Accounting Standards Update Enhances Income Tax Disclosures

As a result of investor feedback and ongoing research, FASB has issued Accounting Standards Update 2023-09 to enhance income tax disclosures.

Enhancing disclosures relating to income tax rate reconciliation and income taxes paid will provide investors with better information for evaluating how tax rates, risks, and planning, along with other related matters, may affect an entity’s operations and future cash flows.

ASU 2023-09 applies to all entities subject to ASC Topic 740; however, certain disclosure requirements established by the amendments are not required for entities other than public business entities.

Effective date and transition considerations

The update’s amendments are effective for the following annual periods:

• Public business entities (PBE) beginning after December 15, 2024.
• Entities other than PBEs beginning after December 15, 2025.

Early adoption is permitted for annual financial statements not yet issued (or made available for issuance), either prospectively or retrospectively.

An entity may not adopt this update in an interim period.

Rate reconciliation disclosures and public business entities

This update amends ASC 740-10-50-12 to require a PBE to disclose a reconciliation “between the amount of reported income tax expense (or benefit) from continuing operations and the amount computed by multiplying the income (or loss) from continuing operations before income taxes by the applicable statutory federal (national) income tax rate of the jurisdiction (country) of domicile.”

Additionally, ASC 740-10-50-12 is amended to indicate that when a PBE is not domiciled in the United States, it should use the federal (national) income tax rate in that entity’s country of domicile in the reconciliation. Further, whenever the United States federal tax rate is not used in the reconciliation, the PBE should disclose what rate is used and the basis for using that rate.

Eight categories for Public Business Entities

The update establishes eight categories where PBEs are required to disaggregate the income tax reconciliation by both percentage and reporting currency amount in a tabular format. These include:

Any reconciling item with an absolute value equal to or exceeding the quantitative threshold of “five percent of the amount computed by multiplying the income (or loss) from continuing operations before income taxes by the applicable federal (national) income tax rate” must be further disaggregated, except for categories one, three, six, and eight.

While some reconciling items may be closely related and offset each other, presentation on a gross basis is required unless net presentation is specifically permitted. If a reconciling item meets the 5% threshold but does not fall into one of the specified categories, it is required to be disaggregated by nature and presented separately as an “other adjustment.”

An entity based in the United States subject to the 21% statutory federal income tax rate must separately disclose reconciling items with a tax effect greater than 1.05% (21% x 5%).

ASC 740-10-50-12C requires a PBE to provide an explanation for individual reconciling items “such as the nature, effect, and underlying causes of the reconciling items and the judgement used in categorizing” when not otherwise apparent.

1. State and local income taxes, net of federal (national) income tax effect

This category refers to income taxes imposed at the state and local level within the jurisdiction (country) of domicile. A qualitative description of the states and local jurisdictions that make up a majority (greater than 50%) of the effect of this category is also required.

To identify the jurisdictions that comprise the majority of the effect, a PBE must begin with the state or local jurisdiction that has the largest effect and add states or local jurisdictions with the next largest effect (in descending order) until the aggregated effect exceeds 50%.

2. Foreign tax effects

This category includes reconciling items resulting from income taxes imposed by jurisdictions outside the entity’s country of domicile. Reconciling items must be disaggregated by both jurisdiction (country) and nature based on the 5% threshold discussed above.

Each foreign jurisdiction meeting the 5% threshold must be disclosed as a separate reconciling item. Additionally, any reconciling item within a foreign jurisdiction which meets the 5% threshold, regardless of whether that jurisdiction in total meets the 5% threshold, should be separately disclosed by nature.

3. Effects of changes in tax laws or rates enacted in the current period

Any cumulative tax effects of a change in enacted tax laws or rates on deferred tax assets and liabilities at the date of enactment are to be included in this category.

This category includes only reconciling items resulting from income taxes in the entity’s country of domicile.

4. Effect of cross-border tax laws

This category includes the effect of incremental income taxes imposed by the jurisdiction (country) of domicile on income earned in foreign jurisdictions. If a tax credit is provided on the same income during the same reporting period by the jurisdiction (country) of domicile, the net basis of this effect may be presented.

ASC 740-10-15-12A(c)(3) provides the specific example, “the tax effect related to the global intangible low-taxed income and its related foreign tax credits may be presented on a net basis as one reconciling item in the effect of cross-border tax laws category.

This category includes only reconciling items resulting from income taxes in the entity’s country of domicile.

5. Tax credits

All federal tax credits not included in the effect of cross-border tax laws category should be presented in this category. This category includes only reconciling items resulting from income taxes in the entity’s country of domicile.

6. Changes in valuation allowances

Valuation allowances for deferred tax assets initially recognized or subsequently changed during the current period should be reflected in this category.

7. Nontaxable or nondeductible items

This category is comprised of the effects of all items that are nontaxable or nondeductible. It also includes only reconciling items resulting from income taxes in the entity’s country of domicile.

8. Changes in unrecognized tax benefits

This category includes reconciling items resulting from changes in judgment related to tax positions taken in prior periods. Unrecognized tax benefits related to tax positions taken in the current period are excluded from this category and instead presented on a net basis in the category in which the tax position is presented. Finally, reconciling items within this category may be disclosed on an aggregated basis for all jurisdictions.

Rate reconciliation disclosures for entities other than PBEs

This update does not require non-PBE entities to disclose a numerical reconciliation between the statutory and effective tax rates. However, this update does require an entity other than a PBE to “qualitatively disclose the nature and effect of specific categories of reconciling items” listed above and “individual jurisdictions that result in a significant difference between the statutory tax rate and the effective tax rate.”

Income taxes paid

This update requires for each annual period presented that all entities (PBE and non-PBE) disclose the amount of income taxes paid (net of refunds received) disaggregated by federal (national), state, and foreign.

Further disaggregation is required for each individual jurisdiction in which income taxes paid (net of refunds received) equals or exceeds “5% of total income taxes paid (net of refunds received).”

Disclosure of disaggregated amounts for all entities

Additional disclosures added by this update include:

• Income (or loss) from continuing operations before income tax expense (or benefit) disaggregated between domestic and foreign.
• Income tax expense (or benefit) from continuing operations disaggregated by federal (national), state and foreign.

These are required to be presented for each annual reporting period.

Disclosures removed

The update removes the following disclosure requirements for all entities:

• The nature and estimate of the range of the reasonably possible change in the unrecognized tax benefits balance in the next 12 months (or to make a statement that an estimate of the range cannot be made).
• The cumulative amount of each type of temporary difference when a deferred tax liability is not recognized because of the exceptions to comprehensive recognition of deferred taxes related to subsidiaries and corporate joint ventures.

Next Steps for ASU 2023-09

All types of entities are affected by the changes to ASU 2023-09. It’s important to have a trusted advisor on your side to help you navigate the complexity of assurance and accounting changes.