4.1 Overview and Scope

As discussed in Chapter 1, an entity’s overall objectives in the accounting for income taxes are to (1) “recognize the amount of taxes payable or refundable for the current year” and (2) “recognize deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entity’s financial statements or tax returns.” The total tax provision includes current tax expense (benefit) (i.e., the amount of income taxes paid or payable [or refundable] for a year as determined by applying the provisions of the enacted tax law to the taxable income or the excess of deductions over revenues for that year) and deferred tax expense (or benefit) (i.e., change in DTAs and DTLs during the year). The total tax expense reported in the financial statements should reflect the income tax effects of tax positions on the basis of the two-step process in ASC 740-10, recognition (step 1) and measurement (step 2). The recognition and measurement requirements of ASC 740 should be applied only to uncertainties in income taxes and do not apply to non-income taxes such as sales tax, value-added tax, and payroll tax.

See Section 11.4 for a discussion of the accounting for uncertainty in income taxes in business combinations.

4.1.1 UTB Decision Tree and Assumptions in Recognition and Measurement

The decision tree below provides an overview of the process for recognizing the benefits of a tax position under ASC 740.

The table below summarizes the framework an entity uses when applying the two-step process of recognition and measurement under ASC 740-10.

Step 1 — Recognition	Step 2 — Measurement
The position will be examined	Same
The examiner will have full knowledge of all relevant information	Same
Offsetting or aggregating tax positions should not be considered	Same
The evaluation should be based solely on the position’s technical merits	The evaluation should be based on all relevant information available on the reporting date
It should be assumed that the position will be resolved in a court of last resort	The conclusion should be based on the amount the taxpayer would ultimately accept in a negotiated settlement with the tax authority

4.1.2 Consideration of Tax Positions Under ASC 740

ASC 740 applies to all tax positions in a previously filed tax return or tax positions expected to be taken in a future tax return. A tax position can result in a permanent reduction of income taxes payable, a deferral of income taxes otherwise currently payable to future years, or a change in the expected realizability of DTAs.

The definition of “tax position” in ASC 740-10-20 also lists the following examples of tax positions that are within the scope of ASC 740:

“A decision not to file a tax return” (e.g., a decision not to file a specific state tax return because nexus was not established).
“An allocation or a shift of income between jurisdictions” (e.g., transfer pricing).
“The characterization of income or a decision to exclude reporting taxable income in a tax return” (e.g., interest income earned on municipal bonds).
“A decision to classify a transaction, entity, or other position in a tax return as tax exempt” (e.g., a decision not to include a foreign entity in the U.S. federal tax return).
“An entity’s status, including its status as a pass-through entity or a tax-exempt not-for-profit entity.”

Uncertainties related to tax positions not within the scope of ASC 740, such as taxes based on gross receipts, revenue, or capital, should be accounted for under other applicable literature (e.g., ASC 450).

4.1.2.1 Tax Positions Related to Entity Classification

Many entities are exempt from paying taxes because they qualify as either a tax-exempt (e.g., not-for-profit organization) or a pass-through entity (e.g., Subchapter S corporation, partnership), or they function similarly to a pass-through entity (e.g., REIT, RIC). To qualify for tax-exempt or pass-through treatment, such entities must meet certain conditions under the relevant tax law.

According to the definition of a tax position in ASC 740-10-20, a decision to classify an entity as tax exempt or as a pass-through should be evaluated under ASC 740 for recognition and measurement. In some situations, it may be appropriate for the entity to consider how the administrative practices and precedents of the relevant tax authority could affect its qualification for tax-exempt or pass-through treatment.

For example, a Subchapter S corporation must meet certain conditions to qualify for special tax treatment. If the Subchapter S corporation violates one of these conditions, it might still qualify for the special tax treatment under a tax authority’s widely understood administrative practices and precedents. Sometimes, however, these administrative practices and precedents are available only if an entity self-reports the violation. In assessing whether self-reporting affects an entity’s ability to avail itself of administrative practices and precedents, the entity should consider whether relief would still be as readily available if, before self-reporting, the tax authority contacts the entity for an examination. If an entity has the ability to pursue relief, and the likelihood of relief is not compromised even if, before self-reporting, the tax authority makes contact for an examination, then the entity can rely on these administrative practices and precedents for recognition purposes because such administrative practices and precedents are not contingent upon self-reporting. However, if relief were no longer available, or the likelihood of relief were compromised had the tax authority contacted the entity for examination before self-reporting, then the administrative practice would be contingent upon self-reporting, and the entity would not be able to rely on these administrative practices and precedents for recognition purposes until the violation had actually been self-reported.

4.1.2.2 Unit of Account

Each individual tax position must be analyzed separately under ASC 740. ASC 740-10-25-13 states that an entity’s determination of what constitutes a unit of account for its individual tax position “is a matter of judgment based on the individual facts and circumstances.” To determine the unit of account, the entity should consider, at a minimum, (1) the manner in which it prepares and supports its income tax return and (2) the approach it expects the tax authorities will take during an examination. The entity may also consider:

The composition of the position — whether the position is made up of multiple transactions that could be individually challenged by the tax authority.
Statutory documentation requirements.
The nature and content of tax opinions.
The history of the entity (or reliable information about others’ history) with the relevant tax authority on similar positions.

The determination of the unit of account to which ASC 740 is applied is not an accounting policy choice; rather, it is a factual determination that is based on the facts and circumstances for the tax position being considered. Every tax position (e.g., transaction, portion of transaction, election, decision) for which a tax reporting consequence is reported in the financial statements is within the scope of ASC 740 and is, therefore, a possible unit of account to which ASC 740 applies. The unit of account is determined by evaluating the facts and circumstances of the tax position.

Once determined, the unit of account for a tax position should be the same for each position and similar positions from period to period unless changes in facts and circumstances indicate that a different unit of account is appropriate.

Changes in facts and circumstances that could cause management to reassess its determination of the unit of account include significant changes in organizational structure (e.g., sale of a subsidiary), recent experience with tax authorities, a change in tax law, and a change in the regulatory environment within a jurisdiction.

Although ASC 740-10-55-87 through 55-89 acknowledge that changes in a unit of account may occur, such changes are expected to be infrequent. Further, if a change in unit of account is caused by something other than a change in facts and circumstances, it may be an indication that ASC 740 was applied incorrectly in prior periods.

A change in judgment regarding the appropriate unit of account that does not result from the correction of an error should be treated as a change in estimate and applied prospectively.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.