adjusted for permanent items, based on
the previous 12 quarters of activity. A company in that situation will
typically not take forecasts of future income into account as positive
evidence.
ASC 740-10-30-24 Future realization of a tax benefit sometimes will
be expected for a portion but not all of a deferred tax asset, and the
dividing line between the two portions may be unclear. In those
circumstances, application of judgment based on a careful assessment
of all available evidence is required to determine the portion of a
deferred tax asset for which it is more likely than not a tax benefit will
not be realized.
The Need to Schedule Temporary Difference Reversals
In assessing the need for a VA, a company may be required to schedule
the reversal of temporary differences to determine the amount of DTLs
that are expected to offset the DTAs. The company should use a
systematic and logical methodology to schedule the reversals. If no other
sources of taxable income are available, a VA is recorded against the
residual amount of DTAs that are not offset by DTLs in the scheduling
exercise.
A VA is recorded solely against DTAs, not DTLs. To the extent that the
DTLs will reverse and allow the company to utilize all of its DTAs, no VA is
recorded. Consequently, it is common for companies that have
determined that a valuation allowance is necessary, to record a valuation
allowance equal to the amount that DTAs exceed DTLs.
Indefinite-Lived Intangibles
If the determination is made that a VA is necessary, the existence of DTLs
related to indefinite-lived intangibles will result in a situation where the VA
recognized either exceeds the amount of any net DTA or requires the
recognition of a VA for a company in a net DTL position. © 2015 Tax Prodigy, LLC. This publication contains general information only and is not, by means of this
publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or
services. This publication does not substitute for such professional advice or services, nor should it be used as
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26
Tax-Planning Strategies
ASC 740-10-55-39 A qualifying tax-planning strategy is an action that:
a. Is prudent and feasible. Management must have the ability to
implement the strategy and expect to do so unless the need is
eliminated in future years. For example, management would not
have to apply the strategy if income earned in a later year uses the
entire amount of carryforward from the current year.
b. An entity ordinarily might not take, but would take to prevent an
operating loss or tax credit carryforward from expiring unused. All
of the various strategies that are expected to be employed for
business or tax purposes other than utilization of carryforwards that
would otherwise expire unused are, for purposes of this Subtopic,
implicit in management's estimate of future taxable income and,
therefore, are not tax-planning strategies as that term is used in this
Topic.
c. Would result in realization of deferred tax assets. The effect of
qualifying tax-planning strategies must be recognized in the
For the purposes of evaluating the need for a valuation allowance, taxplanning strategies include:
a. elections for tax purposes,
b. strategies that shift estimated future taxable income between
years, and
c. strategies that shift the estimated pattern and timing of future
reversals of temporary differences.
A plan that involves the repatriation of earnings from an entity whose
earnings meet the indefinite reversal criteria does not constitute a taxplanning strategy.3
Release of a Valuation Allowance
A VA should be reversed in the period in which the positive evidence
outweighs the negative evidence. The reversal of the VA will be recorded
as a deferred income tax benefit. A company should give significant attention to the appropriate timing of
the release of a valuation allowance.
3
ASC 740-10-55-46
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Interim Reporting
For interim reporting, if a portion of the valuation allowance removal relates
to current year activity (i.e. earnings, permanent items and reversals of
temporary items) that amount is included in the annual effective tax rate
calculation rather than adjusted discretely. Conversely, the amount of
valuation allowance that relates to positive evidence with respect to past
and future earnings is released as a discrete item.
Valuation Allowances and Share-Based Awards
With respect to DTAs associated with share-based awards, the existence
of underwater options (options where the exercise price exceeds the fair
value) is not negative evidence in considering the need for a valuation
allowance. However, if a DTA associated with underwater options is
material, it should be disclosed.4
4 ASC 718-740-30-2
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International Tax
Worldwide versus Territorial Systems
The U.S. corporate income tax system imposes tax on U.S. companies,
including their foreign branches, on worldwide income regardless of
whether the foreign branches have repatriated the earnings. Generally, a
U.S. corporation will not pay U.S. income tax associated with the income
of its foreign subsidiaries until the foreign subsidiary makes a distribution,
is sold or is dissolved. However, exceptions to this general rule exist
whereby U.S. tax will be imposed on some or all of the earnings of a U.S.
corporation’s foreign subsidiaries prior to these events.
Virtually all other countries have territorial tax systems. Under a territorial
system, income tax is only imposed on the income earned in the country.
Under most territorial systems, dividends and capital gains or losses are
fully or partially excluded from taxable income.
Foreign Tax Credits
To mitigate the impact of double taxation on worldwide income, U.S. tax
law allows a taxpayer to either deduct foreign taxes paid or to claim a
Foreign Tax Credit (FTC). The amount of foreign tax eligible for credit in a
particular year is generally limited to the amount of U.S. tax on foreign
income. Foreign income taxes are generally translated to U.S. dollars, at the
average foreign exchange rate during the year.5
Foreign Source Income
Income derived directly or indirectly from the foreign operations in the U.S.
return is called foreign source income (FSI). FSI and the related FTCs are
tracked in two “baskets,” the passive basket and the general basket.
The passive basket generally includes investment income such as interest,
dividends, rent and royalties, whereas the general basket includes all other
types of FSI. There are numerous exceptions to the general rule including exceptions as
to which basket FSI is included in.
