Appendix D — Sample Disclosures of Income Taxes

D.8 Notes to Consolidated Financial Statements

D.8.1 Note A — Summary of Significant Accounting Policies

D.8.1.1 Income Taxes

Sample Disclosure

We account for income taxes under the asset and liability method, which requires the recognition of DTAs and DTLs for the expected future tax consequences of events that have been included in the financial statements. Under this method, we determine DTAs and DTLs on the basis of the differences between the financial statement and tax bases of assets and liabilities by using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on DTAs and DTLs is recognized in income in the period that includes the enactment date.

We recognize DTAs to the extent that we believe that these assets are more likely than not to be realized. In making such a determination, we consider all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax-planning strategies, carryback potential if permitted under the tax law, and results of recent operations. If we determine that we would be able to realize our DTAs in the future in excess of their net recorded amount, we would make an adjustment to the DTA valuation allowance, which would reduce the provision for income taxes.

We record uncertain tax positions in accordance with ASC 740 on the basis of a two-step process in which (1) we determine whether it is more likely than not that the tax positions will be sustained on the basis of the technical merits of the position and (2) for those tax positions that meet the more-likely-than-not recognition threshold, we recognize the largest amount of tax benefit that is more than 50 percent likely to be realized upon ultimate settlement with the related tax authority.

D.8.1.2 Classification of Interest and Penalties

Sample Disclosure

We recognize interest and penalties related to UTBs on the income tax expense line in the accompanying consolidated statement of operations. Accrued interest and penalties are included on the related tax liability line in the consolidated balance sheet.

Sample Disclosure

We recognize interest and penalties related to UTBs on the interest expense line and other expense line, respectively, in the accompanying consolidated statement of operations. Accrued interest and penalties are included on the related liability lines in the consolidated balance sheet.

For more information, see ASC 740-10-50-19.

D.8.1.3 ITC Recognition Policy

Sample Disclosure

We earn ITCs from the state of X’s economic development program. We use the deferral method of accounting for ITCs.

Sample Disclosure

We use the flow-through method to account for ITCs earned on eligible scientific R&D expenditures. Under this method, the ITCs are recognized as a reduction to income tax expense in the year they are earned.

For more information, see ASC 740-10-50-20.

D.8.2 Note B — Statement of Cash Flows

Sample Disclosure

Supplemental cash flows and noncash investing and financing activities are as follows:

Connecting the Dots

Under ASC 230-10-50-2, the supplemental cash flow information for income taxes paid is required when an indirect method is used. Such disclosure can be included in the company’s statement of cash flows or in a footnote.

D.8.3 Note C — Acquisitions

Sample Disclosure

The preliminary purchase price allocation resulted in goodwill of $XX million, which is not deductible for income tax purposes. Goodwill consists of the excess of the purchase price over the fair value of the acquired assets and represents the estimated economic value attributable to future operations.

The purchase price allocation is preliminary and subject to revision. At this time, except for the items noted below, we do not expect material changes to the value of the assets acquired or liabilities assumed in conjunction with the transaction. Specifically, the following assets and liabilities are subject to change:

Intangible customer contracts.
Payments due from and to related parties.
Deferred income tax assets and liabilities.

As management receives additional information during the measurement period, these assets and liabilities may be adjusted.

Under the acquisition method of accounting for business combinations, if we identify changes to acquired DTA valuation allowances or liabilities related to uncertain tax positions during the measurement period, and they are related to new information obtained about facts and circumstances that existed as of the acquisition date, those changes are considered a measurement-period adjustment, and we record the offset to goodwill. We record all other changes to DTA valuation allowances and liabilities related to uncertain tax positions in current-period income tax expense. This accounting applies to all of our acquisitions, regardless of acquisition date.

Sample Disclosure

Goodwill of $XX million was assigned to the X and Y segments in the amounts of $XX million and $XX million, respectively, and is deductible for tax purposes. The amounts of intangible assets and goodwill have been assigned to the X and Y segments on the basis of the respective profit margins of the acquired customer contracts. The transaction was taxable for income tax purposes, and all assets and liabilities have been recorded at fair value for both book and income tax purposes. Therefore, no deferred taxes have been recorded.

See ASC 805-10-50-5 for more information on financial effects of adjustments related to business combinations that occurred in the current or previous reporting periods, and see ASC 805-30-50-1(d) for total amount of goodwill that is expected to be deductible for tax purposes.

