Chapter 14 — Disclosure of Income Taxes | DART – Deloitte Accounting Research Tool

Chapter 14 — Disclosure of Income Taxes

14.1 Overview

This chapter outlines the income tax accounting disclosures that entities are required to provide in the notes to, and on the face of, the financial statements. Appendix D provides disclosure examples that may be helpful as the requirements outlined in this chapter are considered. Disclosure requirements related to certain special areas are addressed in other chapters of this Roadmap as follows:

Chapter 7 — interim tax reporting.
Chapter 8 — separate or carve-out financial statements (including abbreviated separate or carve-out financial statements).
Chapter 11 — the effects of a business combination on an entity’s valuation allowance.
Chapter 12 — noncontrolling interests, equity method investments, and QAHP investments, including specific exceptions in ASC 740 related to corporate joint ventures and changes in ownership of investees.

In 2014, the FASB added to its agenda a project on income tax disclosures. The project, which is still on the Board’s agenda, has included initial deliberations along with the issuance of two versions of proposed ASUs that ultimately were never finalized after outreach was performed.

In March 2019, the FASB issued a proposed ASU that would have modified or eliminated certain requirements related to income tax disclosures as well as establish new disclosure requirements. However, in feedback on the proposed guidance, financial statement users indicated that when making capital allocation decisions, they needed additional information that entities could provide by incrementally improving their income tax disclosures. Therefore, at a March 2022 meeting, the FASB updated the project’s objective from improving the effectiveness of disclosures in notes to the financial statements to improving the transparency and decision-usefulness of income tax disclosures. In March 2023, the Board issued a new proposed ASU with a comment deadline of May 30, 2023.

The revised project is focused on improvements to disclosures about income taxes paid and the rate reconciliation. Such improvements include disclosure at a more disaggregated level and more guidance on the required reconciling items to be disclosed within the rate reconciliation for both public and private companies.

For more information about the scope and status of this project, see Appendix B.

14.2 Balance Sheet

ASC 740-10

50-2 The components of the net deferred tax liability or asset recognized in an entity’s statement of financial position shall be disclosed as follows:

The total of all deferred tax liabilities measured in paragraph 740-10-30-5(b)
The total of all deferred tax assets measured in paragraph 740-10-30-5(c) through (d)
The total valuation allowance recognized for deferred tax assets determined in paragraph 740-10-30-5(e).

The net change during the year in the total valuation allowance also shall be disclosed.

50-3 An entity shall disclose both of the following:

The amounts and expiration dates of operating loss and tax credit carryforwards for tax purposes
Any portion of the valuation allowance for deferred tax assets for which subsequently recognized tax benefits will be credited directly to contributed capital (see paragraph 740-20-45-11).

50-4 In the event that a change in an entity’s tax status becomes effective after year-end in Year 2 but before the financial statements for Year 1 are issued or are available to be issued (as discussed in Section 855-10-25), the entity’s financial statements for Year 1 shall disclose the change in the entity’s tax status for Year 2 and the effects of that change, if material.

50-5 An entity’s temporary difference and carryforward information requires additional disclosure. The additional disclosure differs for public and nonpublic entities.

Public Entities

50-6 A public entity shall disclose the approximate tax effect of each type of temporary difference and carryforward that gives rise to a significant portion of deferred tax liabilities and deferred tax assets (before allocation of valuation allowances).

50-7 See paragraph 740-10-50-16 for disclosure requirements applicable to a public entity that is not subject to income taxes.

Nonpublic Entities

50-8 A nonpublic entity shall disclose the types of significant temporary differences and carryforwards but may omit disclosure of the tax effects of each type.

14.2.1 Deferred Taxes

ASC 740-10-50-6 requires that a public entity disclose “the approximate tax effect of each type of temporary difference and carryforward that gives rise to a significant portion of deferred tax liabilities and deferred tax assets (before allocation of valuation allowances).”

14.2.1.1 Required Level of Detail

When disclosing the tax effect of each type of temporary difference or carryforward as required by ASC 740-10-50-6, an entity should separately disclose deductible and taxable temporary differences. An entity can determine individual disclosure items by looking at financial statement captions (e.g., PP&E) or by subgroup (e.g., tractors, trailers, and terminals for a trucking company) or individual asset. An entity should look to the level of detail in its general accounting records (e.g., by property subgroup) but is not required to quantify temporary differences by individual asset. The level of detail used should not affect an entity’s net deferred tax position but will affect its footnote disclosure of gross DTAs and DTLs.

14.2.1.2 Definition of “Significant” With Respect to Disclosing the Tax Effect of Each Type of Temporary Difference and Carryforward That Gives Rise to DTAs and DTLs

Neither the ASC master glossary nor SEC Regulation S-X defines “significant,” as used in ASC 740-10-50-6. However, the SEC staff has indicated that to meet this requirement, public entities should disclose all components that equal or exceed 5 percent of the gross DTA or DTL.

14.2.2 Other Balance Sheet Disclosure Considerations

14.2.2.1 Disclosure of Temporary Difference or Carryforward That Clearly Will Never Be Realized

ASC 740-10-50-6 requires that a public entity disclose “the approximate tax effect of each type of temporary difference and carryforward that gives rise to a significant portion of deferred tax liabilities and deferred tax assets (before allocation of valuation allowances).” Questions have arisen about whether it is appropriate to write off a DTA and its related valuation allowance when an entity believes that realization is not possible in future tax returns (e.g., situations in which an entity with a foreign loss carryforward discontinues operations in a foreign jurisdiction in which the applicable tax law does not impose an expiration period for loss carryforward benefits).

Paragraph 156 of the Basis for Conclusions of FASB Statement 109 states:

Some respondents to the Exposure Draft stated that disclosure of the amount of an enterprise’s total deferred tax liabilities, deferred tax assets, and valuation allowances is of little value and potentially misleading. It might be misleading, for example, to continue to disclose a deferred tax asset and valuation allowance of equal amounts for a loss carryforward after operations are permanently terminated in a particular tax jurisdiction. The Board believes that it need not and should not develop detailed guidance for when to cease disclosure of the existence of a worthless asset. Some financial statement users, on the other hand, stated that disclosure of the total liability, asset, and valuation allowance as proposed in the Exposure Draft is essential for gaining some insight regarding management’s decisions and changes in decisions about recognition of deferred tax assets. Other respondents recommended significant additional disclosures such as the extent to which net deferred tax assets are dependent on (a) future taxable income exclusive of reversing temporary differences or even (b) each of the four sources of taxable income cited in paragraph 21. After reconsideration, the Board concluded that disclosure of the total amounts as proposed in the Exposure Draft is an appropriate level of disclosure.

