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Accounting, Audit & Corporate Finance Library

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Accounting and Financial Statements (US GAAP)

Accounting for Income Taxes

Chapter 1 Introduction and Authoritative Literature for Accounting for income Taxes

100 Introduction

100 Introduction

Coverage of PPC's Guide to Accounting for Income Taxes

100.1 Not long after the introduction of the United States federal income tax in the early twentieth century,

practitioners and academics began to question the proper accounting for income taxes in financial reports. The

first formal accounting pronouncement concerning income taxes, Accounting Research Bulletin No. 23,

Accounting for Income Taxes, was issued almost 70 years ago, but did little to quell the different theories. As

subsequent pronouncements that addressed the accounting for income taxes were issued, differing opinions

remained concerning the practical and theoretical approach to accounting for income taxes. It was not until the

end of the twentieth century that these differences were substantially resolved with the issuance of SFAS

No. 109, Accounting for Income Taxes. The Statement made significant changes to the methods used to

account for income taxes in annual financial statements. SFAS No. 109 was substantially superseded all other

standards for accounting for income taxes in annual financial statements.

100.2 Similar to previous guidance, SFAS No. 109 required the financial statements to recognize the tax effects

of transactions in the same period the transactions are recorded. But its liability method was fundamentally

different from previous standards. SFAS No. 109 was subsequently incorporated into the FASB Accounting

Standards Codification (ASC). The FASB ASC effectively combines SFAS No. 109 with all other authoritative

literature that affects accounting for income taxes and organizes that literature within a single ASC Topic—

FASB ASC 740, Income Taxes. PPC's Guide to Accounting for Income Taxes provides an in-depth explanation

of the rules under FASB ASC 740, which affect all GAAP financial statement services since GAAP is the same

regardless of whether the financial statements are audited, reviewed, or compiled.

How the Guide Is Organized

100.3 PPC's Guide to Accounting for Income Taxes is organized as follows:

• Chapter 1—Introduction and Authoritative Literature for Accounting for Income Taxes—provides an

overview of the authoritative literature governing accounting for income taxes. Appendix 1A, “Quick Start to

Accounting for Income Taxes,” provides an overview of the current and deferred income tax calculation.

Appendixes 1B and 1C provide practice aids that may be used to compute and record income taxes for

most entities. Appendix 1D provides a practice aid for assessing the reasonableness of income tax

calculations. Appendix 1E provides a checklist for accounting for income taxes in accordance with FASB

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ASC 740. Appendix 1F provides a discussion of how to utilize Excel to compute income tax provisions.

Appendix 1G provides guidance on accounting for uncertainty in income taxes.

• Chapter 2—Temporary and Permanent Differences—discusses temporary and permanent differences

between accounting for transactions for financial statement and income tax reporting. Permanent

differences will never be included in taxable income, while temporary differences will be included in both

financial and taxable income but in different periods. Thus, temporary differences result in the recording of

deferred income taxes. The chapter provides detailed guidance on identifying temporary differences and

accounting for them. An appendix to the chapter describes the types of temporary differences commonly

encountered by closely held businesses.

• Chapter 3—Calculating Current Income Taxes—describes the accounting for current income taxes. Since

current income taxes represent taxes actually due for the year, the chapter focuses on current income tax

rules and regulations with special emphasis on the alternative minimum tax system (AMT). The text of the

chapter relies heavily on illustrations, which generally are designed to explain a single concept. An

appendix to the chapter provides more complex illustrations of the major points. The illustrations in the text

and in the appendix use actual tax rates and consider both the regular tax system and the AMT system.

• Chapter 4—Calculating Deferred Income Taxes—explains accounting for deferred income taxes. Similar

to Chapter 3, the chapter relies heavily on illustrations. The chapter also provides guidance on selecting a

tax rate, considering the need for a valuation allowance, and estimating future taxable income. Appendixes

to the chapter provide illustrative calculations as well as a worksheet for considering the need for a

valuation allowance.

• Chapter 5—Presentation and Disclosure of Income Taxes—addresses presentation and disclosure

considerations, including balance sheet classification of deferred tax assets and liabilities, intraperiod tax

allocation, and disclosures required by FASB ASC 740. The chapter provides excerpts from illustrative

financial statements and sample wording for notes. Appendixes to the chapter illustrate more complex

situations and provide additional examples of disclosures as well as an income tax disclosure checklist and

worksheets for reconciling the expected and actual tax provision.

• Chapter 6—Accounting for Income Taxes—Special Areas—discusses the following special areas of

accounting for income taxes:

a. Interim financial statements.



b. Accounting for a change in a company's tax status with special emphasis on changes to and

from S corporation status.

c. Consolidated financial statements.

d. Equity method investees.

e. Indefinite reversal criteria.

f. Acquisition method business combinations.

g. Special disclosures for nontaxable entities.

h. Income taxes in personal financial statements.

i. Tax benefits resulting from investments in affordable housing projects.

j. Tax consequences of employee stock compensation.

k. Accounting for acquired temporary differences in acquisitions not accounted for as business

combinations.

l. Accounting for tax benefits recognized after a quasi reorganization.

m. Effect of deferred taxes on goodwill impairment.



Each section of the chapter provides illustrations of the major points and sample notes. Appendixes to the

chapter include interim period tax expense worksheets as well as example calculations for many of the

preceding items.

Using the Guide

100.4 Changes in tax law, combined with the accounting rules under FASB ASC 740, make accounting for

income taxes even more difficult. For example, the Tax Reform Act of 1986 imposed an alternative minimum tax

system that needs to be considered under the standards. To assist, PPC's Guide to Accounting for Income

Taxes integrates relevant accounting and tax guidance into a useful tool for all accountants, whether they

specialize in accounting, auditing, or tax.

100.5 Each chapter of the Guide is structured to stand alone and provides the essential guidance on the subject

matter addressed. The chapters may either be read in their entirety for an overview of the issues and problems

or used as a reference source to research a particular question. Each chapter contains a detailed table of

contents to facilitate the location of specific topics.

© 2012 Thomson Reuters/PPC. All rights reserved.

END OF DOCUMENT -

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101 Authoritative Literature for Accounting for Income Taxes

101 Authoritative Literature for Accounting for Income Taxes

The Scope of GAAP for Income Taxes

101.1 FASB ASC 740 provides the principal guidance on all aspects of accounting for income taxes including

the following:

a. Computing deferred tax assets or liabilities.

b. Presenting income tax expense in the income statement.

c. Disclosing information about income taxes.

d. Recognizing the effects of operating loss carrybacks and carryforwards.

e. Accounting for changes in tax rates.

f. Accounting for changes in a company's tax status.

101.2 FASB ASC 740 applies to all income taxes including federal, foreign, state, and local (including franchise)

taxes based on income. The guidance applies to a company's domestic and foreign operations that are

consolidated, combined, or accounted for by the equity method and to foreign companies that prepare financial

statements in accordance with U.S. generally accepted accounting principles.



The Liability Method

101.3 FASB ASC 740 uses the concept of comprehensive tax allocation; that is, the tax effects of events that

will ultimately affect both pretax accounting income and taxable income are reported in the period that the

events occur. FASB ASC 740 requires an asset and liability approach for accounting for income taxes,

commonly called the liability method. It focuses on the balance sheet and on calculating deferred tax assets and

liabilities. Its objective is to measure the future tax effects of differences between events recorded for financial

and income tax purposes at a particular point in time—the balance sheet date. Deferred income tax provisions

are the differences between deferred tax balance sheet accounts during the year. Under FASB ASC 740, the

basic calculation of the annual tax provision consists of the following elements:

a. Calculate the current tax provision for the year.

b. Calculate the tax effects at the end of the year of (1) differences between transactions recorded in the

financial statements and those recorded in the tax return and (2) loss and tax credit carryforwards.

c. Provide a valuation allowance for the portion of deferred tax assets for which there is not more than a

50% chance of realization.

d. Subtract the deferred tax asset and liability at the beginning of the year from the amounts at the end of

the year in steps b. and c. to obtain the deferred tax provision.

e. Add the difference to the current tax provision to obtain the total tax provision.

101.4 Under the liability method prescribed by FASB ASC 740, the amount of deferred taxes reported in the

balance sheet is determined based on the tax rates that are expected to be in effect in the period that

differences between the financial statements and the tax returns reverse. The initial calculations of deferred

taxes are considered to be estimates and are subject to adjustment if tax rates change, if taxes are repealed, or

if new taxes are imposed. Thus, at any point in time, deferred taxes recorded in the balance sheet represent the

tax effect of reversals of differences between the financial statements and tax return when the differences are

added to or subtracted from other sources of taxable income. The deferred tax effect is measured using the flat

tax rate (34% under current federal tax law or 35% if taxable income exceeds $10 million) or, when graduated

rates are a significant factor, using the average tax rate that would apply to the estimated average annual

taxable income during the reversal period. Therefore, calculating the tax effect requires estimating what that rate

will be and what taxable income will be during the reversal period.

101.5 An overview of the basic requirements of FASB ASC 740 is included in Appendix 1A to this chapter.

Detailed explanations of the requirements are provided in Chapters 2-6.



Accounting for Uncertainty in Income Taxes

101.6 GAAP for uncertainties in income taxes in FASB ASC 740 defines a criterion that an individual tax

position must meet before that position can be recognized in an enterprise's financial statements. The guidance

requires a presumption that the uncertain tax position will be audited by a tax examiner. The position should not

be recognized in the financial statements unless it is more likely than not (greater than 50%) to pass a tax audit

based solely on the technical merits of the position. Thus, the basic calculation of the annual tax provision (in

items a and b at paragraph 101.3) only considers tax positions that satisfy the more-likely-than-not criterion,

which may not agree to the tax positions used for the tax return. GAAP for uncertainties in income taxes also

provides guidance for measurement, classification, and disclosure of uncertain tax positions for annual and

interim financial statements.

101.7 Historically, temporary differences (the foundation of deferred income taxes) arise when the reported tax

basis of an asset or liability differs from its reported amount in the financial statements. When uncertainty exists,

however, a deferred temporary difference equals the difference between the portion of a reported tax basis of an

asset or liability that is more likely than not to pass a tax audit based solely on the technical merits of the

position and the reported amount in the financial statements.