D.8.4 Note D — Income Taxes3

Sample Disclosure

For financial reporting purposes, income before income taxes includes the following components:

The expense (benefit) for income taxes consists of:

Sample Disclosure

For financial reporting purposes, income before income taxes includes the following components:

The provision for income taxes for 20X3, 20X2, and 20X1 consists of the following:

D.8.4.1 Components of Income Tax Expense or Benefit

Sample Disclosure

For more information, see ASC 740-10-50-9, which requires disclosure of other items, such as the effects of changes in tax law or in valuation allowances, that may be disclosed elsewhere (i.e., in the reconciliation of the ETR).

Sample Disclosure

If presented, the other tax expense (benefit) line above would include items affecting the expense that neither meet the definition of a deferred tax item (see ASC 740-10-30-4) nor the definition of a current tax item (see ASC 740-10-20). If material, the components of the other tax expense (benefit) should be separately described below the table. For additional information, see ASC 740-10-50-9.

D.8.4.2 Rate Reconciliation

Sample Disclosure

Reconciliation between the ETR on income from continuing operations and the statutory tax rate is as follows:

For more information, see Regulation S-X, Rule 4-08(h), and ASC 740-10-50-12 through 50-14.

Connecting the Dots

SEC Regulation S-X, Rule 4-08(h)(2), indicates that for entities subject to SEC reporting requirements, the reconciliation should disclose all components of the income tax expense or benefit that constitute 5 percent or more of income tax expense or benefit from continuing operations, determined by using the statutory tax rate. Entities that are not subject to SEC reporting requirements are permitted to omit this reconciliation but must disclose the nature of significant reconciling items.

Sample Disclosure

The differences between income taxes expected at the U.S. federal statutory income tax rate of 21 percent and the reported income tax (benefit) expense are summarized as follows:

* See footnote 3.

D.8.4.3 Unrecognized DTL Related to Investments in Foreign Subsidiaries4

Sample Disclosure

As of December 31, 2018, the company has accumulated undistributed earnings generated by foreign subsidiaries of approximately $XXX million. We have not recognized a DTL for these unremitted earnings and related translation adjustments. Because $XXX million of such earnings have previously been subject to (1) the one-time transition tax on foreign earnings required by the 2017 Act or (2) the GILTI tax, the amount of outside basis difference in our foreign subsidiaries is not material. In addition, any additional taxes due with respect to the reversal of the outside basis difference as a result of a repatriation would generally be limited to the tax effect of currency gains or losses, capital gains, foreign withholding, and state taxes. The amount of unrecognized DTL is not material.

D.8.4.4 Components of the Net DTA or DTL

Sample Disclosure

For more information, see ASC 740-10-50-2, ASC 740-10-50-6, ASC 740-10-50-8, and ASC 740-10-50-16.

D.8.4.5 Operating Loss and Tax Credit Carryforwards

Sample Disclosure

We have income tax NOL carryforwards related to our international operations of approximately $XXX. We have recorded a DTA of $XXX reflecting the benefit of $XXX in loss carryforwards. Such DTAs expire as follows:

For more information, see ASC 740-10-50-3.

D.8.4.6 Valuation Allowance5 and Risks and Uncertainties

Sample Disclosure

Management assesses the available positive and negative evidence to estimate whether sufficient future taxable income will be generated to permit use of the existing DTAs. A significant piece of objective negative evidence evaluated was the cumulative loss incurred over the three-year period ended December 31, 20X3. Such objective evidence limits the ability to consider other subjective evidence, such as our projections for future growth.

On the basis of this evaluation, as of December 31, 20X3, a valuation allowance of $XXX has been recorded to recognize only the portion of the DTA that is more likely than not to be realized. The amount of the DTA considered realizable, however, could be adjusted if additional objectively verifiable positive evidence materializes in future reporting periods, such as a demonstrated operating profitability.

Sample Disclosure

Such objective evidence limits the ability to consider other subjective evidence, such as our projections for future growth. We have determined that the reversal of future taxable temporary differences corresponding to our DTLs will provide a sufficient source of income for realization of our DTAs.

On the basis of this evaluation, as of December 31, 20X3, no valuation allowance has been recorded against our DTAs. In the absence of future taxable income, reductions in our DTLs may result in the need for a valuation allowance in a subsequent period.

For more information, see ASC 275-10-50-8.

Sample Disclosure

We have federal and state income tax NOL carryforwards of $XXX and $XXX, which will expire on various dates in the next 15 years as follows:

We believe that it is more likely than not that the benefit from certain state NOL carryforwards will not be realized. In recognition of this risk, we have provided a valuation allowance of $XXX on the DTAs related to these state NOL carryforwards. If or when recognized, the tax benefits related to any reversal of the valuation allowance on DTAs as of December 31, 20X3, will be accounted for as follows: Approximately $XXX will be recognized as a reduction of income tax expense and $XXX will be recorded as an increase in equity.