Therefore, while an entity is generally required to disclose the total amount of its DTLs, DTAs, and valuation allowances, there is no detailed guidance for when to cease disclosure of the existence of a worthless tax benefit, and the entity needs to use judgment. As noted above, it is appropriate to write off the DTA if the entity will not continue operations in that jurisdiction. However, if operations are to continue, it is not appropriate to write off the DTA and valuation allowance regardless of management’s assessment about future realization.

14.2.2.2 Disclosure of Outside Basis Differences

If an entity has two foreign subsidiaries operating in different tax jurisdictions and has a “taxable” outside basis difference (i.e., an outside basis difference for which, in the absence of the exception in ASC 740-30-25-1 through 25-6, the accrual of a DTL would be required) related to one subsidiary and a “deductible” outside basis difference related to the other, it is not acceptable for the entity to net the outside basis differences to meet the disclosure requirements of ASC 740-30-50-2. The disclosures required by ASC 740-30-50-2(b) for the cumulative amount of the temporary difference and by ASC 740-30-50-2(c) for unrecognized DTLs related to foreign subsidiaries should include only subsidiaries with “taxable” outside basis differences.

14.3 Income Statement

ASC 740-10

50-9 The significant components of income tax expense attributable to continuing operations for each year presented shall be disclosed in the financial statements or notes thereto. Those components would include, for example:

Current tax expense (or benefit)
Deferred tax expense (or benefit) (exclusive of the effects of other components listed below)
Investment tax credits
Government grants (to the extent recognized as a reduction of income tax expense)
The benefits of operating loss carryforwards
Tax expense that results from allocating certain tax benefits directly to contributed capital
Adjustments of a deferred tax liability or asset for enacted changes in tax laws or rates or a change in the tax status of the entity
Adjustments of the beginning-of-the-year balance of a valuation allowance because of a change in circumstances that causes a change in judgment about the realizability of the related deferred tax asset in future years. For example, any acquisition-date income tax benefits or expenses recognized from changes in the acquirer’s valuation allowance for its previously existing deferred tax assets as a result of a business combination (see paragraph 805-740-30-3).

50-10 The amount of income tax expense (or benefit) allocated to continuing operations and the amounts separately allocated to other items (in accordance with the intraperiod tax allocation provisions of paragraphs 740-20-45-2 through 45-14 and 852-740-45-3) shall be disclosed for each year for which those items are presented.

50-11 The reported amount of income tax expense may differ from an expected amount based on statutory rates. The following guidance establishes the disclosure requirements for such situations and differs for public and nonpublic entities.

Public Entities

50-12 A public entity shall disclose a reconciliation using percentages or dollar amounts of the reported amount of income tax expense attributable to continuing operations for the year to the amount of income tax expense that would result from applying domestic federal statutory tax rates to pretax income from continuing operations. The statutory tax rates shall be the regular tax rates if there are alternative tax systems. The estimated amount and the nature of each significant reconciling item shall be disclosed.

Nonpublic Entities

50-13 A nonpublic entity shall disclose the nature of significant reconciling items but may omit a numerical reconciliation.

All Entities

50-14 If not otherwise evident from the disclosures required by this Section, all entities shall disclose the nature and effect of any other significant matters affecting comparability of information for all periods presented.

Related Implementation Guidance and Illustrations

Income-Tax-Related Disclosures [ASC 740-10-55-79].
Example 29: Disclosure Related to Components of Income Taxes Attributable to Continuing Operations [ASC 740-10-55-212].

14.3.1 Rate Reconciliation

Reporting entities often pay income taxes in multiple jurisdictions other than the domestic federal jurisdiction (e.g., domestic state and local jurisdictions, foreign federal and foreign local or provincial jurisdictions), and the applicable income tax rates vary in each jurisdiction. Further, tax laws often differ from financial accounting standards; therefore, permanent differences can arise between pretax income for financial reporting purposes and taxable income.

Thus, a reporting entity’s income tax expense cannot generally be determined for a period by simply applying the domestic federal statutory tax rate to the reporting entity’s pretax income from continuing operations for financial reporting purposes. See ASC 740-10-50-12 and 50-13 above.

The disclosure requirement addressed by ASC 740-10-50-12 and 50-13 is often referred to as the “rate reconciliation” disclosure requirement. ASC 740 does not require a reporting entity to include a specific number or type of reconciling items in the rate reconciliation. Reconciling items will vary depending on the reporting entity’s facts and circumstances. However, the SEC staff frequently comments on rate reconciliation disclosures that are not clear and transparent. A reporting entity should evaluate its reconciling items to ensure that they clearly communicate to financial statement users the events and circumstances affecting the reporting entity’s ETR.

14.3.1.1 Evaluating Significance of Reconciling Items in the Rate Reconciliation

ASC 740-10-50 does not define the term “significant.” However, SEC Regulation S-X, Rule 4-08(h)(2), states that as part of the reconciliation, public entities should disclose all reconciling items that individually make up 5 percent or more of the computed amount (i.e., income before tax multiplied by the applicable domestic federal statutory tax rate).

Reconciling items may be aggregated in the disclosure if they are individually less than 5 percent of the computed amount. Reconciling items that are individually equal to or greater than 5 percent of the computed amount should not be netted against other offsetting reconciling items into a single line item that is itself less than 5 percent.

SEC Regulation S-X, Rule 4-08(h)(2), states that public entities can omit this reconciliation in the following circumstances:

[When] no individual reconciling item amounts to more than five percent of the amount computed by multiplying the income before tax by the applicable statutory Federal income tax rate, and the total difference to be reconciled is less than five percent of such computed amount, no reconciliation need be provided unless it would be significant in appraising the trend of earnings.

Because SEC Regulation S-X, Rule 4-08(h), does not apply to non-PBEs, such entities must often use judgment in determining whether they need to disclose the nature of a particular reconciling item or items.

14.3.1.2 Appropriate Federal Statutory Rate for Use in the Rate Reconciliation of a Foreign Reporting Entity

ASC 740-10-50-12 indicates that the federal statutory income tax rate a foreign reporting entity (i.e., the parent of the consolidated group that is not domiciled in the United States) should use when preparing the rate reconciliation disclosure should be based on application of “domestic federal statutory tax rates to pretax income from continuing operations.” SEC Regulation S-X, Rule 4-08(h)(2), states, in part:

Where the reporting person is a foreign entity, the income tax rate in that person’s country of domicile should normally be used in making the above computation, but different rates should not be used for subsidiaries or other segments of a reporting entity.

As noted, the appropriate rate for public entities is normally the federal rate in the reporting entity’s jurisdiction of domicile. That rate should be applied to pretax income from continuing operations of all subsidiaries or other segments of the reporting entity, even if most of the operations are located outside that jurisdiction.1 SEC Regulation S-X, Rule 4-08(h)(2), also notes that if the rate used differs from the U.S. federal corporate income tax rate (e.g., because the reporting entity is domiciled in a foreign jurisdiction), “the rate used and the basis for using such rate shall be disclosed.”

