7.4 Intraperiod Tax Allocation in Interim Periods

ASC 740-270

45-1 Subtopic 740-20 establishes requirements to allocate total income tax expense (or benefit) of an entity for a period to different components of comprehensive income and shareholders’ equity. That process is referred to as intraperiod tax allocation. This Section addresses that required allocation of income tax expense (or benefit) in interim periods.

45-2 Section 740-20-45 describes the method of applying tax allocation within a period. The tax allocation computation shall be made using the estimated fiscal year ordinary income together with unusual items, infrequently occurring items, and discontinued operations for the year-to-date period.

45-3 Discontinued operations that will be presented net of related tax effects in the financial statements for the fiscal year shall be presented net of related tax effects in interim financial statements. Unusual or infrequently occurring items that will be separately disclosed in the financial statements for the fiscal year shall be separately disclosed as a component of pretax income from continuing operations, and the tax (or benefit) related to those items shall be included in the tax (or benefit) related to continuing operations. See paragraphs 740-270-25-12 through 25-14 for interim period recognition guidance when an entity has a significant unusual or infrequently occurring loss or a loss from discontinued operations. See paragraphs 740-270-45-7 through 45-8 for the application of interim period allocation requirements to recognized income tax expense (or benefit) and discontinued operations. See Example 7 (paragraph 740-270-55-52) for an illustration of the income statement display of these items.

45-4 Paragraph 740-20-45-3 requires that the manner of reporting the tax benefit of an operating loss carryforward recognized in a subsequent year generally is determined by the source of the income in that year and not by the source of the operating loss carryforward or the source of expected future income that will result in realization of a deferred tax asset for the operating loss carryforward. The tax benefit is allocated first to reduce tax expense from continuing operations to zero with any excess allocated to the other source(s) of income that provides the means of realization, for example, discontinued operations, other comprehensive income, and so forth. That requirement also pertains to reporting the tax benefit of an operating loss carryforward in interim periods.

45-5 Paragraph 740-270-25-11 establishes the requirement that when the tax effects of losses that arise in the early portions of a fiscal year are not recognized in that interim period, no tax provision shall be made for income that arises in later interim periods until the tax effects of the previous interim losses are utilized.

Specific Requirements Applicable to Discontinued Operations

45-6 This guidance addresses specific requirements for the intraperiod allocation of income taxes in interim periods when there are discontinued operations.

45-7 When an entity reports discontinued operations, the computations described in paragraphs 740-270-25-12 through 25-14, 740-270-30-11 through 30-13, and 740-270-45-2 through 45-3 shall be the basis for the tax (or benefit) related to the income (or loss) from operations of the discontinued operation before the date on which the criteria in paragraph 205-20-45-1E are met.

45-8 Income (or loss) from operations of the discontinued operation, prior to the interim period in which the date on which the criteria in paragraph 205-20-45-1E are met occurs, will have been included in ordinary income (or loss) of prior periods and thus will have been included in the estimated annual effective tax rate and tax (or benefit) calculations described in Sections 740-270-30 and 740-270-35 applicable to ordinary income. The total tax (or benefit) provided in the prior interim periods shall not be recomputed but shall be divided into two components, applicable to the remaining ordinary income (or loss) and to the income (or loss) from operations of the discontinued operation as follows. A revised estimated annual effective tax rate and resulting tax (or benefit) shall be computed, in accordance with Sections 740-270-30 and 740-270-35 applicable to ordinary income, for the remaining ordinary income (or loss), on the basis of the estimates applicable to such operations used in the original calculations for each prior interim period. The tax (or benefit) related to the operations of the discontinued operation shall be the total of:

The difference between the tax (or benefit) originally computed for ordinary income (or loss) and the recomputed amount for the remaining ordinary income (or loss)
The tax computed in accordance with paragraphs 740-270-25-12 through 25-14; 740-270-30-11 through 30-13; and 740-270-45-2 through 45-3 for any unusual or infrequently occurring items of the discontinued operation.

See Example 4 (paragraph 740-270-55-29) for an illustration of accounting for income taxes applicable to income (or loss) from discontinued operations at an interim date.

The requirements within ASC 740-20 to allocate the total income tax expense (or benefit) of an entity to different components of comprehensive income and shareholder’s equity are applicable to interim periods (the “with-and-without” intraperiod allocation model; see Chapter 6). ASC 740-270-45-2 states, in part, that “[t]he tax allocation computation shall be made using the estimated fiscal year ordinary income together with unusual items, infrequently occurring items, and discontinued operations for the year-to-date period.”