5 §986(c)
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For each basket, the amount of FTC that can be utilized in a tax year (the
Limitation) is calculated as follows:
FSI / Total taxable income x U.S. Tax before FTC
A company utilizes current year FTCs first and is allowed a 10-year
carryforward and a 1-year carryback of any FTC in excess of the
Limitation. FTC carryforwards are utilized on a FIFO basis.
Any FTC carryforward generated is recorded as a DTA subject to the
analysis for uncertain tax positions and valuation allowances.
Expense Allocations
Certain expenses are “not definitely allocable” to either the U.S. or foreign
operations of a company. These expenses, such as state incomes taxes,
research and development costs, stewardship costs, and interest
expense, are apportioned to FSI, therefore reducing the Limitation. There
are various allowable methodologies for allocation and apportionment
under Reg. §1.861.
Entity Classification
A company’s foreign operations are generally conducted by foreign
branches, controlled foreign corporations (CFCs), or foreign corporate
joint ventures.
U.S. tax law allows companies to make elections with respect to the
treatment of an entity. Due to these elections, the treatment of that entity
for U.S. income tax purposes may differ from its treatment for local
country tax purposes or legal purposes. Companies may elect to treat certain legal entities as disregarded entities
(DREs) for U.S. tax purposes. A DRE is an entity that has no status for
U.S. tax purposes and therefore is treated as a branch for U.S. income tax
purposes. Transactions between the owner of a DRE and the DRE itself
are also disregarded.
Foreign Branches
A foreign branch is a foreign taxpayer that is also either:
a) a DRE or flow-through entity for U.S. income tax purposes, or b) a U.S. entity
The FTCs associated with foreign branches are §901 or direct credits.
Direct credits are for taxes paid directly to the foreign country by a U.S.
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30
taxpayer based on net income.
The FSI and related FTCs from foreign branches are accounted for in the
appropriate FSI basket.
Accounting for Foreign Branch Operations
A foreign branch will calculate a separate current, deferred and noncurrent income tax provision for each jurisdiction it is subject to tax.
U.S. deferred taxes are recognized to reflect the future U.S. income tax
consequences of any foreign deferred tax accounts. If a company is
claiming a FTC, the existence of a foreign branch DTA or DTL gives rise to
a future reduction or increase in U.S. FTCs (Anticipatory FTCs).
A DTA for an Anticipatory FTC carryover would be subject to analysis to
determine if a VA is needed. If a VA has been recorded in the foreign
country against its DTAs and no net deferred taxes exist, no U.S.
Anticipatory FTCs should be recorded. Under this scenario, the company
has concluded that it is not more-likely-than not that the foreign DTAs will
be realized and therefore those deferred items will not give rise to a U.S.
tax consequence.
For a company deducting foreign taxes rather than claiming an FTC, U.S.
deferred taxes are taken into account based on the foreign deferred taxes
by applying the appropriate federal and state rate to the foreign DTAs and
DTLs.6
Controlled Foreign Corporations
CFCs are entities organized under foreign law and treated as corporations
for U.S. income tax purposes that are directly or indirectly 50% or more
controlled by a U.S. parent. CFCs typically do not have U.S. operations.
Generally, a U.S. corporation will not pay U.S. income tax associated with
the income of a CFCs until the CFC makes a distribution, is sold or is
dissolved. However, exceptions to this general rule exist whereby U.S. tax
will be imposed on some or all of the earnings of a U.S. corporation’s
foreign subsidiaries prior to these events.
Accounting for CFC Operations
6 Most states do not allow the deduction of foreign taxes but instead treat them as a permanent
state modification
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A CFC will calculate a separate current, deferred and non-current income
tax provision for each jurisdiction in which it is subject to tax.
ASC 740 presumes that the earnings of a subsidiary will ultimately be
repatriated to its parent. Accordingly, any deferred taxes that would arise
from the repatriation are accounted for in the period in which the earnings
occur.7 Accordingly, the U.S. tax effects associated with repatriation of a CFC's
earnings should be calculated based on the expected manner of
repatriation, often a taxable dividend. The calculation should include any
FTC and foreign exchange impacts that would be triggered upon
repatriation.
A DTL is recorded to the extent that the repatriation of earnings would
result in additional income tax to the parent of the CFC.
A DTA associated with un-repatriated earning is only recognized to the
extent it is expected to reverse in the foreseeable future. In practice the
foreseeable future is typically understood to be less than 1 year from the
balance sheet date.
Indefinite Reversal Criteria/Permanent Reinvestment
ASC 740 allows a specific exception to the recognition of a DTL on the
outside basis difference/U.S. tax consequence of repatriating the historic
earnings of a foreign corporation or foreign corporate joint venture if the
earnings are expected to be permanently reinvested outside of the U.S.
To satisfy the indefinite reversal criteria a company must have a plan for
reinvestment of its foreign earnings.
A company may make distributions out of current year earnings without
contradicting an assertion that it is permanently reinvested with respect to
historic earnings.
Though the indefinite reversal criteria is most often applied to the earnings
of a CFC owned by a U.S. parent, the permanent reinvestment assertion
is available to any corporation and corporate joint venture that would
constitute a foreign entity from the perspective of its parent.
7 Exceptions to the general rule are described at ASC 740-30-25-3
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Consistency Between Indefinite Reversal Criteria and VA Analysis
The repatriation of historic earnings from a foreign entity that has asserted
the indefinite reversal criteria does not constitute positive evidence when
considering the need for a VA against a DTA.