Question 1 in paragraph 5 of SAB Topic 6.I (codified in ASC 740-10-S99-1(5)) provides an exception to the general rule and states:

Question 1: Occasionally, reporting foreign persons may not operate under a normal income tax base rate such as the current U.S. Federal corporate income tax rate. What form of disclosure is acceptable in these circumstances?

Interpretive Response: In such instances, reconciliations between year-to-year effective rates or between a weighted average effective rate and the current effective rate of total tax expense may be appropriate in meeting the requirements of Rule 4-08(h)(2). A brief description of how such a rate was determined would be required in addition to other required disclosures. Such an approach would not be acceptable for a U.S. registrant with foreign operations. Foreign registrants with unusual tax situations may find that these guidelines are not fully responsive to their needs. In such instances, registrants should discuss the matter with the staff.

The use of a rate other than the federal rate in the reporting entity’s jurisdiction of domicile could be subject to challenge and, accordingly, consultation is encouraged in these situations.

While SEC Regulation S-X, Rule 4-08(h), does not apply to non-PBEs, we believe that it would generally be appropriate for such entities to determine the domestic federal statutory rate in a manner consistent with how public reporting entities determine it.

14.3.1.3 Computing the “Foreign Rate Differential” in the Rate Reconciliation

The unit of account for various reconciling items is not always clear. For example, an entity with foreign operations will commonly include a reconciling item referred to as a “foreign rate differential.” Because it is often unclear what the foreign rate differential reconciling line should include, diversity in practice exists.

We believe that a line in the rate reconciliation described as the foreign rate differential should generally include only the effects on an entity’s ETR of differences between the domestic federal statutory tax rate and the statutory income tax rate in the applicable foreign jurisdiction(s), multiplied by pretax income from continuing operations in each respective foreign jurisdiction.

14.3.2 Other Income Statement Disclosure Considerations

ASC 740-10-50-9 requires an entity to disclose significant components of income tax expense or benefit that are attributable to continuing operations for each year presented in the financial statements.

14.3.2.1 Disclosure of the Components of Deferred Tax Expense

One of the components required to be disclosed in ASC 740-10-50-9 is deferred tax expense (or benefit). In many circumstances, certain changes between the beginning-of-year and end-of-year deferred tax balances do not affect the total deferred tax expense or benefit. Examples of such circumstances include, but are not limited to, the following:

If a business combination has occurred during the year, DTLs and DTAs, net of any related valuation allowance, are recorded as of the acquisition date as part of acquisition accounting. There would be no offsetting effect to the income tax provision.
If a single asset is purchased (other than as part of a business combination) and the amount paid is different from the tax basis attributable to the asset, the tax effect should be recorded as an adjustment to the carrying amount of the related asset in accordance with ASC 740-10-25-51.
For consolidated subsidiaries in foreign jurisdictions for which the functional currency is the same as the parent’s reporting currency but income taxes are assessed in the local currency, deferred tax balances should be remeasured in the functional currency as transaction gains or losses or, if considered more useful, as deferred tax benefit or expense, as described in ASC 830-740-45-1.
For consolidated subsidiaries in foreign jurisdictions for which the local currency is the functional currency and income taxes are assessed in the local currency, deferred tax balances should be translated into the parent’s reporting currency through the CTA account. The revaluations of the deferred tax balances are not identified separately from revaluations of other assets and liabilities.

In addition, other changes in deferred tax balances might result in an increase or a decrease in the total tax provision but are allocated to a component of current-year activity other than continuing operations (e.g., discontinued operations and the items in ASC 740-20-45-11 such as OCI).

14.3.2.2 Disclosure of the Tax Effect of a Change in Tax Law, Rate, or Tax Status

ASC 740-10-50-9(g) requires an entity to disclose the tax consequences of adjustments to a DTL or DTA for enacted changes in tax laws or rates or a change in the entity’s tax status. An entity may provide such disclosures on the face of its income statement as a separate line item component (e.g., a subtotal) that, in the aggregate, equals the total amount of income tax expense (benefit) allocated to income (loss) from continuing operations for each period presented. However, the entity should not present the effects of these changes on the face of the income statement or in the footnotes in terms of per-share earnings (loss) amounts available to common shareholders because such disclosure would imply that the normal earnings per share (EPS) disclosures required by ASC 260 are not informative or are misleading.

Footnotes

1

This would apply to (or include) a tax inversion.

14.4 UTB-Related Disclosures

ASC 740-10

[All Entities]

50-15 All entities shall disclose all of the following at the end of each annual reporting period presented: . . .

c. The total amounts of interest and penalties recognized in the statement of operations and the total amounts of interest and penalties recognized in the statement of financial position

d. 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:

1. The nature of the uncertainty

2. The nature of the event that could occur in the next 12 months that would cause the change

3. An estimate of the range of the reasonably possible change or a statement that an estimate of the range cannot be made.

e. A description of tax years that remain subject to examination by major tax jurisdictions.

[Public Entities]

50-15A Public entities shall disclose both of the following at the end of each annual reporting period presented:

A tabular reconciliation of the total amounts of unrecognized tax benefits at the beginning and end of the period, which shall include at a minimum:
1. The gross amounts of the increases and decreases in unrecognized tax benefits as a result of tax positions taken during a prior period
2. The gross amounts of increases and decreases in unrecognized tax benefits as a result of tax positions taken during the current period
3. The amounts of decreases in the unrecognized tax benefits relating to settlements with taxing authorities
4. Reductions to unrecognized tax benefits as a result of a lapse of the applicable statute of limitations.
The total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate.

See Example 30 (paragraph 740-10-55-217) for an illustration of disclosures about uncertainty in income taxes.

Related Implementation Guidance and Illustrations

Example 30: Disclosure Relating to Uncertainty in Income Taxes [ASC 740-10-55-217].

14.4.1 The Tabular Reconciliation of UTBs

ASC 740-10-50-15A(a) requires public entities to disclose a “tabular reconciliation of the total amounts of unrecognized tax benefits at the beginning and end of the period.” In some cases, the beginning and ending amounts in the tabular disclosure equal the amount recorded as a liability for the UTBs in the balance sheet. However, that is not always the case, since the reconciliation must include, on a comprehensive basis, all UTBs that are recorded in the balance sheet, not just the amount that is classified as a liability. In other words, the reconciliation should include an amount recorded as a liability for UTBs and amounts that are recorded as a reduction in a DTA, a current receivable, or an increase in a DTL. (See Section 13.2.3 for an example of a UTB recorded as a reduction in a DTA.)

An entity’s policy election for interest and penalties under ASC 740-10-45-25 does not affect the disclosures under ASC 740-10-50-15A.

Interest and penalties that are classified as part of income tax expense in the statement of operations, and that are therefore classified as a component of the liability for UTBs in the statement of financial position, should not be included by public entities in the tabular reconciliation of UTBs under ASC 740-10-50-15A(a).