The federal, state, and foreign NOL carryforwards in the income tax returns filed included UTBs. The DTAs recognized for those NOLs are presented net of these UTBs.

Because of the change of ownership provisions of the Tax Reform Act of 1986, use of a portion of our domestic NOL and tax credit carryforwards may be limited in future periods. Further, a portion of the carryforwards may expire before being applied to reduce future income tax liabilities.

D.8.4.7 Valuation Allowance Reversal6

Sample Disclosure

As of December 31, 20X3, our DTAs were primarily the result of U.S. NOL, capital loss, and tax credit carryforwards. A valuation allowance of $XXX and $XXX was recorded against our gross DTA balance as of December 31, 20X3, and December 31, 20X2, respectively. For the years ended December 31, 20X3, and December 31, 20X2, we recorded a net valuation allowance release of $XXX (comprising a full-year valuation release of $XXX related to the X segment, partially offset by an increase to the valuation allowance of $XXX related to the Y segment) and $XXX, respectively, on the basis of management’s reassessment of the amount of its DTAs that are more likely than not to be realized.

As of each reporting date, management considers new evidence, both positive and negative, that could affect its view of the future realization of DTAs. As of December 31, 20X3, in part because in the current year we achieved three years of cumulative pretax income in the U.S. federal tax jurisdiction, management determined that there is sufficient positive evidence to conclude that it is more likely than not that additional deferred taxes of $XXX are realizable. It therefore reduced the valuation allowance accordingly.

As of December 31, 20X3, and December 31, 20X2, we have NOL carryforwards of $XXX and $XXX, respectively, which, if unused, will expire in years 20Y6 through 20Z2. We have capital loss carryforwards totaling $XXX and $XXX as of December 31, 20X3, and December 31, 20X2, respectively, which, if unused, will expire in years 20X4 through 20X8. In addition, as of December 31, 20X3, and December 31, 20X2, we have qualified affordable housing tax credit carryforwards totaling $XXX and $XXX, respectively, which, if unused, will expire in years 20X8 through 20Z3, and alternative minimum tax credits of $XXX and $XXX, respectively, that may be carried forward indefinitely. Certain tax attributes are subject to an annual limitation as a result of the acquisition of our Subsidiary A, which constitutes a change of ownership as defined under IRC Section 382.

D.8.4.8 Tax Holidays

Sample Disclosure

We operate under tax holidays in other countries, which are effective through December 31, 20X3, and may be extended if certain additional requirements are satisfied. The tax holidays are conditional upon our meeting certain employment and investment thresholds. The impact of these tax holidays decreased foreign taxes by $XXX, $XXX, and $XXX for 20X3, 20X2, and 20X1, respectively. The benefit of the tax holidays on net income per share (diluted) was $.XX, $.XX, and $.XX for 20X3, 20X2, and 20X1, respectively.

For more information, see SAB Topic 11.C.

D.8.4.9 Unrecognized Tax Benefits

D.8.4.9.1 Tabular Reconciliation of UTBs

Sample Disclosure

Below is a tabular reconciliation of the total amounts of UTBs; this tabular reconciliation disclosure is not required for nonpublic entities.

Sample Disclosure

The table below illustrates a selection of reconciling items that may be reported separately or aggregated on the basis of the specific facts and circumstances. The list is not intended to be all-inclusive. If reported separately, the descriptions should be appropriately titled so that the user of the financial statements will understand the nature of the reconciling item being reported.

D.8.4.9.2 UTBs That, if Recognized, Would Affect the ETR

Sample Disclosure

Included in the balance of UTBs as of December 31, 20X3; December 31, 20X2; and December 31, 20X1, are $XXX, $XXX, and $XXX, respectively, of tax benefits that, if recognized, would affect the ETR. Also included in the balance of UTBs as of December 31, 20X3; December 31, 20X2; and December 31, 20X1, are $XXX, $XXX, and $XXX, respectively, of tax benefits that, if recognized, would result in adjustments to other tax accounts, primarily deferred taxes.

For more information, see ASC 740-10-50-15A(b).

D.8.4.9.3 Total Amounts of Interest and Penalties Recognized in the Statement of Operations and Total Amounts of Interest and Penalties Recognized in the Statements of Financial Position

Sample Disclosure

We recognize interest accrued related to UTBs and penalties as income tax expense. We accrued penalties of $XX and interest of $XX during 20X3 and in total, as of December 31, 20X3, recognized a liability related to the UTBs noted above for penalties of $XX and interest of $XX. During 20X2, we accrued penalties of $XX and interest of $XX and in total, as of December 31, 20X2, recognized a liability for penalties of $XX and interest of $XX. During 20X1, we accrued penalties of $XX and interest of $XX.