Dividends and Indirect Foreign Tax Credits from CFCs
A dividend from a CFC to the U.S. parent is generally a taxable event for
U.S. income tax purposes. Additionally, Subpart F provides for several
exceptions to the general rule of deferral of current taxation on the income
of a CFC.
Subpart F income is considered a deemed taxable dividend of income
from the CFC to its U.S. parent, followed by a subsequent contribution of
capital back to the CFC.
U.S. tax law allows taxpayers to claim deemed paid or indirect FTCs
based on the proportion of taxes paid by a CFC on its distributed
(deemed or otherwise) earnings and profits.
A dividend or deemed dividend is generally included in the appropriate FSI
basket based on whether it arose from trade or business activity versus
passive activity.8
Subpart F
Two common types of Subpart F income are foreign personal holding
company income and foreign base sales company income. There are
numerous exceptions and additional complexities to the general rules that
must be analyzed to conclude the appropriate amount of Subpart F in a
given year.
Foreign Personal Holding Company Income
Generally, a CFC’s interest income, dividends, royalties, and gains on sale
of property not used in a trade or business are considered foreign
personal holding company income (FPHCI) for the purposes of Subpart F.
FPHCI is taxable to the U.S. shareholders of the foreign corporation at the
time it is earned. FPHCI is generally passive basket FSI for the purposes of calculating the
FTC.
Foreign Base Sales Company Income
8
Look-through treatment under §904(d)(3)(D)
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Foreign base company sales income (FBSCI) is income derived from
either buying products from a related party and selling them or buying
products and selling them to a related party, where the products are both
made and sold outside the CFC's country of incorporation.9 FBSCI is
taxable to the U.S. shareholders of the foreign corporation at the time it is
earned.
FBSCI is typically general basket FSI for the purposes of calculating the
FTC.
Earnings and Profits
A CFC must track its annual earnings and profits (E&P). E&P represents
the economic profit of the CFC and its ability to pay dividends. E&P is
similar in concept to retained earnings but subject to certain adjustments.
The accumulated E&P of the CFC is tracked in the company’s functional
currency. Dividends are deemed to first arise from current year E&P and
then from historic E&P. To the extent that the company has no E&P,
dividends are treated as a nontaxable return of capital.
Sec. 78 Gross-Up
Since E&P is computed net of any income taxes, any dividend, deemed or
otherwise, is paid out on an after-tax basis. Under U.S. tax law, the §78
Gross-up is the mechanism for addressing the inherent tax included in
E&P. The §78 Gross-Up is included both as additional taxable income and
as an additional FTC in the year of a dividend or deemed dividend. The
§78 Gross-Up is a deemed credit under §902.
Calculation of the §78 Gross-Up is as follows:
Dividend or Deemed Dividend / E&P x Tax Pool in U.S. Dollars
A separate §78 Gross-Up is calculated for each dividend or deemed
dividend and included in the appropriate FSI basket and FTC calculation
with any appropriate direct credits.
Subpart F and Permanent Reinvestment
A foreign corporation whose earnings are not permanently reinvested will
typically record a DTL with respect to the ultimate repatriation of the
earnings to the U.S. In this case, taxation under Subpart F simply
accelerates the timing of U.S. taxation (i.e., reduces the related DTL) and
9 §954(d)(1)
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34
has no incremental impact on total tax expense. Conversely, a foreign corporation that has asserted that it is permanently
reinvesting its earnings abroad will not have recorded a DTL. Instead
Subpart F income constitutes a permanent item included in the U.S.
shareholder’s tax provision in the year of the inclusion.
Foreign Exchange
Foreign companies must designate a functional currency for GAAP
reporting purposes. The functional currency is “the currency of the primary
economic environment in which the entity operates.”10 A functional
currency is not required to be the local currency. Differences between the
functional currency and local currency can have impacts on the manner in
which items are taken into account in the financial statements and
therefore in the income tax provision.
Foreign provisions are typically calculated in the currency in which the
income tax liability would be payable, regardless of the entity’s functional
currency. The provision is translated to U.S. dollars at the average foreign
exchange rate or income statement exchange rate for the period.
Currency Translation Gains and Losses
GAAP balance sheet accounts are translated from a non-U.S. dollar
currency to U.S. dollars at the exchange rate on the balance sheet date.
Therefore changes in the exchange rates will cause the U.S. dollar value
of the foreign currency denominated tax accounts to change independent
of any business activity. Changes in the tax accounts arising solely due to
foreign exchange rate changes are accounted for as currency translation
adjustments (CTA), a component of other comprehensive income (OCI)
rather than as a component of operating income.
CTA is calculated as follows:
Beginning Balance in Functional Currency x (Ending Balance Sheet
Foreign Exchange Rate - Beginning Balance Sheet Foreign
Exchange Rate)
Plus
Current Year Activity in Functional Currency x (Ending Balance
Sheet Foreign Exchange Rate - Average Foreign Exchange Rate for
the Period)
10 ASC 830
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Items are booked to the income statement at the average foreign
exchange rate. Translation where the Indefinite Reversal Criteria Has Not Been Asserted
Changes in foreign exchange rates will often cause changes to the
balance of a DTL or DTA recorded to reflect the repatriation of historical
earnings of a foreign corporation or corporate joint venture.