14.4.1.1 Items Included in the Tabular Disclosure of UTBs From Uncertain Tax Positions May Also Be Included in Other Disclosures

ASC 740-10-50-15A(a) indicates that the tabular reconciliation of the total amounts of UTBs should include the “gross amounts of the increases and decreases in unrecognized tax benefits as a result of tax positions taken during a prior period” or a current period. Increases and decreases in the estimate that occur in the same year can be reflected on a net basis in the tabular reconciliation. However, if these changes in estimate are significant, it may be appropriate to disclose them on a gross basis elsewhere in the footnotes to the financial statements. For example, if a public entity does not recognize any tax benefit for a significant position taken in the second quarter (and therefore recognizes a liability for the full benefit) but subsequently recognizes the full benefit in the fourth quarter (and therefore derecognizes the previously recorded liability), the entity would be expected to disclose the significant change in estimate in the footnotes to the financial statements.

14.4.1.2 Periodic Disclosures of UTBs

Both ASC 740-10-50-15 and 50-15A appear to require entities to provide disclosures at the end of each annual reporting period presented. Accordingly, entities should present the information required by ASC 740-10-50-15 and 50-15A for each applicable period. For example, if a public entity were to present three years of income statements and two years of balance sheets, the disclosures listed in ASC 740-10-50-15 and 50-15A would be required for each year in which an income statement is presented.

14.4.1.3 Presentation of Changes Related to Exchange Rate Fluctuations in the Tabular Reconciliation

Exchange rate fluctuations are not changes in judgment regarding recognition or measurement and are not considered as part of the settlement when a tax position is settled. Therefore, in the tabular reconciliation, increases or decreases in UTBs caused by exchange rate fluctuations should not be combined with other types of changes; rather, they should be presented as a separate line item (a single line item is appropriate).

14.4.1.4 Disclosure of Fully Reserved DTAs in the Reconciliation of UTBs

Public entities with NOLs and a full valuation allowance are required to include in their tabular disclosure amounts for positions that, if recognized, would manifest themselves as DTAs that would be reduced by a valuation allowance because it is more likely than not that some portion or all of the DTAs will not be realized. The general recognition and measurement provisions should be applied first; the remaining balance should then be evaluated for realizability in accordance with ASC 740-10-30-5(e).

Example 14-1

A public entity has a $1 million NOL carryforward. Assume a 25 percent tax rate. The entity records a $250,000 DTA, for which management applies a $250,000 valuation allowance because it does not believe it is more likely than not that the entity will have income of the appropriate character to realize the NOL. Management concludes that the tax position that gave rise to the NOL will more likely than not be realized on the basis of its technical merits. The entity concludes that the benefit should be measured at 90 percent. The entity would need to reduce the DTA for the NOL and the related valuation allowance to $225,000, which represents 90 percent of the benefit. In addition, the entity would include a UTB of $25,000 in the tabular disclosure under ASC 740-10-50-15A(a).

14.4.1.5 Disclosure of the Settlement of a Tax Position When the Settlement Amount Differs From the UTB

In some cases, cash that will be paid as part of the settlement of a tax position differs from the UTB related to that position. The difference between the UTB and the settlement amount should be disclosed in line 1 of the reconciliation, which includes the gross amounts of increases and decreases in the total amount of UTBs related to positions taken in prior periods. The cash that will be paid to the tax authority to settle the tax position would then be disclosed in line 2 of the reconciliation, which contains amounts of decreases in UTBs related to settlements with tax authorities.

Example 14-2

Entity A has recorded a UTB of $1,000 as of December 31, 20X7 (the end of its fiscal year). During the fourth quarter of fiscal year 20X8, Entity A settles the tax position with the tax authority and makes a settlement payment of $800 (recognizing a $200 benefit related to the $1,000 tax position). Entity A’s tabular reconciliation disclosure as of December 31, 20X8, would show a decrease of $200 in UTBs from prior periods (line 1) and a decrease of $800 in UTBs related to settlements (line 2). A “current taxes payable” for the settlement amount of $800 should be recorded until that amount is paid to the tax authority.

14.4.1.6 Consideration of Tabular Disclosure of UTBs in an Interim Period

ASC 740-10-50-15A(a) requires public entities to provide a “tabular reconciliation of the total amounts of unrecognized tax benefits at the beginning and end of the period.”

Although such disclosure is not specifically required in an interim period, if a significant change from the prior annual disclosure occurs, management should consider whether a tabular reconciliation or other qualitative disclosures would inform financial statement users about the occurrence of significant changes or events that have had a material impact since the end of the most recently completed fiscal year. Management should consider whether to provide such disclosure in the notes to the financial statements if it chooses not to provide a tabular reconciliation.

Management of entities subject to SEC reporting requirements should consider Form 10-Q’s disclosure requirements, which include providing disclosures about significant changes from the most recent fiscal year in estimates used in preparation of the financial statements.

14.4.1.7 Presentation in the Tabular Reconciliation of a Federal Benefit Associated With Unrecognized State and Local Income Tax Positions

The recognition of a UTB may indirectly affect deferred taxes. For example, a DTA for a federal benefit may be created if the UTB is related to a state tax position. If an evaluation of the tax position results in an entity’s increasing its state tax liability, the entity should record a DTA for the corresponding federal benefit. However, the UTB related to a state or local income tax position should be presented by a public entity on a gross basis in the tabular reconciliation required by ASC 740-10-50-15A(a).

Example 14-3

Entity P, a public entity, records a liability for a $1,000 UTB related to a position taken in a state tax return. Its federal tax rate is 21 percent. The additional state income tax liability associated with the unrecognized state tax deduction results in a state income tax deduction on the federal tax return, creating a federal benefit of $210 ($1,000 × 21%). Entity P would include only the gross $1,000 unrecognized state tax benefit in the tabular reconciliation. However, in accordance with ASC 740-10-50-15A(b), P would include $790 in the amount of UTBs that, if recognized, would affect the ETR.

14.4.1.8 Presentation in the Tabular Reconciliation of the Interaction of UTBs Between Different Jurisdictions

As noted previously, public entities are required to disclose a tabular reconciliation (or rollforward) of the “total” amount of UTBs. This total would include the direct effects of an uncertain tax position. The evaluation of what is and what is not a direct effect often involves judgment and depends on how the unit of account is determined for the particular uncertain tax position. For example, when evaluating the impact of a transfer pricing position on the tabular reconciliation of UTBs, an entity should generally present the amount of UTB liability in one jurisdiction gross of the offsetting UTB receivable in the other jurisdiction because each represents a separate unit of account with a separate taxing authority.