101.8 Discussions and illustrative examples in this Guide generally assume that tax positions satisfy the more

likely than not requirements of GAAP for uncertainties in income taxes unless specifically stated otherwise.

(Accordingly, tax positions supporting income tax returns are the same as those used to support the income tax

provision for financial reporting purposes.) However, GAAP for uncertainties in income taxes is discussed

thoroughly in Appendix 1G and throughout the Guide, including illustrative examples and disclosures covering

topics such as identifying tax positions, evaluating and measuring uncertain tax positions, determining the effect

on the current and deferred tax provisions, and reporting uncertain tax positions in the financial statements.

GAAP Codification

101.9 As part of the Sarbanes-Oxley Act of 2002, the Securities and Exchange Commission (SEC) conducted a

study of the U.S. financial reporting system, resulting in recommendations to simplify the rulemaking process by

having a single entity establish general accounting standards and to improve the GAAP hierarchy. Partly in

response to the SEC's recommendations, the FASB released the FASB Accounting Standards Codification

(FASB ASC or Codification) on July 1, 2009, which is where the authoritative literature for accounting for income

taxes currently resides.

101.10 The FASB ASC superseded all previously existing GAAP sources and combined that underlying

accounting guidance, resulting in a single source of authoritative GAAP literature. Any accounting guidance not

in the FASB ASC is considered nonauthoritative. The Codification is organized as follows:

a. Topics. Topics represent a collection of related guidance, such as Leases. The four main types of topics

are:



(1) Presentation (200 Series). These topics relate only to presentation matters and do not address

recognition, measurement, or derecognition matters. Such topics include income statement,

balance sheet, earnings per share, etc.

(2) Financial Statement Accounts (300-700 Series). These topics are organized in a financial

statement order including assets (300s), such as receivables and inventory; liabilities (400s);

equity (500s); revenue (600s); and expenses (700s), including income taxes (740).

(3) Broad Transactions (800 Series). These topics relate to multiple financial statement accounts

and are generally transaction-oriented. Such topics include leases, business combinations,

derivatives, nonmonetary transactions, etc.

(4) Industries (900 Series). These topics relate to accounting that is unique to an industry or type

of activity. Such topics include airlines (908), healthcare entities (954), software (985), etc.

b. Subtopics. Subtopics represent subsets of a topic and are generally distinguished by type or by scope.

For example, operating leases and capital leases are two subtopics of the leases topic distinguished by

type of lease. Each topic contains an overall subtopic that generally represents the pervasive guidance for

the topic. Each additional subtopic represents incremental or unique guidance not contained in the overall

subtopic. Subtopics unique to a topic use classification numbers between 00 and 99.

c. Sections. Sections represent the nature of the content in a subtopic such as recognition, measurement,

disclosure, and so forth. Every subtopic uses the same sections unless there is no content for a particular

section.

d. Paragraphs. Paragraphs represent the order of the content in a section.

101.11 If the accounting treatment for a transaction or event is not specified within a source of authoritative

GAAP, an entity should first consider accounting principles for similar transactions or events within a source of

authoritative GAAP and then consider nonauthoritative guidance from other sources. Nonauthoritative sources

of guidance and literature include practices widely recognized or generally prevalent in the industry, FASB

Concepts Statements, AICPA Issues Papers, International Financial Reporting Standards (IFRSs) of the



International Accounting Standards Board (IASB), pronouncements of other professional associations or

regulatory agencies, Technical Information Service Inquiries and Replies included in AICPA Technical Practice

Aids, and accounting textbooks, handbooks, and articles.

101.12 Codification References in This Guide

FASB ASC references in this Guide are provided in a TTT-XX-SS-PP format (T=Topic, X=Subtopic, S=Section,

P=Paragraph). If portions of a reference are missing, that indicates that the guidance comes from multiple

subtopics, sections, or paragraphs. For those who subscribe to this Guide on either CD-ROM or Checkpoint and

also purchase the FASB material, the references to the Codification are active.

Codified Authoritative Literature for Income Taxes

101.13 Although SFAS No. 109 provided the primary source of guidance on accounting for income taxes prior to

the Codification, certain general and industry tax-related areas were covered by other pronouncements,

including a SFAS No. 109 implementation guide and numerous conclusions reached by the FASB Emerging

Issues Task Force. During the Codification, some of those other pronouncements were combined with the

guidance in SFAS No. 109 to become Topic 740 within the FASB ASC; some were codified within other FASB

ASC Topics; and others were not codified and are no longer authoritative. Most of the codified authoritative

literature on accounting for income taxes was placed in the following subtopics of FASB ASC 740:

• FASB ASC 740-10, Income Taxes—Overall.

• FASB ASC 740-20, Income Taxes—Intraperiod Tax Allocation.

• FASB ASC 740-30, Income Taxes—Other Considerations or Special Areas.

101.14 Income Tax Guidance Not Located in FASB ASC 740

Although the Codification dramatically improves the organization of income tax-related authoritative literature

compared to the numerous pre-codified sources, not all of the authoritative literature on accounting for income

taxes is located in one area. For example, most industry-related income tax issues are not covered in FASB

ASC 740. That guidance is generally found in the income taxes subtopic within the topic for that particular

industry (i.e., XXX-740). The industries with income tax guidance include the following:

• Casino Enterprises

• Common Interest Realty Associations



• Depository and Lending Entities

• Health Care Entities

• Insurance Entities

• Investment Companies

• Oil and Gas Producing Entities

• Regulated Entities

• Steamship Entities

Note that discussion of industry-related income tax guidance is generally outside the scope of this Guide.

101.15 Also, the following broad accounting areas outside FASB ASC 740 include guidance on accounting for

income taxes:

• Business Combinations (See section 606.)

• Equity Method Investees (See section 604.)

• Foreign Operations (See Appendix 2A and section 605.)

• Interim Periods (See section 601.)

• Investments in Qualified Affordable Housing Projects (See section 608 and Appendix 6D.)



• Leveraged Leases

• Reorganizations (See section 608.)

• Share-based Payments (See Appendix 2A and section 608.)

101.16 Index of Codified Literature

Exhibit 1-1 provides a subject index of the Codified authoritative literature for income taxes within and outside of

FASB ASC 740, including the related ASC references.

Exhibit 1-1

Index of Codified Authoritative Literature for Income Taxes

Subject

FASB ASC Reference

Topic-

Subtopic Section-Paragraph

Accounting for Income Taxes—

General

740-10 05-1 through 05-5, 05-7 through 05-10, 10-1

through 10-3, 15-1, 15-3 and 15-4, 25-1 through

25-4, 25-32 through 25-36, 25-38, 30-1 through 30

-5, 30-8 through 30-12, 40-6, 50-1 through 50-14,

50-16 through 50-18, 55-1 and 55-2, 55-49 and 55

-50, 55-79 and 55-80, 55-139 through 55-144, 55-

168 and 55-169, 55-212 through 55-216


Tax Accounting Method Change

740-10 55-59 through 55-63, 55-77, 55-205 through 55-

207


Alternative Minimum Tax

740-10 55-31 through 55-33


Built-in Capital Gains

740-10 55-64 and 55-65


Carryforward and Carrybacks

740-10 55-34 through 55-38


Deferred Tax Assets

740-30 25-9 through 25-14



Subject

FASB ASC Reference

Topic-



Deferred Tax Measurement

740-10 55-23 and 55-24


Deferred Tax Recognition

740-10 55-7 through 55-11, 55-120 through 55-123


Graduated Tax Rates

740-10 55-136 through 55-138


State and Local Taxes

740-10 55-25 and 55-26


Tax Planning Strategies

740-10 55-39 through 55-48, 55-159 through 55-164


Temporary Differences

715-30

740-10

55-4 and 55-5

25-18 through 25-31, 55-12 through 55-22, 55-52

and 55-53, 55-66, 55-149 through 55-158

740-30 25-7 and 25-8


Valuation Allowance

740-10 30-16 through 30-25, 45-20, 55-124 through 55-

128

Alternative Minimum Tax 740-10 25-42 through 25-44

Business Combinations 805-50 05-8, 15-8 and 15-9

805-740 All

Casino Enterprises 924-740 All

Change in Tax Laws or Rates 740-10 25-47 and 25-48, 30-26, 35-4, 45-16 through 45-

18, 55-129 through 55-135

Change in Tax Status 740-10 45-19

Common Interest Realty

Associations

924-740 All

Consolidated Financial Statements 740-10

740-30

30-27 and 30-28

05-1 through 05-7, 15-1 through 15-4, 25-1

through 25-6, 25-15 through 25-19, 45-1 through

45-3, 50-1 and 50-2

810-10 45-8

Contingencies 450-10 55-4

Convertible Debt 740-10 55-51



Subject

FASB ASC Reference

Topic-


Deferred Taxes for Asset Purchases

Not Considered Business Combinations

740-10 25-49 through 25-55, 35-5, 45-22 through 45-24,

55-170 through 55-204

Depository and Lending Entities 942-740 All

Equity Method Investees 323-10 35-7 through 35-11, 55-27 through 55-29

323-30 35-2

323-740 All

Financial Statement Presentation—

General

740-10 45-1


Balance Sheet

740-10 45-2 through 45-13, 45-27, 55-78, 55-205 through

55-211


Comprehensive Income

220-10 45-10B through 45-12


Income Statement

740-10 45-14 through 45-26, 45-28

Foreign Operations 830-10 45-18

830-20 05-3, 45-3, 45-5

830-30 45-21

830-740 All

Goodwill Impairment 350-20 35-7, 35-20 and 35-21, 35-25 through 35-27, 55-

10 through 55-23

Health Care Entities 954-740 All

Indefinite Reversal Criteria 740-30 25-17 through 25-19, 45-1 through 45-3, 50-1 and