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publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or
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ASC 740-30-25-17
The presumption in paragraph 740-30-25-3 that all undistributed
earnings will be transferred to the parent entity may be overcome, and
no income taxes shall be accrued by the parent entity, for entities and
periods identified in the following paragraph if sufficient evidence shows
that the subsidiary has invested or will invest the undistributed earnings
indefinitely or that the earnings will be remitted in a tax-free liquidation. A
parent entity shall have evidence of specific plans for reinvestment of
undistributed earnings of a subsidiary which demonstrate that remittance
of the earnings will be postponed indefinitely. These criteria required to
overcome the presumption are sometimes referred to as the indefinite
reversal criteria. Experience of the entities and definite future programs of
operations and remittances are examples of the types of evidence
required to substantiate the parent entity’s representation of indefinite
postponement of remittances from a subsidiary. The indefinite reversal
criteria shall not be applied to the inside basis differences of foreign
subsidiaries.
ASC 740-30-25-18
As indicated in paragraph 740-10-25-3, a deferred tax liability shall not
be recognized for either of the following types of temporary differences
unless it becomes apparent that those temporary differences will reverse
in the foreseeable future:
An excess of the amount for financial reporting over the tax basis of an
investment in a foreign subsidiary or a foreign corporate joint venture that
is essentially permanent in duration
Undistributed earnings of a domestic subsidiary or a domestic corporate
joint venture that is essentially permanent in duration that arose in fiscal
years beginning on or before December 15, 1992. A last-in, first-out
(LIFO) pattern determines whether reversals pertain to differences that
arose in fiscal years beginning on or before December 15, 1992.
ASC 740-30-25-19
If circumstances change and it becomes apparent that some or all of the
undistributed earnings of a subsidiary will be remitted in the foreseeable
future but income taxes have not been recognized by the parent entity, it
shall accrue as an expense of the current period income taxes
attributable to that remittance; income tax expense for such
undistributed earnings shall not be accounted for as an extraordinary
item. If it becomes apparent that some or all of the undistributed
earnings of a subsidiary on which income taxes have been accrued will
not be remitted in the foreseeable future, the parent entity shall adjust
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Intercompany Profits
Transactions between the legal entities included in the consolidated
financial statements are eliminated such that the consolidated results
solely reflect the effects of 3rd party transactions. However, intercompany
transactions may be taxable prior to the ultimate 3rd party transaction
occurring.
Most tax regimes impose an income tax when the entity or entities
included in a particular return enter into a transaction with any entity not
included in that same return, regardless of whether those entities are
related parties or not. This creates a situation where there is an economic
cost that must be accounted in the income taxes currently payable
despite the fact that the transaction that gives rise to the tax is eliminated
from the financial statements.
The elimination of the income tax expense on intercompany profits is
recorded as a credit to current income tax expense offset by a deferred
charge/prepaid tax rather than a DTA. ASC 740-10-25-3(e) prohibits the
recognition of a DTA relating to intercompany profits.
There is diversity in practice regarding the types of transactions that
should be eliminated and when to account for secondary effects such as
Subpart F and FTC implications that arise due to the intercompany
transactions.
The FASB is currently deliberating changes to these rules.!3434
!
Payments of Income Tax and Account
Reconciliations
Cash tax payments are recorded as debits against income taxes currently
payable. Upon completion of a given income tax return, a provision-toreturn true-up entry should be calculated to account for differences
between the tax provision estimated at the end of the fiscal year and the
actual tax return filed. The true-up entry is typically recorded in the interim
period in which the return is completed.
After the completion of the true-up, the income taxes currently payable
account should be reconciled to validate that for each income tax return,
the balance agrees to the refund or amount payable on the return.
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publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or
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Business Combinations
ASC 805 defines a business combination as “a transaction or other event
in which an acquiring entity obtains control of one or more businesses.”
Generally, in a business combination, any assets acquired, liabilities
assumed and noncontrolling interests are recognized at fair value.
Goodwill is generally the total value of the acquisition in excess of the fair
value of identifiable net assets (including deferred tax accounts and
intangibles). The process of determining the initial opening balance sheet
of the acquiree is often referred to as purchase accounting.
Companies may record retrospective adjustments to the opening balance
sheet during a measurement period. The measurement period begins on
the acquisition date and ends on the earlier of:
• the date in which all information, facts and circumstances as of the
acquisition date are known, or
• the one year anniversary of the acquisition date.
Taxable or Nontaxable Business combination
ASC 805 uses the terms “taxable” and “nontaxable” business
combinations. These terms refer to the whether or not a tax is imposed on
the acquired entity as a result of a business combination. This should not
be confused with the terminology regarding tax-free reorganizations under
U.S. tax law.
Taxable Asset Acquisitions
Taxable business combinations typically involve the acquisition of the net
assets of the acquired entity rather than its stock. Tax deductible goodwill
may be created equal to the excess of the purchase price over the fair
value of the net assets required under U.S. tax law.
The tax attributes of an acquiree, such as NOLs and credit carryovers, are
not transferred to the acquiror in an asset acquisition.
Though the acquired net assets are recorded at fair value for both GAAP
and tax purposes, there are often differences in determining the fair value
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publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or
services. This publication does not substitute for such professional advice or services, nor should it be used as
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or allocating value between the acquired assets and liabilities under the
two systems. Deferred taxes are recorded for the differences between the
book basis and the tax basis of the acquired assets and liabilities.
Nontaxable Stock Acquisitions
Generally, in a nontaxable business combination the acquiror purchases
the stock of the acquiree. Under U.S. tax law, in a stock acquisition of a
corporate entity, the acquiror has carryover tax basis in the assets of the
acquired company. Unlike an asset purchase, no tax deductible goodwill
is created in a stock acquisition.