Example 14-4

Subsidiary 1 of Entity P, a public entity, records $500,000 of revenue in Jurisdiction A. Revenue is generated through the licensing of intellectual property (IP) to P’s Subsidiary 2, which operates in Jurisdiction B. Entity P determines that upon examination by the taxing authority for Jurisdiction A, the taxing authority will conclude that the licensing revenue recorded was understated on the basis of its interpretation of Jurisdiction A’s arm’s-length pricing requirement. After considering the ASC 740 recognition and measurement guidance, P recorded a UTB liability for the tax position taken in Jurisdiction A.

Because the UTB liability is recorded by Subsidiary 2 under the licensing agreement, P also evaluated whether a corresponding adjustment was needed for the tax position taken in Jurisdiction B. After considering the recognition and measurement criteria discussed in Section 4.6.3, P determined that management has recognized a UTB receivable in Jurisdiction B.

In the tabular rollforward of UTBs, P should reflect the total amount of UTB liability associated with Jurisdiction A in the table without considering the offsetting impact associated with the UTB receivable related to Jurisdiction B. Although related to the same position (i.e., the same IP licensing agreement), the UTB receivable is a separate unit of account that the Jurisdiction B taxing authorities would evaluate independently; therefore, it should not be netted in the tabular rollforward of UTBs.

14.4.1.9 Reserved

Example 14-5

Reserved

14.4.2 Disclosure of UTBs That, if Recognized, Would Affect the ETR

ASC 740-10-50-15A(b) requires public entities to disclose the “total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate.”

The disclosure under ASC 740-10-50-15A(b) is required if recognition of the tax benefit would affect the ETR from “continuing operations” determined in accordance with ASC 740. However, the SEC staff expects public entities to provide supplemental disclosure of amounts that significantly affect other items outside continuing operations (e.g., goodwill or discontinued operations).

14.4.2.1 Example of UTBs That, if Recognized, Would Not Affect the ETR

Certain UTBs, if recognized, would not affect the ETR and would be excluded from the ASC 740-10-50-15A(b) disclosure requirements. The example below illustrates a situation involving such UTBs.

Example 14-6

An entity expenses $10,000 of repair and maintenance costs for book and tax purposes. Upon analyzing the tax position, the entity believes, on the basis of the technical merits, that the IRS will more likely than not require the entity to capitalize and depreciate the cost over 10 years. The entity has a 25 percent applicable tax rate. The entity would recognize a $2,250 ($9,000 × 25%) DTA for repair cost not allowable in the current period ($1,000 would be allowable in the current period for depreciation expense) and a liability for the UTB. Because of the impact of deferred tax accounting, the disallowance of the shorter deductibility period would not affect the ETR but would accelerate the payment of cash to the tax authority to an earlier period. Therefore, the entity recognizes a liability for a UTB and a DTA, both affecting the balance sheet, with no net impact on overall tax expense.

14.4.3 Disclosure of UTBs That Could Significantly Change Within 12 Months of the Reporting Date

ASC 740-10-50-15(d) requires an entity to disclose information “[f]or 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.”

Sometimes, the total amount of a UTB will change without affecting the income statement (e.g., a UTB may be expected to be settled in an amount equal to its carrying value). In other cases, a change in the total amount of a UTB will affect the income statement (e.g., the tax benefit will be recognized because the applicable statute of limitations has expired). Further, UTBs may be attributable to either permanent differences, which generally affect the income statement if adjusted, or temporary differences, which generally do not affect the income statement if adjusted.

The ASC 740-10-50-15(d) disclosure is intended to provide financial statement users with information about future events (such as settlements with the tax authority or the expiration of the applicable statute of limitations) that may result in significant changes to the entity’s total UTBs within 12 months of the reporting date. “Total UTBs” would be those reflected in the tabular reconciliation required by ASC 740-10-50-15A. The disclosure should not be limited to UTBs for which it is reasonably possible that the significant changes will affect the income statement or to UTBs associated with permanent differences.

While ASC 740-10-50-15(d) does not require disclosure of whether a reasonably possible change in UTB will affect tax expense, an entity may consider disclosing the amounts of the expected change that will affect tax expense and the amounts that will not.

Example 14-7

An entity identifies an uncertain tax position and measures the UTB at $40 million as of the reporting date of year 1. The tax authorities are aware of the uncertain tax position, and the entity expects that it is reasonably possible to settle the amount in the fourth quarter of year 2 for between $20 million and $60 million and that the potential change in UTB would be significant. In this example, the entity’s ASC 740-10-50-15(d) financial statement disclosure for year 1 should report that because of an anticipated settlement with the tax authorities, it is reasonably possible that the amount of UTBs may increase or decrease by $20 million.

Example 14-8

An entity identifies an uncertain tax position and measures the UTB at $40 million as of the reporting date of year 1. The tax authorities are aware of the uncertain tax position, and while the entity expects to settle the amount for $40 million in the fourth quarter of year 2, it is reasonably possible that the entity could sustain the position. The uncertain tax position is a binary position with only zero or $40 million as potential outcomes. In this example, provided that the change in UTB would be significant, the entity’s ASC 740-10-50-15(d) financial statement disclosure for year 1 should state that it is reasonably possible that a decrease of $40 million in its UTB obligations could occur within 12 months of the reporting date because of an anticipated settlement with the tax authorities.

Example 14-9

On January 1 of year 1, an entity (1) incurs $10 million of costs related to maintaining equipment and (2) claims a deduction for repairs and maintenance for the entire amount of the costs incurred in its tax return filed for year 1. It is more likely than not that the tax law requires the costs to be capitalized and depreciated over a five-year period. As of the reporting date in year 1, the entity recognizes an $8 million liability for a UTB associated with the deductions taken for tax purposes in year 1. Management believes that the $8 million liability will be reduced by $2 million per year over the next four years as the entity forgoes claiming depreciation for the asset previously deducted. In this example, provided that the change in UTB would be significant, the entity’s ASC 740-10-50-15(d) financial statement disclosure for year 1 should state that it is reasonably possible that a decrease of $2 million will occur within 12 months of the reporting date. The entity should continue to disclose such information in subsequent years until the liability balance is reduced to zero (provided that the entity does not believe that it is reasonably possible that a more accelerated reversal of the UTB will result from an audit of the year of deduction).

While ASC 740-10-50-15(d) does not require disclosure of whether a reasonably possible change in UTB will affect tax expense, an entity may consider disclosing the amounts of the expected change that will affect tax expense and the amounts that will not.

14.4.3.1 Disclosure of Expiration of Statute of Limitations

A scheduled expiration of the statute of limitations within 12 months of the reporting date is subject to the disclosure requirements in ASC 740-10-50-15(d). If the statute of limitations is scheduled to expire within 12 months of the date of the financial statements and management believes that it is reasonably possible that the expiration of the statute will cause the total amounts of UTBs to significantly decrease, the entity should disclose the required information.

14.4.3.2 Disclosure Requirements for Effectively Settled Tax Positions

There are no specific disclosure requirements for tax positions determined to be effectively settled as described in ASC 740-10-25-10. However, for positions expected to be effectively settled, an entity should not overlook the requirements in ASC 740-10-50-15(d). Under those requirements, the entity must disclose 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.