50-2

Insurance Entities 944-740 All

Interim Periods 270-10 45-17

740-270 All

Intraperiod Tax Allocation—General 740-270 05-1, 15-1 and 15-2, 60-1

Intraperiod Tax Allocation—Income Tax

Expense or Benefit

740-270 05-2, 45-1 through 45-5

Intraperiod Tax Allocation—Continuing

Operations

740-270 45-6 through 45-9, 55-1 through 55-7



Subject

FASB ASC Reference

Topic-


Intraperiod Tax Allocation—Continuing

Operations and One Other Item

740-270 55-8 through 55-14

Intraperiod Tax Allocation—Other

Comprehensive Income

740-270 55-18 through 55-24

Intraperiod Tax Allocation—Other Than

Continuing Operations

740-270 45-10 through 45-14

Intraperiod Tax Allocation—Tax Credit

Carryforward

740-270 55-15 through 55-17

Inventory Cost Capitalization 330-10 55-3 and 55-4

Investment Entities 946-740 All

Investment in Qualified Affordable

Housing Projects

323-740

325-20

All

35-5 and 35-6

Investment Tax Credit 740-10 25-45 and 25-46, 45-26 through 45-28, 50-20

Leveraged Leases 840-30 25-8, 30-14, 35-33 through 35-52, 45-5 through 45

-7, 50-6, 55-17 and 55-18, 55-39 through 55-56

Nonmonetary Transactions 845-10 30-9

Nontaxable Subsidies 740-10 55-54 through 55-57, 55-166 and 55-167

Oil and Gas Producing Entities 932-740 All

Other Tax Credits 740-10 25-39 through 25-41, 30-14 and 30-15

Payments to Taxing Authorities 740-10 55-67 through 55-76

Reorganizations 852-740 All

Regulated Entities 980-250 55-4

980-740 All

Sale-leaseback Transfer of Tax

Benefits

840-40 55-29 through 55-34

Segment Reporting 280-10 50-22, 50-25

Share-based Payments 260-10 45-29

718-740 All

Significant Estimates 740-10 55-218 through 55-222



Subject

FASB ASC Reference

Topic-


Special Areas 740-30 25-5, 50-2

Special Deductions 740-10 25-37, 30-13, 55-27 through 55-30, 55-145

through 55-148

Steamship Entities 995-740 All

Tax Indemnification in Lease

Agreements

460-10

840-10

55-23A

25-10 and 25-11, 25-53

Transactions With Shareholders 740-10 45-21

Uncertainties in Income Taxes 740-10 05-6, 15-2AA, 25-5 through 25-17, 25-56 and 25-

57, 30-6 and 30-7, 30-29, 35-1 through 35-3, 40-1

through 40-5, 45-11 and 45-12, 45-25, 50-15 and

50-15A, 50-19, 55-3 through 55-6, 55-81 through

55-119, 55-217, 55-223 through 55-229

____________________

101.17 Post-codification Authoritative Literature on Accounting Income Taxes

The FASB Codification did not end the evolution of accounting for income taxes. The accounting for income

taxes portion of the Codification (FASB ASC 740) has been amended by the following FASB Accounting

Standards Updates:

• FASB ASU No. 2009-06, Implementation Guidance on Accounting for Uncertainty in Income Taxes and

Disclosure Amendments for Nonpublic Entities. (Amended the definition of a tax position and FASB ASC

740-10-50-15, and added paragraphs 740-10-15-2AA, 740-10-50-15A, and 740-10-55-223 through 55-229.)

• FASB ASU No. 2010-07, Not-for-Profit Entities: Mergers and Acquisitions. (Added three definitions to

FASB ASC 740 and amended FASB ASC 740-10-25-20 and 740-10-30-4.)

• FASB ASU No. 2010-08, Technical Corrections to Various Topics. (Amended the definition of corporate

joint venture and FASB ASC 740-30-25-7.)

• FASBU ASU No. 2012-04, Technical Corrections and Improvements. (Amended the definition of gains

and losses included in comprehensive income but excluded from net income.)



Although post-codification GAAP guidance is officially issued as an ASU, the guidance primarily originates from

the sources discussed in the following paragraphs.

101.18 FASB Board.

The FASB Board is responsible for approving authoritative accounting guidance. Although the FASB Staff

prepares the documents, the FASB Board deliberates the various issues identified at a series of public Board

meetings. The Board then issues an Exposure Draft for public comment that aggregates its proposed positions

and analysis. If necessary, the Board will also hold public roundtable meetings to discuss the Exposure Draft.

After an exposure period that is generally at least 30 days, the Board redeliberates its proposed provisions

based on the analysis of the public comment letters received and any public roundtable discussions or other

information. The seven-person Board then conducts a simple majority vote for issuance of a final standard.

101.19 FASB Staff.

The FASB staff comprises approximately 60 professionals from public accounting, industry, academia, and

government and is responsible for preparing recommendations and drafts of documents for consideration by the

FASB Board. To facilitate the preparation process, the FASB staff works directly with the FASB Board and

resource groups, conducts research, participates in FASB roundtable meetings, and analyzes oral and written

comments received from the public.

101.20 FASB Emerging Issues Task Force.

The FASB Emerging Issues Task Force (EITF) is a standing task force of the FASB consisting of accountants

from public practice and industry. It was organized in 1984 to identify emerging accounting issues promptly and

to assist in resolving the diversity of accounting practices in areas not explicitly addressed by existing literature.

The task force discusses factual situations and reaches a consensus on the appropriate accounting treatment.

From task force meetings, the FASB learns whether views differ on how a particular transaction should be

reported and obtains insight into areas for which additional guidance may be needed. Tentative EITF

conclusions are exposed for public comment. After revisions due to public comments, if any, the EITF votes for

final consensus. All final EITF consensuses are subject to FASB Board ratification at a public Board meeting.

Currently, a ratified EITF is issued as a FASB Accounting Standards Update rather than an EITF Issue. 1

1 The Emerging Issues Task Force meets approximately every eight weeks, and its meetings are open to

observers. Copies of agenda materials, detailed issue summaries, and minutes of the meetings may be viewed

directly from the FASB's website at www.fasb.org.


END OF DOCUMENT -




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102 Income Tax Laws

102 Income Tax Laws

102.1 GAAP for income taxes is closely tied to income tax laws. Under the liability method required by FASB

ASC 740, deferred taxes recorded in the balance sheet are based on tax laws in effect at the financial statement

date. Thus, accountants must be familiar with federal income tax laws and those of other jurisdictions, when

applicable. This Guide gives an overview of the federal income tax laws that are likely to be encountered most

frequently by accountants and explains the effect of those laws on the income tax amounts recorded in the

financial statements. Although this Guide is designed to provide accurate information regarding income tax laws,

because of their complex and transient nature, it is not a substitute for a careful study of the relevant laws or the

professional judgment that must be exercised in every circumstance. Because state, local, and foreign tax

provisions vary widely among jurisdictions, this Guide only discusses them in a general manner.

Federal Taxes

102.2 The current federal tax system for corporations consists of a regular tax system and an alternative

minimum tax system. (Certain C corporations are exempt from the alternative minimum tax. See further

discussion at paragraph 102.5.) The basic concept underlying the two systems is that companies should pay a

minimum amount of federal taxes based on the earnings reported in their financial statements. Simply stated,

companies that are not exempt from the alternative minimum tax calculate their income tax liability under both

methods, and their tax liability is the higher amount. This section briefly discusses both the regular rate schedule

and the alternative minimum tax system and highlights several issues related to other tax jurisdictions.

102.3 Regular Tax Rates

As of the date of this Guide, regular corporate tax rates are as follows:

Taxable Income Tax Rate

First $50,000 15%

$50,001 to $75,000 25%

$75,001 to $100,000 34%



$100,001 to $335,000 39%

$335,001 to $10,000,000 34%

$10,000,001 to $15,000,000 35%

$15,000,001 to $18,333,333 38%

Over $18,333,333 35%

Chapter 3 discusses regular tax rates in greater detail, and Exhibit 3-1 provides a table for calculating current

taxes that incorporates the surtaxes into the marginal tax rates.

102.4 Net Operating Losses

Deferred tax amounts are determined by applying existing tax laws, including those related to net operating loss

deductions, to temporary differences that are scheduled to reverse in future years. Current federal tax rules

permit companies to carryback or carryforward net operating losses—generally the excess of allowable

deductions over gross income—to offset the taxable income of another year. All of the illustrations in this Guide

are based on the current statutory provisions for tax years beginning after August 5, 1997, which allow net

operating losses to be first carried back two years (beginning with the second preceding year) with any

unabsorbed loss carried forward 20 years (beginning with the first year immediately following the loss year). See

further discussion at paragraph 303.4.

102.5 Alternative Minimum Tax System

Perhaps the most significant provision of the Tax Reform Act of 1986 is the corporate alternative minimum tax

rules, which were conceived to ensure that all companies pay at least a minimum amount of tax. Under the

rules, a company's tax liability is the greater of taxes calculated using either the regular tax system or the

alternative minimum tax (AMT) system. In reality, the AMT rules are structured so that companies calculate two

tax amounts: one based on the regular tax rules and a tentative minimum tax (TMT) based on the AMT rules. If

TMT exceeds the regular tax, an additional tax equal to the excess, referred to as the AMT, also must be paid.

The AMT is calculated by adjusting taxable income as determined in accordance with the regular tax system by

certain adjustments and preference items to obtain alternative minimum taxable income (AMTI) and applying a

flat 20% tax rate to AMTI in excess of an exemption amount. The exemption allowed is $40,000, which is

reduced by 25% of the amount by which AMTI exceeds $150,000. Thus, if AMTI is $310,000 or more, the

exemption is zero. The AMT calculation is summarized as follows:

Taxable income

+ or − Adjustments

+ Preference items

= Alternative minimum taxable income (AMTI) before exemption

− Exemption

= AMTI



× 20%

= Alternative minimum tax (AMT)

Since the Taxpayer Relief Act of 1997, certain C corporations have been exempt from the alternative minimum

tax. Beginning with the 1997 tax year, existing corporations were exempt from AMT if their three-year average

annual gross receipts did not exceed $5 million for the 1997 tax year and $7.5 million for subsequent tax years.