Tax attributes, such as NOLs and credit carryovers, are typically retained
subsequent to a change in ownership in an stock acquisition and the
appropriate deferred taxes should be recorded for those attributes.11
However, §382 and §383 may impose limitations on an acquiror’s ability
to utilize pre-acquisition date tax attributes to offset post-acquisition
taxable income. In that case, it may be appropriate to record a VA based
on the facts and circumstances.
‑
Since the financial reporting basis in the net assets is reported at fair value
whereas the tax basis is carryover basis, deferred taxes will be recorded
on differences between the book basis and the tax basis of the net assets
in the acquired company.
A taxpayer may elect to treat a stock acquisition as an asset acquisition
for U.S. tax purposes.12 If a company has made such an election, the
purchase accounting and related deferred taxes should reflect the fair
value tax basis based on that election and should be accounted as a
taxable business combination.
Other Deferred Impacts
A business combination may also have other deferred tax consequences
due to the expected impact of the acquired business on federal state and
foreign tax filings. These income tax impacts are recorded to continuing
operations rather than through purchase accounting.
Uncertain Tax Positions
11 Analysis should be completed to validate that this is the case in the specific business
combination.
12 §338(h)(10)
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services. This publication does not substitute for such professional advice or services, nor should it be used as
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A company must record any acquired uncertain tax positions and evaluate
the measurement of acquired positions that meet the recognition
threshold as of the acquisition date.
Measurement Period
Changes to a tax position recorded in purchase accounting, that result
from new information about facts and circumstances that existed on the
acquisition date, are recorded to goodwill during the measurement
period.13
Valuation Allowances
A company must evaluate the need for a VA against its acquired DTAs as
of the acquisition date. A VA that is recorded as part of purchase
accounting will increase the amount of goodwill recognized for GAAP
purposes on the acquisition date.
Conversely, if a business combination causes a change in judgement with
respect to the need for a VA against the acquiror’s DTAs, any increase or
decrease to the VA is recorded in income tax expense from continuing
operations.
Measurement Period
Changes to a VA recorded in purchase accounting that result from new
information about facts and circumstances that existed on the acquisition
date are recorded to goodwill during the measurement period.14
Transaction costs
For GAAP purposes, transaction costs such as professional, legal and
accounting fees are expensed as period costs rather than capitalized as a
part of the consideration paid.
Only certain transaction costs related to a business combination may be
deductible for tax purposes. However, these transaction costs are often
incurred in advance of the acquisition date and the ultimate deductibility
often cannot be determined until the transaction is consummated.
13 Ibid.
14 If goodwill is reduced to zero, the acquiror will recognize a reduction in goodwill as a bargain
purchase under ASC 805-30-25-2 through 25-4.
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Due to diversity in practice, the company should consult with its auditor
on the appropriate tax accounting treatment of transaction costs when it
begins to incur them.
Goodwill
Goodwill is the residual value of the acquired net assets, including DTAs
and DTLs. Consequently, goodwill can only be calculated after
consideration of UTPs and VAs related to the acquired company.
Though tax deductible goodwill only arises from asset acquisitions
(deemed or otherwise), there are often situations in which tax deductible
goodwill may exist within the acquired company from a prior acquisition
that continues to be deductible after a subsequent stock acquisition/
nontaxable business combination. Since goodwill represents a residual
value, ASC 805 does not distinguish the period in which the tax
deductible goodwill originated when determining the two components of
goodwill.
Components of Goodwill
Type
Description
Deferred Taxes
Component I
Lesser of goodwill for
GAAP purposes or
deductible goodwill for
tax purposes.
No deferred taxes at the
acquisition date. Any
subsequent difference is
a temporary difference
that creates a DTA or
DTL.
Component II
GAAP Goodwill
Excess of GAAP goodwill
over tax deductible
goodwill.
No deferred taxes are
recognized at the
acquisition date or in
future years.
Component II
Tax Deductible
Goodwill
Excess of tax deductible
goodwill over GAAP
goodwill.
A DTA is recorded at the
acquisition date. Any
subsequent difference is
a temporary difference
that creates a DTA or
DTL.
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Interim Reporting
Annual Effective Tax Rate (AETR)
Generally, ASC 740-270 requires a company to calculate the income tax
associated with ordinary income using an estimated annual effective tax
rate (AETR). At the end of each interim period, the AETR is applied to
year-to-date (YTD) ordinary income (or loss) to arrive at the YTD income
tax expense. The AETR is the company’s best estimate of the effective rate expected
for the full year. The estimated AETR should include any changes in a VA
that arise from deferred tax items expected to originate during the year
and the reversal of existing deferred tax items.
Typically a company will base its estimated AETR on a variety of data
sources, including forecasts, prior year information, and YTD results.
AETR Versus the Reported Income Tax Rate
Though an AETR is estimated each interim period, it is distinct from the
reported income tax rate in the interim period. The AETR is applied to YTD
pretax income to derive the interim reported income tax rate.
Even in the absence of discrete items, changes to the AETR between
interim periods will have an exaggerated impact on the reported income
tax rate since the subsequent period must include any “catch up” amount
in order to arrive at the appropriate YTD AETR.