Example 14-10

A calendar-year-end entity is undergoing an audit of its 20X4 tax year. The 20X4 tax year includes tax positions that did not meet the more-likely-than-not recognition threshold. Therefore, the entity recognizes a liability for the UTBs associated with those tax positions. The entity believes that the tax authority will complete its audit of the 20X4 tax year during 20X8. It also believes that it is reasonably possible that the tax positions within that tax year will meet the conditions to be considered effectively settled. When preparing its ASC 740-10-50-15(d) disclosure as of December 31, 20X7, the entity should include the estimated decrease of its UTBs for the tax positions taken in 20X4 that it believes will be effectively settled.

14.4.3.3 Interim Disclosure Considerations Related to UTBs That Will Significantly Change Within 12 Months

The ASC 740-10-50-15(d) disclosure is required as of the end of each annual reporting period presented. However, material changes since the end of the most recent fiscal year-end should be disclosed in the interim financial statements in a manner consistent with SEC Regulation S-X, Article 10.

Therefore, in updating the ASC 740-10-50-15(d) disclosure for interim financial reporting, an entity must consider changes in expectations from year-end as well as any events not previously considered at year-end that may occur within 12 months of the current interim reporting date and that could have a material effect on the entity. This effectively results in a “rolling” 12-month disclosure. For example, an entity that is preparing its second-quarter disclosure for fiscal year 20X7 should consider any events that may occur in the period from the beginning of the third quarter of fiscal year 20X7 to the end of the second quarter of fiscal year 20X8 to determine the total amounts of UTBs for which a significant increase or decrease is reasonably possible within 12 months of the reporting date.

14.4.4 Separate Disclosure of Interest Income, Interest Expense, and Penalties

740-10

Interest and Penalty Recognition Policies

50-19 An entity shall disclose its policy on classification of interest and penalties in accordance with the alternatives permitted in paragraph 740-10-45-25 in the notes to the financial statements.

ASC 740-10-50-15(c) states that entities must disclose “[t]he total amounts of interest and penalties recognized in the statement of operations and the total amounts of interest and penalties recognized in the statement of financial position.” Interest income, interest expense, and penalties should be disclosed separately. Accordingly, an entity should disclose interest income, interest expense, and penalties gross without considering any tax effects. In accordance with ASC 740-10-50-19, an entity should also disclose its policy for classification of interest and penalties.

14.4.4.1 Interest Income on UTBs

The SEC staff has advised us that if an entity’s accounting policy is to include interest income attributable to overpayment of income taxes within the provision for income taxes, this policy must be prominently disclosed and transparent to financial statement users. Public entities should consider presenting the following disclosure of the components of the income tax provision, either on the face of the statements of operations or in a note to the financial statements:

Interest expense and interest income in the table above should not include any related tax effects since those amounts should be included in the deferred tax expense (benefit) line.

This disclosure is also recommended for nonpublic entities, since it may help financial statement users understand the effect of interest expense and income.

14.4.5 Disclosure of Liabilities for UTBs in the Contractual Obligations Table

In November 2020, the SEC issued a final rule that amends Regulation S-K to (1) eliminate Item 301, “Selected Financial Data”; (2) simplify the requirements in Item 302 on supplementary financial information; and (3) modernize, simplify, and enhance the requirements in Item 303 on MD&A.

As a result, registrants are no longer required to include in the MD&A section a tabular disclosure of all known contractual obligations, such as long-term debt, capital and operating lease obligations, purchase obligations, and other liabilities recorded in accordance with U.S. GAAP. However, Item 303(b) specifies that the registrant must provide an analysis of “material cash requirements from known contractual and other obligations.”

A registrant that chooses to disclose contractual obligations within the MD&A section should include the liability for UTBs in the tabular disclosure of contractual obligations in MD&A if it can make reasonably reliable estimates about the period of cash settlement of the liabilities. For example, if any liabilities for UTBs are classified as a current liability in a registrant’s balance sheet, the registrant should include that amount in the “Less than 1 year” column of its contractual obligations table. Similarly, the contractual obligations table should include any noncurrent liabilities for UTBs for which the registrant can make a reasonably reliable estimate of the amount and period of related future payments (e.g., uncertain tax positions subject to an ongoing examination by the respective tax authority for which settlement is expected to occur after the next operating cycle).

Often, however, the timing of future cash outflows associated with some liabilities for UTBs is highly uncertain. In such cases, a registrant (1) might be unable to make reasonably reliable estimates of the period of cash settlement with the respective tax authority (e.g., UTBs for which the statute of limitations might expire without examination by the respective tax authority) and (2) could exclude liabilities for UTBs from the contractual obligations table or disclose such amounts within an “other” column added to the table. If any liabilities for UTBs are excluded from the contractual obligations table or included in an “other” column, a footnote to the table should disclose the amounts excluded and the reason for the exclusion.

14.4.6 Disclosing the Effects of Income Tax Uncertainties in a Leveraged Lease Entered Into Before the Adoption of ASC 842

On the effective date of ASC 842, leases previously classified as leveraged leases under ASC 840 will be subject to the guidance in ASC 842-50. The legacy accounting requirements are grandfathered in for leases that were entered into and accounted for as leveraged leases before the effective date of ASC 842. A leveraged lease modified on or after the effective date of ASC 842 would be accounted for as a new lease under the lessor model in ASC 842. Entities are not permitted to account for any new or subsequently amended lease arrangements as leveraged leases after the effective date of ASC 842. For additional information on the impact of ASC 842 on leveraged lease accounting, see Section 9.5.2 of Deloitte’s Roadmap Leases.

ASC 840-30-35-42 indicates that a change or projected change in the timing of cash flows related to income taxes generated by a leveraged lease is a change in an important assumption that affects the periodic income recognized by the lessor for that lease. Accordingly, the lessor should apply the guidance in ASC 840-30-35-38 through 35-41 and ASC 840-30-35-45 through 35-47 whenever events or changes in circumstances indicate that a change in timing of cash flows related to income taxes generated by a leveraged lease has occurred or is projected to occur.

In addition, ASC 840-30-35-44 states, in part, “Tax positions shall be reflected in the lessor’s initial calculation or subsequent recalculation based on the recognition, derecognition, and measurement criteria in paragraphs 740-10-25-6, 740-10-30-7, and 740-10-40-2.”

The tax effects of leveraged leases are within the scope of ASC 740. Accordingly, a lessor in a leveraged lease should apply the disclosure provisions of ASC 740-10-50 that would be relevant to the income tax effects for leveraged leases, including associated uncertainties and effects of those uncertainties.