Current tax laws state that a new corporation receives an automatic AMT exemption in the first year of

existence. The corporation remains exempt in its second year if gross receipts from the first year do not exceed

$5 million, and the corporation remains exempt in its third year if average gross receipts from the first two years

do not exceed $7.5 million. The corporation remains exempt in subsequent years as long as its average gross

receipts for the three prior years do not exceed $7.5 million. (See further discussion at paragraph 302.3.)

102.6 Within limitations, tax rules allow the excess of the alternative minimum tax over the regular tax to be

carried forward indefinitely to reduce regular tax in future years. However, the credit cannot reduce the tax

liability below the alternative minimum tax.

102.7 The regular tax system and the alternative minimum tax system are discussed in detail in Chapter 3.

Other Tax Jurisdictions

102.8 In calculating deferred taxes, FASB ASC 740-10-30-5 requires separate calculations to be made for each

tax jurisdiction. Thus, if a company is subject to state, local, or foreign income taxes in addition to federal taxes,

deferred taxes should be determined for each tax jurisdiction and the results combined to obtain the amounts to

record in the financial statements. However, separate calculations are not necessary if the effect of applying a

combined federal and state tax rate to the federal temporary differences is not materially different from separate

calculations.


END OF DOCUMENT -




Checkpoint Contents


Editorial Materials




103 Tax Accounting Workpapers

103 Tax Accounting Workpapers

IRS Access

103.1 During an IRS audit, the agent may request a copy of the tax adviser's workpapers. Normally, this does

not present much of a problem since the workpapers simply reflect information provided by the taxpayer.

Furthermore, these documents can be obtained by the IRS through an administrative summons. Accordingly, it

usually is advisable to provide the agent with copies of specific workpapers when requested. Consequently, all

tax workpapers should be prepared with the understanding that the IRS can, if necessary, obtain access to

them.

103.2 The Supreme Court held that tax accrual workpapers prepared by a CPA firm were not privileged and had

to be disclosed to the IRS [Arthur Young, 465 U.S. 805, 53 AFTR 2d 84-866 (1984)]. Note that the privilege

procedures for tax practitioners apply only to the extent the communication is for tax advice in a noncriminal

matter before the IRS or in a federal court [IRC Sec. 7525(a)]. The courts have held this definition to a very strict

standard and it does not include documents used in return preparation or accountant's workpapers [U.S. v.

Frederick, 182 F.3d 496, 83 AFTR 2d 99-1870 (7th Cir. 1999), cert den. 528 U.S. 1154 (2000)].

103.3 The IRS has established guidelines in the Internal Revenue Manual (IRM 4.10.20) for Revenue Agents to

follow in requesting accountant's workpapers. These guidelines apply in all cases except fraud cases. [The

guidance (guidelines) of the Internal Revenue Manual (IRM) referred to in this discussion adhere to the

guidance from IRS Announcement 2002-63 and Chief Council Notices CC-2003-012 and CC-2004-010.] The

guidelines differentiate tax accounting workpapers as follows:

a. Tax Reconciliation Workpapers. Workpapers that are used in assembling and compiling financial data for

the tax return. These papers typically include final trial balances for each entity and a schedule of

consolidating and adjusting entries. They include information used to trace financial information to the tax

return.

b. Tax Accrual Workpapers. Workpapers, whether prepared by the taxpayer, the taxpayer's accountant, or

the independent auditor, that relate to the tax reserve for current, deferred and potential or contingent tax



liabilities, reported on and disclosed in audited financial statements. These workpapers reflect an estimate

of a company's tax liabilities and may also be referred to as the tax pool analysis, tax liability contingency

analysis, tax cushion analysis, or tax contingency reserve analysis.

103.4 Under these guidelines, the IRS agent (agent) is instructed to routinely request tax reconciliation

workpapers at the beginning of the examination from either the taxpayer or the taxpayer's accountant. However,

the guidelines are more restrictive for the agent's authorization to request tax accrual workpapers. The

guidelines emphasize that tax accrual workpapers should be “requested with discretion and not as a matter of

standard examining procedure.”

103.5 Generally, according to the Internal Revenue Manual (IRM), before the agent can request the taxpayer's

tax accrual workpapers, the agent must satisfy the IRS's unusual circumstances standard. Under the unusual

circumstances standard, the agent should only request the tax accrual workpapers when “such factual data

cannot be obtained from the taxpayer's records or from available third parties, and then only as a collateral

source for factual data.” Specifically, the IRM states that unusual circumstances exist when all of the following

apply:

a. The agent needs additional facts for a specific issue,

b. The agent has requested from the taxpayer and applicable third parties all of the known facts related to

the specific issue,

c. The agent has sought a supplementary analysis of facts related to the specific issue, and

d. The agent has performed a reconciliation of the taxpayer's Schedule M-1 or M-3 as it pertains to the

specific issue.

103.6 The IRM states that the request should be “limited to the portion of the workpapers that is material and

relevant to the examination.” Also, the agent should initially request the tax accrual workpapers from the

taxpayer, but requests of the taxpayer's accountant or independent auditor are also acceptable.

103.7 For requests of tax accrual workpapers supporting tax returns filed on or after July 1, 2002, the unusual

circumstances standard does not apply when the tax return claims a tax benefit from abusive tax avoidance

transactions, which are commonly referred to as listed transactions. {The IRS defines listed transactions as

transactions identified, or substantially similar to transactions identified, as tax avoidance transactions in IRS

notices, regulations, or other public guidance [Regs. 1.6011-4(b)(2) and 301.6111-2(b)(2)].} The movement

away from the unusual circumstances standard when requesting tax accrual workpapers reflects a much more

aggressive approach in the tax shelter area.



103.8 Currently, for any tax return claiming benefits from listed transactions, IRS agents must request the tax

accrual workpapers. However, the degree of access depends on whether the listed transaction was timely and

properly disclosed on the tax return (as described by IRS Reg. 1.6011-4). If the listed transaction was properly

disclosed, IRM guidelines state that the agents will routinely request only the tax accrual workpapers that pertain

to the specific listed transaction for the tax return under examination.

103.9 However, under any of the following circumstances, the agents will routinely request all tax accrual

workpapers for the year under examination:

a. The listed transaction is not properly disclosed.

b. The listed transaction is properly disclosed, but in connection with the examination of the return, there

are reported financial irregularities.

c. The listed transactions were properly disclosed, but the agents determine that the taxpayer claimed

benefits from more than one of the listed transactions.

Furthermore, in all of these circumstances, the agents may also request tax accrual workpapers for years not

under examination if they may be directly relevant to the examination of the listed transaction(s) or financial

irregularities.

103.10 If a transaction becomes a listed transaction subsequent to the filing of the tax return, the agents will

routinely request the tax accrual workpapers if the transaction is a listed transaction at the time of the request.

103.11 Workpapers for Uncertain Tax Positions

The primary concern for taxpayers in complying with GAAP for uncertainties in income taxes is that the required

disclosures would provide a “roadmap” for the IRS and other taxing authorities. The FASB considered this

argument and eliminated certain disclosure requirements for nonpublic entities that caused the greatest concern

for taxpayers.

103.12 However, what if a taxpayer's workpapers for uncertainties in income taxes are not considered tax

accrual workpapers? The IRS would be able to use the disclosures for uncertainties in income taxes to identify

prime audit candidates and routinely request a taxpayer's uncertain tax position workpapers upon initiating an

audit. The workpapers would provide the IRS all the information needed to assess the viability of the taxpayer's

tax positions. Both taxpayers and IRS agents were concerned with how the IRS would eventually classify

workpapers for uncertainties in income taxes.

103.13 In June 2007, IRS Memo AM 2007-012 stated that “documentation resulting from the issuance of FIN 48

is considered tax accrual workpapers,” so the IRS would have to satisfy the unusual circumstances standard to

acquire such workpapers. The decision was based on the reasoning that FASB guidance does not dictate the



documentation requirements for taxpayers and auditors. Rather, the SEC, PCAOB, and AICPA establish such

requirements, which are not affected by FASB guidance.

103.14 The IRS's Large and Mid-Size Business Division [(LMSB) currently named the Large Business and

International Division] submitted a memo to its auditors and updated its field examiners' guide to reflect the

latest IRS policy with respect to disclosures and workpapers for uncertainties in income taxes as follows:

• Financial statement disclosures and other public documents should be considered by examiners when

conducting risk assessments.

• If the examiner is unsure of the implications of a disclosure, the examiner should discuss the information

with appropriate taxpayer personnel—similar to any other tax information that may raise a red flag.

• Workpapers are a subset of tax accrual workpapers, and thus, subject to “our current policy of restraint.”

103.15 Workpapers for Effective Tax Rate Reconciliation

Shortly after IRS Memo 2007-012 was issued, the IRS distinguished another subset of tax accounting

workpapers from tax accrual workpapers. Effective tax rate reconciliation workpapers are used to satisfy a

FASB ASC 740 disclosure requirement to reconcile the reported amount of income tax expense attributed to

continuing operations to the amount of income tax expense that would result if domestic statutory tax rates were

applied to pretax income from continuing operations. The IRS issued Chief Council Notice CC-2007-015, which

stated that effective tax rate reconciliation workpapers are not considered tax accrual workpapers because they

are not prepared for the purpose of determining the proper reserve amount for tax contingencies. Also, effective

tax rate reconciliation workpapers are not audit workpapers because they are not retained by the auditor for

audit documentation purposes. Thus, similar to tax reconciliation workpapers, the IRS can routinely request

effective tax rate reconciliation workpapers during an examination.

103.16 Workpapers for Schedule UTP

In 2010, the IRS issued a tax schedule for uncertain tax positions (Schedule UTP). Schedule UTP is consistent

with GAAP in that a tax position should generally not be included on Schedule UTP if the tax position is either

immaterial or it is sufficiently certain so that a liability for unrecognized tax benefits (LUTB) is not required for

financial reporting purposes. (See the discussion beginning at paragraph 103.23 for when an uncertain tax

position should be included on Schedule UTP.)