Discrete Items
Certain items are excluded from the AETR (Discrete Items) and are instead
recorded in the interim period in which they occur. Typically, Discrete Items
do not relate directly to the ordinary income expected to be reported in
the fiscal year. Some common Discrete Items include:
• Provision to Return True-Ups
• Interest expense associate with uncertain tax positions
• Excess Benefits/Shortfalls from share-based compensation
• Impacts of income tax rate and law changes accounted for in the
period in which the law is enacted
• Taxes related to significant unusual or extraordinary items that will be
separately reported or reported net of their related tax effect
• Changes in judgement about beginning-of-the-year VAs
• Changes with respect to the recognition test or measurement test of
an uncertain tax position
© 2015 Tax Prodigy, LLC. This publication contains general information only and is not, by means of this
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services. This publication does not substitute for such professional advice or services, nor should it be used as
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Losses
The estimated AETR may include only the amount of benefit from a loss
that is expected to be realized and recognized at the end of the fiscal year
(i.e., the amount that will not require a VA). If YTD ordinary losses are
incurred, the amount of benefit recognized cannot exceed the amount of
benefit estimated in the AETR.
Multiple Jurisdictions
Generally, a company that operates in multiple jurisdictions should apply a
consolidated AETR to its YTD consolidated ordinary income to calculate
the tax provision for an interim period.
However, if the company reports a loss for which it does not expect to
recognize a tax benefit or anticipates a fiscal year loss in a jurisdiction, the
loss from that jurisdiction is excluded from both the consolidated AETR
calculation and the YTD ordinary income to which a consolidated AETR is
applied.
For each jurisdiction that a company reports a loss for which it does not
expect to recognize a tax benefit for or anticipates a fiscal year loss, a
separate AETR is calculated and applied to the YTD ordinary income of
that jurisdiction.
Inability to Estimate an AETR
A company that cannot reliably estimate some or all of its AETR will record
its income tax provision for those items in the period in which the items
that cannot be reliably estimated occur. Under these circumstances, the
company will calculate its interim provision for those items or jurisdictions
based on actual results consistent with how it would calculate them at
year end.
© 2015 Tax Prodigy, LLC. This publication contains general information only and is not, by means of this
publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or
services. This publication does not substitute for such professional advice or services, nor should it be used as
a basis for any decision or action that may affect your business. Before making any decision or taking any
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44
Financial Statement Presentation and
Disclosure
The following discussion is focused on the key presentation and
disclosure requirements for publicly traded companies. Privately held
companies do not have all of the disclosure requirements, but as a matter
of practice should produce workpapers that support the same level of
disclosure as a public company.
Balance Sheet Presentation
Deferred Tax Accounts
For each jurisdiction that a company operates in, the deferred accounts
must first be segregated into four categories: current and noncurrent
DTAs (excluding VAs) and current and non-current DTLs. A deferred item is classified as current or noncurrent based on the
balance sheet classification of the underlying asset or liability that gives
rise to the deferred item. 15 If an item does not relate to a balance sheet
account, it will be classified as current or noncurrent based on the period
in which the item is expected to reverse.
Any VA related to the jurisdiction is allocated proportionately between
current and noncurrent DTAs regardless of which underlying DTAs the VA
may relate to.
Finally, the company will net the deferred accounts for each jurisdiction to
report just two deferred balances; a net current deferred (DTA or DTL) and
a net noncurrent deferred (DTA or DTL) in its balance sheet.
In October 2015, the FASB unanimously affirmed its proposal to present
all deferred income amounts as noncurrent for years beginning after
December 15, 2016 for public companies. This change would result in a
single deferred balance for each jurisdiction.
Balance Sheet Disclosures
Deferred Inventory
15 A short-term or current classification typically means the item is expected to be realized, sold, or
paid within one year of the balance sheet date.
© 2015 Tax Prodigy, LLC. This publication contains general information only and is not, by means of this
publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or
services. This publication does not substitute for such professional advice or services, nor should it be used as
a basis for any decision or action that may affect your business. Before making any decision or taking any
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A company must disclose the total of all DTAs, DTLs and VAs as of the
balance sheet dates. In addition, a public entity must disclose the
amounts of significant items making up both the total DTA and DTL.
Typically, an item will be listed separately if it constitutes more than 5% of
the total deferred balance. All other items will be disclosed as a combined
total.
Valuation Allowances
A company must disclose the net change in the total valuation allowance.
NOL and Credit Carryforwards
A company must disclose the gross amount and expiration dates of any
NOL or credit carryforwards.
Permanent Reinvestment
A company must disclose the amount of the unrecognized deferred tax
liability related to investments in foreign subsidiaries and foreign corporate
joint ventures that are essentially permanent in duration if the
determination of that liability is practicable, or a statement that
determination is not practicable.16
Share-Based Compensation
A company with suspended APIC credits associated with excess benefits
from share-based compensation must disclose the amount of benefit that
would be credited to APIC upon utilization of the related NOL.
Income Statement Presentation
Continuing Operations
Total tax expense associated with continuing operations is reported in the
income statement. This is typically the sum of current income tax
expense, deferred tax expense, and noncurrent income tax expense
including any interest associated with uncertain income tax positions.
Intraperiod allocation requires that the total income tax expense is
allocated to continuing operations, extraordinary items, noncontrolling
interests, discontinued operations, other comprehensive income, and
APIC.
Income Statement Disclosures
16 ASC 740-30-50-2
© 2015 Tax Prodigy, LLC. This publication contains general information only and is not, by means of this
publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or
services. This publication does not substitute for such professional advice or services, nor should it be used as
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Components of Income Tax Expense
A company must disclose the fiscal year total current, deferred, and
noncurrent income tax expense associated with each of the federal, state,
and foreign jurisdictions. In practice companies often include the
noncurrent expense with the current expense.