Lessors in a leveraged lease should also be mindful of the SEC observer’s comment in EITF Issue 86-43 (codified in ASC 840-30), which indicates that when an entity applies the leveraged lease guidance in ASC 840-30-35-38 through 35-41 because the after-tax cash flows of the leveraged lease have changed as a result of a change in tax law, the cumulative effect on pretax income and income tax expense, if material, should be reported as separate line items in the income statement. Because ASC 840-30-35-42 through 35-44 clarify that the timing of the cash flows related to income taxes generated by a leveraged lease is an important assumption — just as a change in tax rates had always been — this guidance should be applied by analogy.

14.5 Public Entities Not Subject to Income Taxes

ASC 740-10

50-16 A public entity that is not subject to income taxes because its income is taxed directly to its owners shall disclose that fact and the net difference between the tax bases and the reported amounts of the entity’s assets and liabilities.

14.5.1 Tax Bases in Assets

The disclosure requirement described in ASC 740-10-50-16 above applies to any public entity for which income is taxed directly to its owners, including regulated investment companies (mutual funds), public partnerships, and Subchapter S corporations with public debt.

The reference to “tax bases” in ASC 740-10-50-16 is meant to include the partnership’s or other entity’s tax basis in its (net) assets. The FASB’s rationale for this information is based on the belief that financial statement users would benefit from knowing the approximate tax consequence in the event the flow-through entity changes its tax status and becomes a taxable entity in the future.

14.6 Disclosure of the Components of Income (or Loss) Before Income Tax Expense (or Benefit) as Either Foreign or Domestic

SEC Regulation S-X, Rule 4-08(h), requires public companies to include in their financial statements a disclosure of the domestic and foreign components of income (or loss) before income tax expense (or benefit).

SEC Regulation S-X, Rule 4-08(h), defines foreign income or loss as income or loss generated from a registrant’s “foreign operations, i.e., that are located outside the registrant’s home country.” Conversely, domestic income or loss is income or loss generated from a registrant’s operations located inside the registrant’s home country.

While providing this disclosure is often straightforward, it may be difficult in certain circumstances to determine (1) the source of the income or loss (i.e., foreign or domestic) or (2) the period or manner in which to reflect the income or loss in the disclosure. In particular, it can be challenging to classify income as foreign or domestic when a portion of a registrant’s pretax income or loss is generated by a branch or when intra-entity transactions occur between different tax-paying components2 within the consolidated group.

14.6.1 Branches

A U.S. parent may create an entity in a foreign jurisdiction that is regarded (e.g., as a corporation) in its foreign jurisdiction but then cause that foreign corporation to elect to be disregarded for U.S. federal income tax purposes (commonly referred to as a branch). Because the foreign corporation is disregarded for U.S. federal income tax purposes, the U.S. parent includes the foreign entity’s taxable income or loss in its U.S. federal taxable income. The foreign corporation’s profits are taxed simultaneously in the foreign jurisdiction in which it operates (i.e., the foreign corporation will file a tax return in the foreign jurisdiction in which it operates) and in the United States (because the entity’s taxable income or loss will be included in the U.S. parent’s U.S. federal taxable income). Taxes paid by the foreign corporation in the foreign jurisdiction may be deducted on the U.S. parent’s return or claimed as an FTC, subject to certain limitations.

The foreign corporation is treated like a branch of its U.S. parent for U.S. income tax purposes, which does not change the fact that the profits of the foreign entity are generated from operations located outside the United States. The profits and losses of the foreign entity are considered foreign income or loss in the disclosure of domestic and foreign components of pretax income or loss in the U.S. parent’s financial statements.

14.6.2 Intra-Entity Transactions

Intra-entity transactions between different tax-paying components within the consolidated group often result in tax consequences in each member’s respective taxing jurisdiction in the period in which the transaction occurs. However, the pretax effects of these transactions are eliminated in consolidation for accounting purposes. Accounting for the tax consequences of an intra-entity transaction depends on the nature of the transaction.

14.6.2.1 Intra-Entity Transactions Not Subject to ASC 740-10-25-3(e)

We believe that the primary purpose of the disclosure of the components of pretax income or loss as either domestic or foreign is to give the users of financial statements an ability to relate the domestic and foreign tax provisions to their respective pretax amounts. Therefore, when an intra-entity transaction results in taxable income in one component and deductible losses in another component, and those pretax amounts are eliminated in consolidation, we believe that the disclosure of the foreign and domestic components of pretax income or loss is generally more meaningful if the components are “grossed up” since the grossed-up amounts correspond more closely to the actual amounts of domestic and foreign tax expense and benefit.

However, because SEC Regulation S-X, Rule 4-08(h), is not explicit and simply requires disclosure of “the components of income (loss) before income tax expense (benefit),” we believe that “net” presentation, with appropriate disclosure in the income tax rate reconciliation, would also be acceptable.

Consider the example below.

Example 14-11

Assume the following facts:

Company P is an SEC registrant and is domiciled and operates in the United States, which has a 21 percent tax rate.
Company S is a wholly owned foreign subsidiary of P and is domiciled and operating in Jurisdiction B, which has a 50 percent tax rate.
Company P’s consolidated financial statements are prepared under U.S. GAAP and include S.
Companies P and S enter into a cost-sharing arrangement under which S reimburses P for 50 percent of certain costs incurred by P to further the development of Product X, which S licenses to third parties.
None of the amounts paid qualify for capitalization.
For the year 20X5, P records $200 of development expense before reimbursement by S. Company S reimburses P for 50 percent of the costs. Accordingly, P recognizes a net development expense of $100 under the cost-sharing arrangement, and S records $100 of development expense.
Company P increases its income tax expense by $21 for the cost-sharing expense reimbursement in 20X5, and S receives an income tax benefit of $50 from the development expense it incurs.

The cost-sharing payment is eliminated in P’s 20X5 consolidated financial statements. However, the income tax expense incurred by P and the income tax benefit received by S are recognized in P’s consolidated financial statements in 20X5. Therefore, provided that P discloses the grossed-up amounts of the domestic and foreign components of pretax income or loss, P’s pretax income would reflect the $100 net development cost expense in the disclosure of domestic income or loss and would similarly include $100 of development expense in the disclosure of foreign income or loss. That is, the cost-sharing arrangement has the effect of moving $100 of expense from domestic to foreign. This disclosure corresponds to an applicable amount of domestic and foreign tax expense and benefit, respectively, which is also recognized and disclosed in 20X5.

14.6.2.2 Intra-Entity Transactions Subject to ASC 740-10-25-3(e)

ASC 740-10-25-3(e) and ASC 810-10-45-8 require deferral of the recognition of income taxes paid on intra-entity profits from the sale of inventory for which intra-entity profits are eliminated in consolidation. For these types of transactions, we believe that it is appropriate to include an allocation of the consolidated pretax income or loss to the foreign and domestic components in the year in which the inventory is sold outside the consolidated group.

Consider the example below.