103.17 Although hopeful that workpapers supporting Schedule UTP would be treated as those supporting

uncertain tax positions for financial reporting purposes, the concern among taxpayers was that IRS examiners

could routinely request the taxpayer's Schedule UTP workpapers to assess the strength of its tax positions. After

the initial year of Schedule UTP, the IRS's Large Business and International Division submitted a memo to its



auditors regarding Schedule UTP. Some of the many IRS policy decisions regarding Schedule UTP in the audit

process include the following:

• For issues that are disclosed on the Schedule UTP, IRS examiners may ask the taxpayer for information

about the relevant facts affecting the tax treatment of the position and information about the identity of the

tax issue.

• IRS examiners may not ask the taxpayer to explain his or her rationale for determining a tax issue was

uncertain, or for information about the hazards of the position or an analysis of support for or against the tax

position.

• IRS examiners may not ask the taxpayer why a Schedule UTP issue is uncertain, nor can the examiners

ask the taxpayer for copies of workpapers used to prepare Schedule UTP, any tax accrual workpapers, or

any documents privileged under the modified policy of restraint (such as workpapers for uncertain tax

positions).

These policy decisions should alleviate some taxpayer concern regarding the protections provided to Schedule

UTP workpapers. The following paragraphs discuss the specifics of IRS Schedule UTP.

Schedule UTP

103.18 For federal income tax reporting purposes, a public or privately held corporation must file Schedule UTP

if all of the following apply:

• The corporation files IRS Form 1120, Form 1120-F, Form 1120-L, or Form 1120-PC.

• The corporation or a related party issued audited financial statements prepared using GAAP, IFRS, or a

country-specific accounting standard that reports all or a portion of the corporation's operations for all or a

portion of the corporation's tax year.

• The corporation has at least one tax position that must be reported on Schedule UTP.

• The corporation's total assets equal or exceed Schedule UTP's phase-in amount of $50 million. (For 2014

tax years, the total asset phase-in amount is lowered to $10 million.)



Thus, Schedule UTP will ultimately apply to all corporations that satisfy the first three criteria. For pass-through

entities and tax-exempt entities, the IRS has announced that it will consider whether to extend all or a portion of

the requirements to 2012 or later tax years.

103.19 Schedule UTP is filed as part of Form 1120 and is comprised of three parts. Tax positions taken by the

corporation during the current year's tax return are reported on Part I. Tax positions taken by the corporation on

a prior year's tax return not previously reported on a Schedule UTP are included on Part II. Concise descriptions

of all tax position listed in Parts I and II are reported on Part III. (For the 2010 Schedule UTP, Part II was not

applicable because tax positions taken prior to 2010 tax years were not within the scope of the Schedule.)

103.20 Parts I and II of Schedule UTP require the following for each tax position listed: (a) a UTP number for

identification purposes, (b) the primary internal revenue codes relating to the tax position, (c) whether it is a

temporary or permanent difference (for GAAP purposes), (d) the EIN of the pass-through entity related to the tax

position, if any, (e) whether the size of the tax position is at least 10% of all other uncertain tax positions listed,

(f) whether the UTP is a transfer pricing tax position, and (g) the ranking of all tax positions listed (with 1 being

the largest size). Part II also requires a six-digit number indicating the year and final month of the year

(YYYYMM) in which the tax position was taken. When determining the size of a tax position (for items e and g

above), all tax positions listed in both parts must be considered. Whether a tax position is reported on Schedule

UTP and, if so, whether it belongs on Part I or Part II appears fairly straightforward, but as discussed beginning

at paragraph 103.23, there are subtleties that may cause confusion.

103.21 Part 3 of Schedule UTP requires a concise description for each UTP listed in Parts I and II. The

instructions to Schedule UTP state that “a description of the relevant facts affecting the tax treatment of the

position and information that reasonably can be expected to apprise the IRS of the identity of the tax position

and the nature of the issue. In most cases, the description should not exceed a few sentences . . . [and] should

not include an assessment of the hazards of a tax position or an analysis of the support for or against the tax

position.”

103.22 Due to identified problems with the quality of certain Schedule UTP disclosures, the IRS issued guidance

for preparing concise UTP descriptions. The guidance emphasized that descriptions “that do not clearly identify

the taxpayer's tax position and/or that do not provide sufficient relevant facts to apprise the IRS about the nature

of the issue do not meet the requirements of the instructions.” The guidance also provided a few examples of

sufficient and insufficient descriptions. For instance, an insufficient concise description of “This is a research

credit issue” would be better stated as follows:

The taxpayer incurred support department costs that were allocated to various research projects

based upon a methodology the taxpayer considers reasonable. The issue is whether the

taxpayer's method of allocating these costs is acceptable by the IRS.

This description concisely identifies the tax position and the nature of the uncertainty without including an

assessment of the hazards of the tax position or an analysis of the support for or against the position.

103.23 Note that tax positions taken in years before 2010 should not be reported on Schedule UTP even if a

LUTB (reserve) is recorded in audited financial statements issued in 2010 or later. More importantly, the final

Schedule UTP does not require disclosure of the rationale for an uncertain tax position, assessment of the



strength or weakness of the position, or a specific UTP amount. Also, as discussed in paragraph 103.16,

Schedule UTP requirements for reporting UTPs is consistent with the more-likely-than-not recognition threshold

in GAAP for uncertainty in income taxes. Specifically, a tax position should not be reported on Schedule UTP for

a particular year unless:

a. A tax position [claiming a deduction, loss, or credit (other than using NOL or credit carryforwards)] is

taken on the corporation's tax return, and

b. Either (1) an income tax reserve for a tax position is recorded in the financial statements of the

corporation or related party or (2) no income tax reserve was recognized because of the corporation's

expectation to successfully litigate the tax position.

For Schedule UTP purposes, recording an income tax reserve consists of either recognizing an LUTB for the tax

position or reducing (not recognizing) a deferred tax asset for an unused NOL or credit carryforward related to

the tax position.

103.24 For example, assume a tax position is taken on a corporation's 20X1 tax return (such as completely

deducting an expenditure). Following GAAP for uncertainties in income taxes when preparing the financial

statements that include the 20X1 tax year, the corporation determines it is more-likely-than-not that the

expenditure should have been capitalized and amortized over five years, resulting in the recognition of a liability

for an unrecognized tax benefit on the corporation's 20X1 financial statements. Although the uncertainty of the

tax position with respect to this expenditure will last through 20X5 for financial reporting purposes (unless the

uncertainty is sufficiently reduced and the liability derecognized within five years), the tax position for this

expenditure will only appear on Schedule UTP in 20X1 because it does not affect subsequent tax returns.

103.25 Now assume the same facts except that following GAAP for uncertainties in income taxes when

preparing the financial statements that include the 20X1 tax year, the corporation determines it is more-likely-

than-not that the expenditure should have been expensed. Thus, the corporation does not establish a liability for

an unrecognized tax benefit for the transaction. Because the corporation did not establish a LUTB for the tax

position taken on the 20X1 tax return for reasons other than expected successful litigation, the tax position does

not have to be included on the corporation's 20X1 Schedule UTP.

103.26 However, in 20X2, new information involving the transaction leads the corporation to determine it is more

-likely-than-not that the expenditure should have been capitalized and amortized over five years. The change in

judgment results in the recognition of a liability for unrecognized tax benefits on the corporation's 20X2 financial

statements for the tax position taken on the 20X1 tax return. Because the corporation took a tax position on its

tax return for which it established a LUTB on its financial statements, the corporation must include the

transaction on its 20X2 Schedule UTP. Also, since the corporation did not include the 20X1 tax position on its

20X1 Schedule UTP, it should report the 20X1 tax position on Part II of the 20X2 Schedule.

103.27 Next, assume the corporation makes an unrelated expenditure in 20X1 that it capitalizes and amortizes

over five years for tax purposes. For financial reporting purposes, the corporation determines it is more-likely-



than-not that the expenditure should not have been amortized or expensed, resulting in the recognition of a

LUTB that will increase each of the four subsequent years as the transaction is amortized for tax purposes. In

this situation, following the Schedule UTP reporting requirements as discussed at the end of paragraph 103.21,

the tax position should be reported on Schedule UTP, Part I for each year of the five-year amortization period,

because (a) the corporation established and maintained a LUTB for the tax position in each of the audited

financial statements during the five-year period and (b) the corporation's tax position resulted in amortization

deductions in each tax return during the five-year period. However, in year 20X6, the corporation would not

report the transaction on Schedule UTP because although the corporation maintains the LUTB for financial

reporting purposes, the transaction did not affect the 20X6 tax return.

103.28 Item a of paragraph 103.23 excludes the use of NOL or credit carryforwards from the reporting

requirements of Schedule UTP. This exclusion agrees with the financial reporting logic of only recognizing a

deferred tax asset associated with a carryforward if the related loss or credit is based on a tax position that

meets the MLTN recognition criterion in FASB ASC 740 (as discussed in Appendix 1G, paragraph B40).

103.29 For example, assume a corporation shows a 20X1 tax return net operating loss equal to its only

deduction. The corporation elects to carry forward the NOL to reduce a future tax liability. However, when

preparing the financial statements that include the 20X1 tax year, the corporation determines it is more-likely-

than-not that the taxing authority would not allow the deduction. Thus, the corporation would not recognize a

deferred tax asset for its tax NOL because the underlying tax position creating the NOL does not satisfy the

MLTN recognition criterion. (The corporation would not establish an LUTB for the uncertain tax position of

claiming the deduction because there was no tax benefit realized in the 20X1 tax return.) On its 20X1 Schedule

UTP, the corporation should include the tax position to take the deduction because not recognizing the related

NOL satisfies items a and b(1) of paragraph 103.23. However, the corporation should not report on Schedule

UTP the fact that it did not recognize the loss carryforward.

103.30 In 20X3, the corporation uses its NOL carryforward to reduce the tax liability reported on its tax return.

When preparing the financial statements that include the 20X3 tax year, the corporation continues to believe it is

more-likely-than-not that the taxing authority would not allow the deduction upon examination. Because the tax

benefit of the 20X1 deduction was actually received for tax reporting during 20X3, the corporation should

recognize a LUTB (with an offset to current tax expense) in its 20X3 financial statements. However, the tax

position to use the NOL carryforward should not be reported on the corporation's 20X3 Schedule UTP because

it does not satisfy item a. of paragraph 103.23. Logically, use of the NOL carryforward for tax reporting in 20X3

is only possible due to the underlying uncertain tax position to claim the deduction in 20X1. Because the

underlying tax position was reported in the 20X1 Schedule UTP, reporting the use of the NOL carryforward in

the 20X3 Schedule UTP would, in essence, result in double counting.

