Corporate Tax Pros: Get Ready for Income Tax Disclosure Changes

Investor-friendly changes proposed for income tax disclosures

According to the FASB, the proposed improvements stem from investor and stakeholder feedback regarding current income tax disclosures and the ability to properly evaluate a company’s worldwide tax exposure. The proposed amendments would result in more transparent and useful information. Specifically, the income tax disclosures would improve visibility into an entity’s worldwide operations, including related income tax expense and cash tax payments. Under the proposal, the reporting of the effective tax rate (ETR) reconciliation would provide more insight into the key drivers of the change in effective tax rate by jurisdiction and classification.

What’s different: clarifications and ASU 740-related revisions

The proposal aims to provide more clarity and usefulness than the current tax financial statement disclosure requirements. The change specifically addresses updating current income tax disclosures related to the tax rate reconciliation as well as requiring more detail in the reporting of income taxes paid. According to FASB, the improved reporting would allow investors to understand risks and opportunities related to an entity’s exposure to possible changes in jurisdictional tax legislation, assess whether income tax information affects cash flow forecasts or capital allocation decisions, and identify possible opportunities to increase future cash flows. Additionally, the proposal includes revisions to the ASU 740 income tax disclosure updates proposed in 2019 and eliminates several reporting requirements:

• Replacing the term public entity with the term public business entity
• Eliminating the requirement for all entities to (a) provide a disclosure of the nature and estimate of the range of the reasonably possible change in the unrecognized tax benefits balance in the next 12 months or (b) make a statement that an estimate of the range cannot be made.
• Removing the requirement to disclose the cumulative amount of each type of temporary differences 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.

Key aspects

The FASB proposals indicate key aspects by organization type (applicable for public companies only, other non-public entities, or all entities) with updates outlined by the description, entity classification, and reporting period.

Rate Reconciliation: Specific Category Reporting – Public/Annual Reporting – Specific categories would be required to be reported in a tabular fashion; these include: (a) state and local income tax, net of federal (national) income tax effect; (b) foreign tax effects; (c) enactment of new tax laws; (d) tax credits; (e) valuation allowances; (f) nontaxable or nondeductible items; and (g) changes in unrecognized tax benefits.

Rate Reconciliation: Separate Disclosure  – Public/Annual Reporting – The proposed reporting would require the disclosure of 5% or greater reconciling items. This rate is determined by multiplying pre-tax income or loss from continued operations by the applicable statutory federal (national) income tax rate if the reconciling item (1) is within the effect of cross-border tax laws, tax credits, and nontaxable or nondeductible items, bifurcated by nature of activity; (2) is within the foreign tax effects category, bifurcated by jurisdiction and nature of activity; or (3) does not fall into the categories referenced above should be disaggregated by nature of activity.

Rate Reconciliation: Classifying Income Taxes by Category – Public/Annual Reporting – Classification by jurisdiction for state and local taxes should include income tax imposed at the state and local level within the country of domicile. Additionally, companies should include a qualitative description of those state and local jurisdictions generating the largest component of this expense. Classification of the foreign tax should only include income taxes imposed by foreign jurisdictions. All other specific categories referenced above should include income taxes incurred by country of domicile.

Rate Reconciliation: Year over Year Change – Public/Annual and Interim Reporting Period – The proposed reporting would require an explanation of substantial variances year over year, including the nature and effect of the changes. For interim reporting periods, an entity would be required to explain where a reconciling item caused substantial change in the estimated annual tax rate as compared to the prior annual effective tax rate including requirements of ASC 740 paragraph 740-270-50-1.

Rate Reconciliation: Qualitative Disclosures – Private Companies/Annual and Interim Reporting Period – Qualitative disclosures are required by specific category and jurisdiction for drivers of significant variations between the statutory and effective tax rate.

Income Taxes Paid – All Entities/Interim and Annual Reporting – All entities would be required to report their year-to-date income tax payments, net of refunds received, bifurcated by federal, state, and foreign taxes. A specific jurisdiction should be identified when income tax payments, net of refunds received, are equal to or greater than 5% or more of overall income taxes paid annually.

Income (Loss) Before Tax and Income Tax Expense – All Entities/Interim and Annual Reporting – Income (Loss) from continuing operations before taxes would be required to be split between domestic and foreign income. Additionally, the income tax expense or benefit would need to be bifurcated between federal, state, and foreign taxes.

Taking action

If enacted, the FASB proposals would lead to a substantial amount of detailed preparation by tax and accounting departments to conform to these new requirements.

Planning for the proposed tax disclosure improvements should be a priority for company’s financial accounting and tax functions. Both public and private companies should begin to take action to prepare for the proposed FASB reporting requirements, which will take some planning and foresight by management. It will be beneficial to reexamine the latest rate reconciliation using the parameters outlined in the FASB proposal (see details above). Additionally, companies could benefit from organizing their income tax payments by federal, state, and foreign taxes for the last reporting period and the current period, as outlined in the proposal.

The FASB will accept comments until May 30, 2023, so companies should take time to go through the proposal exercise before that deadline in order to raise related questions or concerns. There are several ways to provide feedback: emailing comments to director@fasb.org and noting file reference no. 2023-ED100; by sending a letter to Technical Director, File Reference No. 2023-ED100, FASB, 801 Main Ave, PO Box 5116, Norwalk, CT 06856-5116; or by using the FASB e-feedback form. For more information, see the full FASB Exposure Draft.

As companies face evolving tax laws and reporting requirements, they should also continue to allocate time and resources toward educating staff and investing in tools to capture data for efficient and accurate reporting.