Example 14-12

Assume the same facts as in Example 14-9, but instead of entering into a cost-sharing agreement:

During 20X5, Company P sells inventory with a historical cost basis for both book and tax purposes of $200 to Company S for $300, and the inventory is on hand at year-end.
Company P pays tax of $21 in the United States on this intra-entity profit of $100.
The inventory is sold outside the consolidated group at a price of $350 in the following year (20X6).

In 20X5 the $100 gain on the intra-entity sale is eliminated in consolidation, and the related tax is deferred under ASC 740-10-25-3(e) and ASC 810-10-45-8. The intra-entity gain of $100 that is eliminated in 20X5 should not be included in the disclosure of the 20X5 pretax domestic and foreign income or loss.

In 20X6, when the inventory is sold outside the consolidated group, a profit before income taxes of $150 is recorded in the consolidated financial statements ($100 of which is related to profits previously taxed in the United States, and $50 of which is related to profits taxed in Jurisdiction B). In 20X6, $100 of income from the sale should be reported as domestic income, and $50 of income from the sale should be reported as foreign income. This corresponds to an applicable amount of domestic and foreign tax expense, which is also recognized and disclosed in 20X6.

Footnotes

2

As described in ASC 740-10-30-5, a tax-paying component is “an individual entity or group of entities that is consolidated for tax purposes.”

14.7 Pro Forma Financial Statements

14.7.1 Change in Tax Status to Taxable: Pro Forma Financial Reporting Considerations

In certain situations, an entity may be required to disclose, in the financial statements included in an SEC filing, pro forma information regarding a change in tax status. The objective of providing such information is to enable investors to understand and evaluate the continuing impact of a transaction (or a group of transactions) by showing how the transaction might have affected the registrant’s historical financial position and results of operations if the transaction had been consummated on an earlier date. If a transaction (or a group of transactions) includes a change in tax status, the impact of that change should be reflected in the pro forma financial information.

One example would be an entity (e.g., an S corporation) that changes its tax status in connection with an IPO. The financial statements presented in the registration statement for the periods in which the entity was a nontaxable entity are not restated for the effect of income tax. Rather, the entity must provide pro forma disclosures to illustrate the effect of income tax on those years.

Therefore, there may be certain income tax reporting considerations for an entity that changes its status from nontaxable to taxable. Paragraph 3410.1 of the SEC Financial Reporting Manual (FRM) states that if a registrant was formerly an S corporation, a partnership, or a similar tax exempt enterprise, it should present pro forma tax and EPS data for the following periods:

If necessary adjustments include more than adjustments for taxes, limit pro forma presentation to latest fiscal year and interim period
If necessary adjustments include only taxes, pro forma presentation for all periods presented is encouraged, but not required.

The pro forma information should be prepared in accordance with SEC Regulation S-X, Rule 11-02. The tax rate used for the pro forma calculations should normally equal the “statutory rate in effect during the periods for which the pro forma statements of comprehensive income are presented,” as stated in Section 3270 of the FRM. However, Section 3270 of the FRM also indicates that “[c]ompanies are allowed to use different rates if they are factually supportable and disclosed.”

If an entity chooses to provide pro forma information for all periods presented under the option in paragraph 3410.1(b) of the FRM, the entity should continue to present this information in periods after the entity becomes taxable to the extent that the earlier comparable periods are presented.

With respect to the pro forma financial information, any undistributed earnings or losses of an S corporation are viewed as distributions to the owners immediately followed by a contribution of capital to the new taxable entity. ASC 505-10-S99-3 states that these earnings or losses should therefore be reclassified to paid-in capital.

See Deloitte’s Roadmap Initial Public Offerings for additional guidance on pro forma financial information.

14.8 Statement of Cash Flows

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. See Appendix D for a sample of this required disclosure.

14.9 Additional Disclosure Requirements

An entity that becomes a public registrant may be required to provide additional disclosures about its income taxes that were not required in prior financial statements. In addition to providing the disclosures described below, public entities must present, under SEC Regulation S-X, Rule 12-09, a “[l]ist, by major classes, [of] all valuation and qualifying accounts and reserves not included in specific schedules,” including valuation allowances related to DTAs. This information can be disclosed either in the footnotes to the financial statements or in a supplemental Schedule II in an entity’s annual filings. It should also include a rollforward of such accounts, showing additions charged to costs and expenses, additions charged to other accounts, and deductions throughout the year.

14.10 Disclosures Outside the Financial Statements — MD&A

The filings of public entities must include MD&A. Discussion and analysis of income taxes is an important part of an entity’s MD&A since income taxes can be a significant factor in the entity’s operating results. Such discussion should address the following (if material):

Critical accounting estimates — The determination of income tax expense, DTAs and DTLs, and UTBs inherently involves several critical accounting estimates of current and future taxes to be paid. Management should provide information about the nature of these estimates in MD&A.
Liquidity and capital resources — The SEC staff expects registrants to disclose (1) the amount of cash and short-term investments held by foreign subsidiaries that would not be available to fund domestic operations unless the funds were repatriated and (2) whether additional tax expense would need to be recognized if the funds are repatriated. Although we expect scenarios such as these to be less prevalent than they have been historically, an entity may still be subject to income tax on its foreign investments (e.g., foreign exchange gains or losses on distributions and withholding taxes).
Contractual obligations — See Section 14.4.5.

In addition to discussion of the results of operations, SEC Regulation S-K, Item 303(a), requires entities to provide certain forward-looking information related to “material events and uncertainties known to management that would cause reported financial information not to be necessarily indicative of future operating results or of future financial condition.”

Many tax-related events and uncertainties may need to be elaborated on in MD&A. For instance, before the enactment of tax law proposals or changes to existing tax rules, an SEC registrant should consider whether the potential changes represent an uncertainty that management reasonably expects could have a material effect on the registrant’s results of operations, financial position, liquidity, or capital resources. If so, the registrant should consider disclosing information about the scope and nature of any potential material effects of the changes.

After the enactment of a new tax law, registrants should consider disclosing, when material, the anticipated current and future impact of the law on their results of operations, financial position, liquidity, and capital resources. In addition, registrants should consider providing disclosures in the critical accounting estimates section of MD&A to the extent that the changes could materially affect existing assumptions used in estimating tax-related balances.

The SEC staff also expects registrants to provide early-warning disclosures to help users understand various risks and how those risks potentially affect the financial statements. Examples of such risks include situations in which (1) the registrant may have to repatriate foreign earnings to meet current liquidity demands, resulting in a tax payment (e.g., withholding taxes) that may not be accrued for; (2) the historical effective tax rate is not sustainable and may change materially; (3) the valuation allowance on net DTAs may change materially; and (4) tax positions taken during the preparation of returns may ultimately not be sustained. Early-warning disclosures give investors insight into management’s underlying assumptions as well as the conditions and risks an entity faces before a material change or decline in performance is reported.