103.31 In this example, the amount of the uncertain tax deduction and the 20X1 NOL carried forward were the

same. However, the Schedule UTP reporting requirements would not change even if those amounts were

different. That is, if a portion of the deduction was used to lower taxable income to zero on the 20X1 tax return

and the remaining portion became an NOL carryforward, the deduction would still be reported on the 20X1

Schedule UTP because it would satisfy both items a and b(1) of paragraph 103.23. [A tax position was taken on

the tax return with a reserve (an LUTB for the portion of the deduction realized in the 20X1 tax return) recorded

in the financial statements.] Similarly, if the 20X1 NOL was greater than the amount of the deduction, the



deduction would be reported on the 20X1 Schedule UTP because it would also satisfy both items a and b(1) of

paragraph 103.23. [A tax position was taken on the tax return with a reserve (not recognizing a deferred tax

asset for the portion of the unused NOL related to an uncertain tax position) recorded in the financial

statements.] For both of these scenarios, when the corporation uses the NOL carryforward in 20X3 to reduce

the tax liability reported on its tax return, the corporation would not report the tax position to use the NOL

carryforward on its 20X3 Schedule UTP because it does not satisfy item a of paragraph 103.23 for the same

reason indicated in paragraph 103.30.

103.32 Note that item b(2) of paragraph 103.23 results in an inconsistency between recognizing UTPs for

financial reporting purposes and disclosing UTPs for tax purposes under Schedule UTP. For example, assume

the same facts in the scenario discussed at paragraph 103.24 except that although the corporation determines it

is more-likely-than-not that the expenditure should have been capitalized and amortized over five years, it does

not recognize a LUTB because of the corporation's expectation to successfully litigate its tax position to

immediately deduct the entire expense. Thus, although the corporation would not recognize a LUTB for GAAP

purpose, it would have to disclose the tax position on Schedule UTP because it satisfies both of the criteria

listed at items a and b(2) of paragraph 103.23. An implication of this inconsistency is that the pool of potential

tax positions for disclosure on Schedule UTP is not limited to those that resulted in a total or partial LUTB under

GAAP for uncertainties in income taxes. Tax positions taken on the corporation's tax return should be reviewed

to identify those that did not result in any LUTB due to expectations of successful litigation of the tax position.

103.33 In conjunction with the issuance of Schedule UTP, the IRS issued Announcement 2010-76 to clarify its

position for requesting legal opinions and other documents supporting an entity's tax positions as follows:

• Disclosure of an uncertain tax position on Schedule UTP will not waive any privileges under the attorney-

client privilege, the tax-advice privilege in IRC Sec. 7525, or the work product doctrine unless (a) the entity

has engaged in an activity or taken action that would waive these privileges or (b) the IRS requests tax

accrual workpapers because of unusual circumstances or the entity claimed benefits from listed

transactions. (See the discussion beginning at paragraph 103.5 concerning the unusual circumstance

standard and listed transaction standard.)

• Upon routine IRS request of an entity's tax reconciliation workpapers (as discussed beginning at

paragraph 103.3), the entity may redact the following information from any copies of tax reconciliation

workpapers relating to the preparation of Schedule UTP: (a) working drafts, revisions, or comments

concerning the concise description of tax positions reported on Schedule UTP; (b) the amount of any LUTB

related to a tax position reported on Schedule UTP; and (c) computations determining the ranking of tax

positions to be reported on Schedule UTP or the designation of a tax position as a major tax position (as

defined in item e of paragraph 103.20).

This clarification essentially confirms the statement in IRS Memo AM 2007-012 (discussed at paragraph 103.13)

that documentation supporting the disclosure of an uncertain tax position is considered tax accrual workpapers.

Evidential Matter



103.34 Due to the more aggressive stance the IRS has taken with tax accrual workpapers, some taxpayers may

not prepare or maintain appropriate documentation of the income tax accrual calculation. However, suppressing

tax accrual documentation may also interfere with the ability of the taxpayer's independent auditor to issue an

unqualified report on the taxpayer's financial statements.

103.35 Interpretation No. 1 of AU-C 500, Audit Evidence (AU-C 9500.01-.22), 2 emphasizes that the client is

responsible for the tax accrual, the underlying support for the accrual, and the related disclosures, but requires

that auditor's income tax accrual workpapers include appropriate details to allow reviewing and supervising

auditors to understand the nature, timing, extent, and results of the audit procedures, as well as any significant

findings, conclusions reached, and significant judgments made in reaching those conclusions. Limitations on the

auditor's ability to access the information considered necessary to audit the tax accrual, such as through

improper taxpayer documentation or refusing auditor access to the documentation, will affect the auditor's ability

to issue a nonqualified opinion on the taxpayer's financial statements.

103.36 The Interpretation acknowledges that a taxpayer may provide its outside legal counsel, third-party tax

advisors, or internal tax or legal counsel with income tax accrual information. In such situations, the taxpayer

may ask those sources to provide the auditor with an opinion on the adequacy of the income tax accrual, and

perhaps, attempt to limit the auditor's access to the documentation that supports the counsel's (or advisor's)

opinion. The Interpretation states that an auditor is not allowed to accept the analysis or opinion of third party (or

the taxpayer's in-house) advisors or legal counsel “without careful consideration and application of the auditor's

tax expertise and knowledge about the entity's business.”

103.37 To document the auditor's careful consideration of an opinion stated by an outside (or internal) advisor or

legal counsel, the interpretation requires the auditor to obtain access to the opinion even if the taxpayer,

advisors, or legal counsel attempt to restrict access through attorney-client (or similar) privilege. Once obtained,

the auditor's documentation should include either (a) the actual advice or opinions rendered or (b) other

sufficient documentation or abstracts, which support the analysis and conclusions. Also, the auditor may accept

the taxpayer's analysis summarizing an outside adviser's (or legal counsel's) opinion if the taxpayer provides

“sufficient appropriate audit evidence” to the auditor.

Documentation

103.38 Although AU-C 500 states that supporting documentation includes information obtained by the auditor

from inquiry, observation, inspection, confirmation, recalculation, reperformance, and analytical procedures, the

SAS does not discuss the quantity, type, and content of audit documentation. However, Interpretation No. 1

does provide some guidance on the type of supporting documentation necessary for income tax accruals.

Specifically, the Interpretation states that the auditor's documentation of tax accruals includes the following:

a. Copies of the client's documents, schedules, or analyses (or auditor-prepared summaries thereof) to

support the auditor's conclusions regarding the appropriateness of the taxpayer's accounting and disclosure

of significant tax-related contingency matters.



b. Procedures performed and conclusions reached by the auditor, including the taxpayer's documentary

support for its financial statement amounts and disclosures.

c. Significant elements of the taxpayer's analysis of tax contingencies or reserves, including roll-forward of

material reserve changes.

d. Taxpayer's position and support for its income tax related disclosures, such as its effective tax rate

reconciliation.

e. Taxpayer's support for its intraperiod allocation of income tax expense or benefit to continuing operations

and to items other than continuing operations.

f. Taxpayer's basis for assessing deferred tax assets and related valuation allowances and its support for

applying the indefinite reversal criteria in FASB ASC 740-30-25-17, Accounting for Income Taxes—Special

Areas, including its specific plans for reinvestment of undistributed foreign earnings. (See the paragraphs

beginning at 605.1 for further discussion of the indefinite reversal criteria.)

2 In October 2011, the Auditing Standards Board issued SAS No. 122, Statements on Auditing Standards:

Clarification and Recodification, which superseded almost all existing SASs, codified all clarified SASs, and is

effective for audits of financial statements for periods ending on or after December 15, 2012. After that date, the

clarified guidance in AU-C 500 replaces the superseded guidance formerly in SAS No. 106 (AU 326). Similarly,

Interpretation No. 1 of AU-C 500 replaces the superseded guidance formerly in Interpretation No. 2 of SAS No.

106.


END OF DOCUMENT -




Checkpoint Contents


Editorial Materials




Appendix 1A Quick Start to Accounting for Income Taxes

Appendix 1A

Quick Start to Accounting for Income Taxes

Using Quick Start

.01 This appendix presents an overview of the current and deferred income tax calculation. It is designed to

familiarize accountants with the basic tax calculation and related issues that affect most small and midsize

nonpublic entities. Because the discussion is a summary, it is necessarily general in nature. Each section,

however, is cross-referenced to other parts of the Guide that discuss the topic in more detail. This appendix

assumes that there is no uncertainty in income tax positions (unless specifically stated otherwise), which is likely

to be the case for most small and midsize nonpublic entities. Section G of Appendix 1G discusses additional

steps needed to account for uncertainty in income tax positions.

.02 Appendix 1B-1 presents an Income Tax Provision Worksheet that may be used for calculating income taxes

for a single tax jurisdiction or multiple tax jurisdictions using a combined tax rate. Appendix 1B-1 should be used

if the effect of applying a combined tax rate to the federal temporary differences is not materially different from

separate calculations. Appendixes 1C-1 and 1C-2 present Income Tax Provision Worksheets that may be used

for calculating income taxes for multiple jurisdictions using separate tax rates. These should be used if taxable

income in a jurisdiction is computed differently than federal taxable income and the effect of applying a

combined tax rate to the federal temporary differences is materially different from separate calculations.

Accountants may use these worksheets to compute a company's income tax provision and accumulate the

related disclosures. To illustrate how the worksheets should be completed, filled-in forms are included in

Appendixes 1B-2, 1C-3, and 1C-4. The checklist in Appendix 1D may be used to assess the reasonableness of

the income tax calculations in Appendixes 1B and 1C. The checklist in Appendix 1E may be used to determine

that income taxes have been accounted for in accordance with GAAP on accounting for income taxes.