Rate Reconciliation
A public entity must disclose the significant items reconciling the tax
expense at the statutory federal tax rate (typically 35%) to the total
effective income tax expense attributable to continuing operations.
The reconciliation can use either percentages or dollar amounts.17
Typically, an item will be separately disclosed in the reconciliation if it
constitutes 5% of the amount of income tax applicable to pretax income
at the statutory tax rate.
Other Considerations
Typically the rate reconciliation disclosure presents state income taxes net
of the federal benefit. Alternatively, the components of income tax
expense typically show the state current and deferred expense on a gross
basis and the federal current and deferred expense net of the state tax.
Uncertain Tax Position Disclosures
Tabular Rollforward of Uncertain Tax Positions
Annually, a company must disclose a rollforward of the change in the
amount of uncertain tax benefits in the following categories:18
a. Increases related to current year positions
b. Increases and decreases related to prior year positions
c. Settlements of positions with a taxing authority
d. Reductions to unrecognized tax benefits as a result of the lapse of the applicable statute of limitations
The tabular rollforward should include only the tax amounts associated
with the uncertain tax positions. Consequently, the disclosed amount will
not necessarily correspond with the noncurrent payable in the financial
statements due to interest and penalties that have been accrued.
17 ASC 740-10-50-12
18
ASC 740-10-50-15A
© 2015 Tax Prodigy, LLC. This publication contains general information only and is not, by means of this
publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or
services. This publication does not substitute for such professional advice or services, nor should it be used as
a basis for any decision or action that may affect your business. Before making any decision or taking any
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47
Furthermore, the tabular reconciliation should not include any benefits that
may arise in a jurisdiction due to an uncertain position in another
jurisdiction.
Currency translation adjustments associated with uncertain tax positions
may also be included in the reconciliation if necessary.
In all reporting periods, the company must disclose the total amount of
unrecognized tax benefits that, if recognized, would affect the effective tax
rate.
Amount of Interest
A company must disclose the total amount of interest and penalties
recognized in the income statement and the total amounts of interest and
penalties recognized in the statement of financial position.
Policy With Respect to Interest
A company must disclose its policy election to either include interest and
penalties associated with uncertain tax benefits as part of pretax income
or as a component of income tax expense.
Years Subject To Examination
A company must disclose the years that are open to examination for its
major jurisdictions.
Expected Change in the Gross Uncertain Tax Positions
For positions for which it is reasonably possible that the total amounts of
unrecognized tax benefits will significantly increase or decrease within 12
months of the reporting date; the following must be disclosed:
a. The nature of the uncertainty b. The nature of the event that could occur in the next 12 months
that would cause the change c. An estimate of the range of the reasonably possible change, or a
statement that an estimate of the range cannot be made19
Professional judgement should be used in determining any amount to
disclose under this requirement.
Management’s Discussion and Analysis (MD&A)
19 ASC 740-10-50-15
© 2015 Tax Prodigy, LLC. This publication contains general information only and is not, by means of this
publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or
services. This publication does not substitute for such professional advice or services, nor should it be used as
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48
A company should describe the major drivers of its income tax rate in the
MD&A.
The SEC has become more focused on the accumulation of significant
profits oversees and the liquidity concerns that a permanent reinvestment
assertion, among other restrictions, may have on the company’s ability to
fund operations. © 2015 Tax Prodigy, LLC. This publication contains general information only and is not, by means of this
publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or
services. This publication does not substitute for such professional advice or services, nor should it be used as
a basis for any decision or action that may affect your business. Before making any decision or taking any
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49
Variable Interest Entities and Equity Investments
Variable Interest Entities
Variable Interest Entities (VIEs) are less than fully-owned entities that are
consolidated in the financial statements. Accordingly, consolidated pretax
income will include all of the pretax income or loss associated with the
VIE, while income tax expense will only include the amount of tax that
associated with the Company’s ownership of the VIE. The income
associated with the non-controlling interest is reported on a separate line
of the income statement net of the income tax effect.
VIEs are often partnerships or other flow-through entities that do not pay
tax at the entity level. Deferred taxes are recorded on any outside basis
differences for partnerships.
Equity in Earnings
Investments in certain non-consolidated entities are recorded in equity in
earnings net of any income tax impact.
Any dividends received deductions available to a U.S. shareholder should
be taken into account when determining the tax impact of equity in
earnings.
© 2015 Tax Prodigy, LLC. This publication contains general information only and is not, by means of this
publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or
services. This publication does not substitute for such professional advice or services, nor should it be used as
a basis for any decision or action that may affect your business. Before making any decision or taking any
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50
Intraperiod Allocation Intraperiod allocation addresses the requirement to allocate total income
tax expense or benefit (current and deferred) among:
• Continuing operations
• Discontinued operations
• Extraordinary items
• Other comprehensive income
• Items charged or credited directly to shareholders’ equity.
The intraperiod allocation rules should be applied to each tax paying
component (an individual entity or group of entities that is consolidated for
income tax purposes) in each tax jurisdiction.
There can be significant complexities associated with applying the
Intraperiod Allocation rules due to the number of tax paying components
in the financial statements along with the number of items of allocation in
addition to continuing operations.
Continuing Operations
The method for allocating tax expense or benefit to continuing operations
differs depending on whether the company is reporting pretax income or
loss from continuing operations.
Pretax Income from Continuing Operations
If a company reports pretax income from continuing operations, the tax
expense is calculated without consideration of items not included in
continuing operations. This is referred to as the incremental or “without”
approach.
