Simplifying the Rules for Reporting Income Taxes

For years, businesses have complained that the guidance under Accounting Standards Codification Topic 740, Income Taxes, includes many mechanical rules and exceptions. As a result, it often yields information that’s challenging for investors to understand. These complaints intensified with the sweeping changes brought forth under the Tax Cuts and Jobs Act.

On September 4, the Financial Accounting Standards Board (FASB) unanimously voted to finalize a proposal to simplify the existing rules.

What’s changing?

By year end, the FASB expects to publish an updated standard that will simplify income tax accounting requirements in several unrelated areas that companies said were costly and complex. To improve consistency in accounting for income taxes and to simplify practice, the final standard will remove exceptions to:

• The incremental approach for intraperiod tax allocation when there’s a loss from continuing operations and income or a gain from other items,
• The requirement to recognize a deferred tax liability for equity method investments when a foreign subsidiary becomes an equity method investment,
• The ability not to recognize a deferred tax liability for a foreign subsidiary when a foreign equity method investment becomes a subsidiary, and
• The general method for calculating income taxes in an interim period when a year-to-date loss exceeds the anticipated loss for the year.

The FASB also made some narrow clarifications for:

• Franchise taxes that are partially based on income,
• Transactions that result in a step up in the tax basis of goodwill,
• Financial statements of legal entities that aren’t subject to tax, and
• Enacted changes in tax laws in interim periods.

On franchise taxes, the FASB voted to revise the transition method to allow companies a choice in applying the franchise tax amendments either retrospectively or on a modified retrospective basis.

Positive feedback

The final standard is based on Proposed Accounting Standards Update (ASU) No. 2019-700, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes, which was issued in May. In general, response to the proposal was positive. Most respondents agreed that the changes would simplify reporting for income taxes while maintaining or improving the usefulness of information provided to financial statement users.

For public companies, the changes will be effective for fiscal years beginning on or after December 15, 2020. For all other companies, the changes will be effective on or after December 15, 2021. However, because the updated standard is simpler and isn’t expected to increase reporting costs, many companies are expected to adopt the standard early.