An Overview of the Calculation

.03 FASB ASC 740 provides the primary guidance on accounting for income taxes. The guidance adopts a

balance sheet approach to accounting for income taxes. Its objective is to measure the future tax effects of

differences between amounts recorded in the financial statements and income tax returns at a particular point in

time—the balance sheet date—and to record those effects as deferred tax assets and liabilities. The income tax



expense or benefit is merely the sum of the current income tax expense (or benefit) and the change during the

year in the deferred tax asset and liability accounts.

.04 Accounting for income taxes consists of three parts: calculating the deferred income tax provision,

calculating the current income tax provision, and accumulating information for financial statement presentation

and disclosure. Each of those parts is discussed in the following paragraphs.

Deferred Tax Provision

.05 The basic deferred tax calculation consists of the following:

a. Identify taxable and deductible temporary differences and loss carryforwards at the end of the year.

b. Determine the currently enacted tax rate that is expected to apply when temporary differences reverse

and loss carryforwards are realized.

c. Calculate a deferred tax liability for the future tax effects of taxable temporary differences by multiplying

total taxable differences by the expected tax rate.

d. Calculate a deferred tax asset for the future tax effects of deductible temporary differences and loss

carryforwards by multiplying total deductible temporary differences and loss carryforwards by the expected

tax rate.

e. Identify the tax credit carryforwards available for tax reporting at the end of the year and record a

deferred tax asset for the total of the carryforwards.

f. Provide a valuation allowance for the portion of the deferred tax assets for which there is not more than a

50% chance that the benefit of the deductible differences and carryforwards of losses and tax credits will be

realized.

g. Subtract the net deferred tax asset or liability at the end of the year from the net amount at the beginning

of the year to determine the deferred tax benefit or expense for the year. (The net deferred tax asset or

liability is the difference between the deferred tax liability and the deferred tax assets net of the related

valuation allowance.)



.06 Temporary Differences. Temporary differences are differences between the tax bases of assets and

liabilities that are more likely than not to be sustained in a tax audit and the financial reporting bases reported in

the financial statements. For example, fixed asset cost less accumulated book depreciation usually is the

financial basis of fixed assets. Fixed asset cost less accumulated tax depreciation usually is the tax basis. The

difference between the two bases is the temporary difference.

.07 Temporary differences arise because the accounting methods for financial and tax purposes require

recognizing income and expenses in different periods. That is, they are caused entirely by differences in the

timing of the recognition of income or expense in the financial statements and tax returns. They are not

permanent differences that will never be taxable or deductible. Generally, when temporary differences reverse,

both the financial statements and the tax returns will have reported the same amount of income and expenses.

However, following GAAP for uncertain tax positions, if a portion of the tax basis of an asset or liability is not

more likely than not to be sustained in a tax audit, that portion of the tax basis is not recognized when

determining temporary differences for financial reporting purposes. Thus, even when such temporary difference

has reversed, the financial statements and the tax returns may not report the same amount of income and

expenses until the uncertain tax position is effectively settled.

.08 Temporary differences are either taxable or deductible depending on whether their reversal will create

additional income or deductions in future tax returns. That, in turn, decides whether a deferred tax asset or

liability should be recognized as follows:

a. Taxable differences result in future taxable income. The future tax expense related to that future taxable

income is recorded as a deferred tax liability. Taxable differences arise when either:

(1) An asset's financial basis exceeds its tax basis.

(2) A liability's financial basis is less than its tax basis.

b. Deductible differences result in future tax deductions. The future tax benefit related to that future tax

deduction is recorded as a deferred tax asset. Deductible differences arise when either:

(1) An asset's financial basis is less than its tax basis.

(2) A liability's financial basis is greater than its tax basis.



.09 Usually, the types of temporary differences of small to medium-sized companies do not change from year to

year. New temporary differences can be identified using the same process used to identify new Schedule M-1 or

Schedule M-3 items. Look at assets and liabilities and consider whether they would be treated differently for

financial and tax reporting; then, ask about unusual transactions during the year.

.10 Temporary differences should be identified for each tax jurisdiction. If taxable income in a jurisdiction is

determined the same as federal taxable income, temporary differences will be the same. Their deferred tax

effects can be measured by multiplying temporary differences by a combined federal and state (or other

jurisdiction) tax rate. If taxable income in a jurisdiction is computed differently than federal taxable income,

temporary differences may vary with each jurisdiction, and separate calculations for each jurisdiction may be

necessary.

.11 Chapter 2 of this Guide discusses temporary differences in great detail. Appendix 2A of that chapter lists

some of the more common temporary differences for small to medium-sized companies.

.12 Loss and Tax Credit Carryforwards. Net operating losses and tax credits that cannot be used on tax

returns during the current year may be carried back or carried forward to offset taxable income in other years.

The future tax benefits of carryforwards that are available for tax purposes should be recorded in the financial

statements as a deferred tax asset.

.13 Under current federal income tax law, loss carryforwards available to corporations include unused operating

losses, passive activity losses, and capital losses. For tax years beginning after August 5, 1997, operating

losses may be carried forward for 20 years, passive activity losses may be carried forward indefinitely, and

capital losses may be carried forward for five years. (Passive activity losses only apply to two types of C

corporations—personal service corporations and closely held corporations as defined by tax law.) Current tax

law also allows excess charitable contributions to be carried forward for five years, subject to certain limitations.

.14 Tax credits that are available under current federal tax law include the following:

a. Foreign tax credit.

b. General business credits.

c. Alternative minimum tax (AMT) credit.

d. Qualified tax credit bond credit.



General business credits arising in tax years beginning after December 31, 1997, may be carried forward for 20

years. The AMT credit may be carried forward indefinitely to offset the excess of regular tax over the alternative

minimum tax in future years.

.15 The best sources for identifying carryforwards are from prior year tax returns and carryforward working

papers.

.16 Sections 303 and 304 discuss loss and tax credit carryforwards in more detail.

.17 Selecting a Tax Rate to Measure Deferred Tax Assets and Liabilities. The tax rate that generally should

be used in the deferred tax calculation is the flat tax rate, based on currently enacted tax laws, that is expected

to apply during the periods that temporary differences reverse and loss carryforwards are used. Currently, that

tax rate is 34% or 35% under federal tax law.

.18 In some cases, using the flat tax rate may produce significantly different results than if graduated tax rates

had been used. In those situations, deferred taxes should be computed using the average graduated tax rate

that will apply to estimated taxable income in the year the temporary difference is expected to reverse or loss

carryforward is expected to be used. Different average graduated tax rates may apply in different years. Does

that mean that a different rate must be used for each year in which temporary differences are expected to

reverse? In most cases, no. Because the calculation is based on expected taxable income, which is no more

than an estimate, using a single average graduated tax rate based on average estimated annual taxable income

during the reversal period will usually be sufficient.

.19 Some general suggestions for selecting the appropriate tax rate follow:

a. Select the appropriate federal rate first. If graduated tax rates are a significant factor, use an average

graduated tax rate based on the appropriate range of taxable income rather than the flat tax rate. Based on

current federal tax law, the following approximations of average graduated tax rates are appropriate for

various ranges of taxable income:

Taxable Income Average

Graduated

Tax Rate

Up to $50,000 15%

From $50,000 to $100,000 19%

From $100,000 to $150,000 25%

From $150,000 to $335,000 31%

From $335,000 to $15,700,000 34%

Above $15,700,000 35%

If no taxable income is expected, FASB ASC 740-10-55-136 through 55-138 requires use of the lowest tax

rate. Thus, a small corporation that distributes all of its earnings through bonuses and retirement plan

contributions would use a 15% federal rate.



b. If state taxable income is the same as federal taxable income, use the following formula to find a blended

state and federal tax rate that takes into consideration the federal tax deduction for state income taxes paid:

The federal rate used in the preceding formula should be the rate selected in item a. To illustrate, if the

state tax rate is 6% and a federal graduated tax rate of 15% for taxable income up to $50,000 is selected in

item a, the blended federal and state rate would be 20%; that is, [15% × (1 − 6% = 94%)] + 6% = 20%.

c. A combined federal and state tax rate should not be used if state taxable income and federal taxable

income are computed differently. In such cases, temporary differences for state and federal deferred tax

calculations may differ. Consequently, federal and state deferred taxes must be computed separately if

state and federal temporary differences materially differ. Apply the appropriate state tax rate to state

temporary differences and the appropriate federal tax rate to federal temporary differences.

d. If the company is subject to multiple tax jurisdictions, use either the rate of the jurisdiction to which most

of the income is allocated or a simple weighted average. The extra precision of basing the rate on

apportionments rarely has a material effect on the financial statements.

e. Once a rate is set, adjust it only if there is a material change. Year-to-year changes for small to medium-

sized companies normally are not significant.

.20 Section 401 provides additional guidance on selecting a tax rate. Section 405 provides detailed guidance on

computing deferred taxes when a company is subject to taxes in multiple tax jurisdictions.

.21 Consider the Need for a Deferred Tax Asset Valuation Allowance. The probability of realizing a

deferred tax asset must be greater than 50% or a valuation allowance is necessary. Therefore, after calculating

the deferred tax asset, assess the likelihood of its realization, and, if necessary, provide a valuation allowance.

The likelihood of realization depends on the availability of income in prior carryback years (if carryback is

permitted under the tax law) and the company's ability to generate future taxable income. Observations about

assessing the need for a valuation allowance follow:

a. So long as management expects taxable income during each of the years that deductible differences are

expected to reverse, a valuation allowance for the deferred tax effects of the deductible differences is

unnecessary. (Since taxable income includes the effects of future reversals of current deductible



differences, the fact that taxable income is expected to exist indicates that the deductible reversals will be

offset by other sources of taxable income and their deferred tax effects will be realized.)

b. To assess the need for an allowance for loss carryforwards, consider the likelihood of generating

appropriate taxable income at least equal to the amount of the carryforwards. For example, if a company's

$300,000 loss carryforward is available for 10 years, is there greater than a 50% chance that taxable

income will average at least $30,000 for 10 years? If not, estimate how much taxable income will be

available to offset the carryforward and fully reserve the deferred tax asset related to the excess

carryforward.

c. Normally, a valuation allowance is necessary when there are going concern considerations. Those

considerations come into play only when there is substantial doubt about an entity's ability to continue as a

going concern for another year. While the authoritative literature does not quantify substantial doubt, it

seems inappropriate to recognize a deferred tax asset when the company's ability to continue as a going

concern is questionable.