Pretax Loss from Continuing Operations
If a company reports a pretax loss from continuing operations and income
from another item of allocation such as discontinued operations or
extraordinary items, the tax expense is calculated with consideration to all
items not included in continuing operations. The total tax effect for all
items of allocation is calculated and then allocated between the loss from
continuing operations and other items of allocation that are sources of
current year income.
Other Items Included in Expense or Benefit from Continuing Operations
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publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or
services. This publication does not substitute for such professional advice or services, nor should it be used as
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The amount of tax expense or benefit allocated to continuing operations
specifically includes the income tax effects of:
• Changes in circumstances that cause a change in judgment
about the realization of deferred tax assets in future years20
• Changes in tax laws or rates
• Changes in tax status
• Tax-deductible dividends paid to shareholders 21
The tax expense or benefit associated with these items will always be
reported to continuing operations.
Changes in Permanent Reinvestment Assertion
The tax expense arising from a change in a company’s permanent
reinvestment assertion is generally allocated to continuing operations.22
Discontinued Operations
Income or loss from discontinued operations are reclassified out of pretax
income or loss and combined into a single line as a separate component
of income before extraordinary items. Discontinued operations are
presented net of income tax expense or benefit.
Extraordinary Items
Gains and losses due to unusual and infrequent items are reported
separately in the income statement net of income tax expense or benefit.
Other Comprehensive Income
Tax effects related to following components of Other Comprehensive
Income (OCI) are recorded to OCI
• Available for Sale Securities
• Currency Translation Adjustments
• Certain pension and post-retirement items: Net unrecognized gains
and losses and unrecognized prior service cost
• Certain derivative instruments: The portion of the gain or loss on a
derivative instrument designated and qualifying as a cash flow hedge
20 See paragraph 740-10-45-20 for a discussion of exceptions to this allocation for certain items
21 Except as set forth in paragraph 740-20-45-11(e) for dividends paid on unallocated shares held by
an employee stock ownership plan or any other stock compensation arrangement.
By analogy to the out-of-period guidance in ASC 740-20 and because “backward
tracing” of currency translation adjustments to OCI is not permitted under ASC 740.
22
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publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or
services. This publication does not substitute for such professional advice or services, nor should it be used as
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52
instrument. Available for Sale Securities
Securities classified as Available for Sale Securities (AFS) are marked-tomarket as of the balance sheet date. Unrealized gains and losses from
AFS securities are excluded from continuing operation and instead
recorded as a component of OCI. The unrealized gains and losses will
typically create deferred tax consequences due to the tax basis being on
a cost basis. Accordingly, the deferred consequences related to AFS
securities are recorded to OCI.
The deferred taxes associated with AFS securities are typically tracked
either on a security-by-security basis or on a portfolio approach for each
tax paying component of the financial statements.
Available for Sale Securities and VAs
DTAs that arise from unrealized losses on AFS securities are often
unrealized capital loss carryforwards. Under U.S. tax law, a capital loss
can only be offset by capital gains. Accordingly, the Company must
assess the need for a VA against a DTA related to AFS securities. A
conclusion that a VA is needed against an unrealized capital loss DTA
would be recorded to OCI along with any changes arising due to mark to
market adjustments in the current period.
However, changes in circumstances that cause a change in judgment
about the need for a VA will be recorded to continuing operations.
Currency Translation Adjustments
Changes in the tax accounts arising solely due to foreign exchange rate
changes are accounted for as currency translation adjustments (CTA), a
component of OCI rather than as a component of continuing operations.
Foreign VAs and CTA
A foreign entity that has recorded a VA will reflect changes in the VA that
arise due to the effects of CTA on the underlying deferred balances, in
CTA.
However, changes in circumstances that cause a change in judgment
about the need for a VA will be recorded to continuing operations.
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publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or
services. This publication does not substitute for such professional advice or services, nor should it be used as
a basis for any decision or action that may affect your business. Before making any decision or taking any
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53
Items Charged or Credited Directly to Shareholders’
Equity
Excess benefits from share-based compensation are recorded to APIC in
the period in which taxes payable is reduced by the excess deduction.
Single Item of Allocation Other Than Continuing
Operations
Any amount not allocated to continuing operations is allocated to the
remaining item of allocation.
Multiple Items of Allocation Other Than Continuing
Operations
If a company has multiple items of allocation other than continuing
operations, the process can become complex, particularly if there are
losses or VAs. The company should consult with its auditor regarding its
process based on its specific facts and circumstances.
ASC 740-20-45-14 If there are two or more items other than continuing
operations, the amount that remains after the allocation to continuing
operations shall be allocated among those other items in proportion to
their individual effects on income tax expense or benefit for the year.
When there are two or more items other than continuing operations, the
sum of the separately calculated, individual effects of each item
sometimes may not equal the amount of income tax expense or benefit
for the year that remains after the allocation to continuing operations. In
those circumstances, the procedures to allocate the remaining amount to
items other than continuing operations are as follows:
a. Determine the effect on income tax expense or benefit for the
year of the total net loss for all net loss items.
b. Apportion the tax benefit determined in (a) ratably to each net
loss item.
c. Determine the amount that remains, that is, the difference
between the amount to be allocated to all items other than
continuing operations and the amount allocated to all net loss
items.
d. Apportion the tax expense determined in (c) ratably to each net
gain item.
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services. This publication does not substitute for such professional advice or services, nor should it be used as
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54