For more information, see ASC 740-10-50-15(c).

D.8.4.9.4 Tax Positions for Which It Is Reasonably Possible That the Total Amounts of UTBs Will Significantly Increase or Decrease Within 12 Months of the Reporting Date

Sample Disclosure

We believe that it is reasonably possible that a decrease of up to $XX in UTBs related to state exposures may be necessary within the coming year. In addition, we believe that it is reasonably possible that approximately $XX of current other remaining UTBs, each of which is individually insignificant, may be recognized by the end of 20X4 as a result of a lapse of the statute of limitations. As of December 31, 20X2, we believed that it was reasonably possible that a decrease of up to $XX in UTBs related to state tax exposures would have occurred during the year ended December 31, 20X3. During the year ended December 31, 20X3, UTBs related to those state exposures actually decreased by $XX as illustrated in the table above.

For more information, see ASC 740-10-50-15(d).

D.8.4.9.5 Description of Tax Years That Remain Subject to Examination by Major Tax Jurisdictions

Sample Disclosure

We are subject to taxation in the United States and various states and foreign jurisdictions. As of December 31, 20X3, tax years for 20X0, 20X1, and 20X2 are subject to examination by the tax authorities. With few exceptions, as of December 31, 20X3, we are no longer subject to U.S. federal, state, local, or foreign examinations by tax authorities for years before 20X0. Tax year 20W9 was open as of December 31, 20X2.

For more information, see ASC 740-10-50-15(e).

D.8.4.10 Subsequent-Events Disclosure

Sample Disclosure

In January 20X4, we received notice of a tax incentive award of $XX that will allow us to monetize approximately $XX of state R&D tax credits. In exchange for this award, we pledged to hire more employees and maintain the additional head count through at least December 31, 20X8. Failure to do so could result in our being required to repay some or all of these incentives.

For more information, see ASC 855-10-50-2.

Connecting the Dots

Disclosure of a nonrecognized subsequent event is required only when the financial statements would be considered misleading without such disclosure.

Footnotes

At the 2010 AICPA Conference, Jill Davis, associate chief accountant in the SEC’s Division of Corporation Finance, stated that one of the requirements in SEC Regulation S-X, Rule 4-08(h), is to disclose the components of income (loss) before income tax expense (benefit) as either domestic or foreign. Ms. Davis indicated that some registrants’ disclosures about these components have been limited in circumstances in which the registrants had a very low income tax expense because a substantial amount of profits were derived from countries with little or no tax. She explained that the disclosures provided should allow an investor to easily determine the ETR for net income attributable to domestic operations and foreign operations and stated that the lack of such disclosure may result in SEC staff comments. For additional information, see SEC Regulation S-X, Rule 4-08(h), “General Notes to Financial Statements: Income Tax Expense.”

See footnote 1.

At the 2011 AICPA Conference, Mark Shannon advised that entities must consider all available evidence, both positive and negative, in determining whether a valuation allowance is needed to reduce a DTA to an amount that is more likely than not to be realized. Mr. Shannon said that some registrants are placing less weight on recent losses when weighing the positive and negative evidence because they view the current economic downturn as an aberration, as given in an example in ASC 740-10-30-22. He stated that while each company’s facts and circumstances could differ, in general it would be difficult to conclude the economic downturn is an aberration. He also reminded participants that overcoming such negative evidence would require significant objective positive evidence. At the 2012 AICPA Conference, Mr. Shannon reiterated these comments. He also emphasized the importance of evidence that is objectively verifiable and noted that it carries more weight than evidence that is not.

At the 2012 AICPA Conference, Mark Shannon noted that registrants who have returned to profitability may be considering whether they should reverse a previously recognized valuation allowance. He indicated that factors to consider in making this determination include (1) the magnitude and duration of past losses and (2) the magnitude and duration of current profitability as well as changes in the factors that drove losses in the past and those currently driving profitability. Nili Shah further noted that registrants should assess the sustainability of current profits as well as their track record of accurately forecasting future financial results. She pointed out that registrants’ disclosures should include a discussion of the factors or reasons that led to a reversal of a valuation allowance that effectively answers the question “why now.” Such disclosures would include a comprehensive analysis of all available positive and negative evidence and how the entity weighed each piece of evidence in its assessment. She also reminded registrants that the same disclosures would be expected when there is significant negative evidence and a registrant concludes that a valuation allowance is necessary.

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