.22 Assessing the need for a deferred tax asset valuation allowance is discussed in greater detail in section

403.

Current Income Tax Provision

.23 A company's current income tax provision represents income taxes for the period as reported in the

underlying tax returns. It has two components: the taxes reported in the current year tax returns and

adjustments of amounts reported in prior year tax returns. However, benefits reported in the tax return are not

recognized in the current tax provision unless those amounts are more likely than not to be sustained in a tax

audit. FASB ASC 740 allows penalties and interest from tax settlements to be included in either the current tax

provision or pretax income as long as the accounting policy is consistently applied. See Appendix 1G for further

discussion of how uncertainties in income taxes affect measuring, recognizing, and reporting the current tax

provision.

.24 Because many companies issue their financial statements before their tax returns are filed, accountants

may need to estimate the current tax provision to report on the financial statements. The estimate can be made

using tax software or manually. Generally, current income taxes can be estimated manually by starting with

GAAP pretax income and:

a. adjusting for permanent differences (i.e., tax-exempt income and nondeductible expenses), increases or

decreases during the year in temporary differences, and available loss carryforwards;

b. multiplying the result by the appropriate tax rates;



c. subtracting tax credits (or tax credit carryforwards) and benefits from current year loss carrybacks from

that amount; and

d. if applicable, adjusting for changes in the unrecognized tax benefit liability and settlements of prior

returns.

.25 Estimating the current income tax provision is discussed in more detail in Chapter 3.

Presentation and Disclosures

.26 Most of the complexity in accounting for income taxes relates to calculating the current and deferred tax

provisions. Presentation and disclosure requirements generally do not create significant difficulties. The

following paragraphs discuss considerations for presenting income taxes in the balance sheet and income

statement and for making the necessary disclosures in the notes to the financial statements.

.27 Presenting Income Taxes in the Balance Sheet. Income taxes should be segregated into current and

noncurrent components when they are presented in classified balance sheets. The tax liability (or asset) related

to the current tax provision should be classified as a current liability (or asset). Deferred tax assets and liabilities

should be classified as current or noncurrent as follows:

a. Deferred tax assets and liabilities that can be identified with particular assets and liabilities for financial

reporting should be classified in the same manner as those assets and liabilities. For example, a deferred

tax liability related to property and equipment would be classified as noncurrent since it is associated with a

noncurrent asset.

b. Deferred tax assets and liabilities that cannot be identified with particular assets and liabilities for

financial reporting should be classified based on the reversal dates of the temporary differences or

carryforwards. In other words, the portion of those deferred tax assets and liabilities that will reverse during

the next year should be classified as current, and the portion that will reverse after the next year should be

classified as noncurrent. For example, the tax effect of net operating loss carryforwards that are expected to

offset taxable income within the next year should be classified as current, and the portion expected to offset

taxable income after the next year should be classified as noncurrent.

c. The deferred tax asset valuation allowance should be allocated ratably between current and noncurrent

deferred tax assets for that jurisdiction. That applies even if there are several deferred tax assets and the

valuation allowance relates to a specific deferred tax asset, such as a loss carryforward.



.28 All current deferred tax assets and liabilities within a jurisdiction should be offset and presented as a single

current amount. Similarly, all noncurrent deferred tax assets and liabilities within a single jurisdiction should be

offset and presented as a single noncurrent amount.

.29 A liability for unrecognized tax benefits [which is the entity's potential future obligation to all relevant taxing

authorities for all tax positions (or portions thereof) that fail the more-likely-than-not recognition criterion] should

be classified as a current liability to the extent that the entity expects to make (or receive) a cash payment to

settle the related tax position within one year (or operating cycle, if longer). The remaining portion should be

classified as a noncurrent liability. Liabilities for unrecognized tax benefits should not be combined with deferred

tax assets or liabilities.

.30 GAAP for income taxes requires intraperiod tax allocation, which refers to the mechanics of allocating

income taxes within a period to income from continuing operations, other components of net income, other

comprehensive income, and equity. Under current GAAP, certain items are charged or credited directly to other

comprehensive income or stockholders' equity rather than net income. Generally, the tax effects of those items

are also charged or credited directly to other comprehensive income or the related components of stockholders'

equity in the balance sheet. Section 501 and the paragraphs beginning at paragraph 502.38 discuss reporting

tax assets and liabilities in the balance sheet in greater detail.

.31 Presenting Taxes in the Income Statement. Income tax expense generally is presented as a separate

line item in the income statement immediately preceding net income (or income before extraordinary items and

cumulative accounting adjustments, if applicable) and consists of two components: the current income tax

expense (or benefit) and the deferred income tax expense (or benefit). Through intraperiod tax allocation (as

discussed in paragraph .29), income tax expense is allocated to income from continuing operations,

discontinued operations, and extraordinary items in the income statement.

.32 The tax benefit of a previously unrecognized loss carryforward should be classified in the same manner as

the transaction or event allowing it to be realized. Section 502 discusses presenting income taxes in the income

statement in greater detail.

.33 Disclosures.FASB ASC 740-10-50 requires several income tax disclosures. Those disclosures are

discussed in detail in section 504 and in the income tax disclosure checklist in Appendix 5C. Most small to

medium-sized companies need only disclose the following:

a. Method of Accounting for Income Taxes. Although not specifically required by authoritative literature,

many companies disclose their income tax accounting policies at least in a general way. The example note

in item d illustrates how the method of accounting for income taxes might be shown in the accounting

policies note.

b. Current and Deferred Taxes. Both the current and deferred portions of the total tax provision should be

disclosed in the financial statements. The disclosure may be made either in the income statement or the

notes to the financial statements.



c. Total Deferred Tax Assets, Total Deferred Tax Liabilities, Total Deferred Tax Asset Valuation Allowance,

and the Increase or Decrease in the Deferred Tax Asset Valuation Allowance. As a practical matter, the

disclosures may be made on the face of the balance sheet when:

(1) There are only deferred tax assets or only deferred tax liabilities.

(2) Assets and liabilities are not netted. (In other words, the current portion has all taxable or all

deductible differences and the noncurrent portion has all taxable or all deductible differences.)

More often, however, the disclosures are made in the notes to the financial statements as illustrated in

paragraph 504.15.

d. A Description of the Types of Temporary Differences. The nature of temporary differences and

carryforwards that result in significant portions of deferred tax assets or liabilities should be disclosed.

Although GAAP for income taxes does not prescribe how the differences should be described, since

temporary differences are defined as differences between the tax and financial bases of assets and

liabilities, the authors recommend usually describing them by referring to balance sheet, rather than income

statement, accounts. There may be instances, however, when referring to the income statement accounts

is more easily understood. In those cases, describing them in that manner is acceptable. Normally, the

disclosure is made either in the accounting policies note or in a separate note. Examples follow:

In the Accounting Policies Note

Income Taxes

Income taxes consist of taxes on taxable income and deferred taxes for differences in the

bases of assets and liabilities for financial statement and income tax reporting. The

differences arise primarily because collection losses are not deductible until management

exhausts substantially all collection efforts and because of the use of different methods to

calculate depreciation deductions.

In a Separate Note

Deferred tax liabilities total $156,000 and consist primarily of the deferred tax effect of using

accelerated methods to calculate depreciation deductions. Deferred tax assets total $55,000

for the tax benefit of treating administrative costs as inventory costs for tax reporting and the

benefit of loss carryforwards.



e. Taxes Paid. FASB ASC 230-10-45-25, Statement of Cash Flows—Overall—Other Presentation Matters,

requires the total amount of income taxes paid during the period to be disclosed. The guidance does not

address how income tax refunds affect the disclosure. The authors believe that the amount disclosed

should be net of receipts of income tax refunds. (In some years, that might result in disclosing net receipts.)

The authors believe that it is not necessary to disclose the gross amount of receipts or payments or that a

net amount is presented.

f. Significant Reconciling Items between Expected and Actual Income Tax Expense Related to Continuing

Operations. Nonpublic companies need only describe the significant differences between income taxes and

taxes on pretax income; quantifying the amounts is unnecessary. (Publicly held companies must provide a

numerical reconciliation.) The significant differences for many small to medium-sized companies include the

following:

(1) Permanent differences.

(2) Differences between the expected and actual tax rates.

(3) Adjustments of the valuation allowance.

(4) State and local income taxes.

Usually, the descriptions can be general as illustrated by the following examples:

The result of applying statutory rates to pretax income differs from the tax

provision primarily because nondeductible expenses have no tax benefit and because of the

use of estimated rates to calculate deferred taxes.

or

The relationship of income taxes and pretax income is different than expected primarily

because there is no tax benefit for nondeductible life insurance and because the separate

calculations of current and deferred taxes each consider the effect of graduated rates.

Reconciliations of the expected and actual tax provisions are discussed in further detail beginning at

paragraph 504.39. Appendix 5E includes illustrative calculations and disclosures.



g. Amounts and Expiration Dates of Carryforwards Available for Tax Reporting. The carryforward for tax

purposes is the amount that is available to offset future taxable income (that is, the carryforward reported in

the company's tax returns).

h. Interest and Penalties. The policy on classifying interest and penalties should be disclosed. The policy

can be disclosed separately in the notes to the financial statements, as a part of other income tax

disclosures, or as part of the accounting policies note. The disclosure may be general in nature.

i. Unrecognized Tax Benefits. FASB ASC 740-10-50 requires disclosure of (1) information about tax

positions for which it is reasonably possible that the total amount of unrecognized tax benefits will

significantly increase or decrease within 12 months of the reporting date, (2) the total amount of interest and

penalties recognized in the income statement and balance sheet, and (3) a description of the tax years that

remain subject to examination by major tax jurisdictions. Public entities must also provide a tabular

reconciliation of the liability for unrecognized tax benefits (LUTB) at the beginning and end of the period and

the LUTB amount that, if recognized, would affect the effective tax rate. See Appendix 1G and section 504

for further discussion of unrecognized tax benefit disclosures, including illustrative examples.


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