The intraperiod allocation of tax effects in an earlier quarter may be revised in a later quarter. For example, a tax effect may be allocated to an item other than income from continuing operations during the first quarter of the fiscal year. However, as a result of the occurrence of unanticipated events in a later quarter of the same fiscal year, the allocation of the tax effect to that item could change (e.g., a component classified as a discontinued operation might be sold in the current year, whereas the entity’s initial expectation was that it would not be sold until the subsequent year). The change in tax effect should be reflected as an adjustment of the original allocation. The objective should be to properly reflect the intraperiod allocation of tax expense for the annual period. The intraperiod tax allocation should be adjusted at each interim date, if necessary, to achieve that goal.

This approach is consistent with the example in ASC 740-270-55-28, which illustrates the accounting in interim periods for income taxes applicable to unusual or infrequently occurring items. However, this conclusion does not apply to the interim-period effects of changes in tax law or rates. As discussed in ASC 740-10-45-17, the effects of changes in tax law or rates on prior interim periods should be included in the current interim period as part of income from continuing operations.

Example 7-14

In the first and second quarters of 20X1, an entity generates tax benefits from unrealized losses on an AFS debt security, which results in the recognition of a DTA. In accordance with ASC 740-20-45-11(b), the expense related to the unrealized losses is recorded net of tax through OCI. On the basis of the entity’s expected future earnings, no valuation allowance on the DTA is deemed necessary. No further tax benefits are generated in the third and fourth quarters.

Beginning in the third quarter and through the end of the fiscal year, unanticipated events result in continued operating losses for the entity; by year-end, a full valuation allowance on the DTA is necessary. Although the recognition of the benefit of the DTA in OCI was appropriate in the first and second quarters, the application of the intraperiod allocation approach to the YTD income in the third quarter would result in there being no tax benefit allocated to OCI, and a valuation allowance should be recognized through OCI in the fourth quarter.

For the annual period, there is no impact on the intraperiod tax allocation because the need for a valuation allowance occurred in the same annual period in which the DTA was generated. If the valuation allowance was not required until the subsequent year, the change in the valuation allowance would be allocated to income from continuing operations, in accordance with ASC 740-20-45-4.

Example 7-15

In the first quarter of 20X0, an entity is evaluating whether to release a valuation allowance against an NOL DTA on the basis of an expected gain on a sale of a discontinued operation (assume that the income from the sale is of the appropriate character for the entity to realize the DTA and is the only source of income during the year).

When there is uncertainty about the timing of the sale, the entity should determine, by using its best estimate, the period in which the sale will be finalized. If management expects to sell the component in the current year, the entity should follow Approach 1 below. If management does not expect to sell the component in the current year, the entity should follow Approach 2 below. Whichever approach is applied on the basis of an entity’s facts and circumstances, the objective to properly reflect the intraperiod allocation of tax expense for the annual period should be met.

Approach 1 — Allocate the anticipated benefit to discontinued operations in the quarter and YTD period in which income is available to offset the DTA (which would be the period in which the sale occurs in this example, in accordance with ASC 740-270-25-4). If management’s expectation regarding the timing of the sale of the component changes in a subsequent interim period such that the sale is now expected to occur in the subsequent year, the anticipated benefit should be recognized in continuing operations in the quarter in which it becomes apparent, on the basis of the entity’s best estimate, that the transaction will not occur in the current year.
Approach 2 — Allocate the anticipated benefit to income from continuing operations in the first quarter and, if income from discontinued operations becomes available in a subsequent quarter and YTD period and is sufficient to offset the DTA (which would be the period in which the sale occurs in this example), reclassify the benefit to income from discontinued operations.

See Section 6.2.2 for further guidance on accounting for changes in valuation allowances resulting from items other than continuing operations.

7.4.1 Recognition of the Tax Benefit of an Operating Loss Carryforward in an Interim Period

The method of intraperiod tax allocation for annual periods also applies to reporting the tax benefit of an operating loss carryforward in interim periods. ASC 740-20-45-3 indicates that an entity determines the tax benefit of an operating loss carryforward recognized in a subsequent year under ASC 740 in the same way that it determines the source of the income in that year and not in the same way that it determines the source of (1) the operating loss carryforward or (2) the “expected future income that will result in realization of a deferred tax asset” for the operating loss carryforward. The tax benefit is allocated first to reduce income tax expense from continuing operations to zero with any excess benefit allocated to other sources of income that provide a means of realization (e.g., gains from extraordinary items and from discontinued operations).

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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.