Summary:

Entities may be required to disclose more granular information about income taxes.

Specifically, under a proposal issued by the FASB:

• Public business entities (as defined in U.S. GAAP) would be required to disclose a rate reconciliation that is more disaggregated than under current requirements, using set categories. Other entities would be required to provide qualitative disclosure about specific categories of items and individual jurisdictions that result in a significant difference between the statutory tax rate and the effective tax rate.
• All entities would be required to disclose more information about income taxes paid disaggregated by jurisdiction.

In addition, the proposal includes changes previously exposed for comment in 2019, which could result in more disclosures for certain entities.

Comments on the proposal are due by May 30, 2023. Management should consider commenting on the operability of the proposal and the time needed to implement it.

Background

The FASB proposed these amendments to improve the transparency and usefulness of income tax disclosures for investors, lenders, and other users of financial statements, who requested more information to help them assess an entity’s tax risks, planning and cash flows. As shown in the timeline below, this proposal builds upon work that the FASB began in 2014, proposals that were issued in 2016 and 2019, and input from the 2021 FASB Agenda Consultation.

Main Provisions

Companies would be required to provide more information in the rate reconciliation and about income taxes paid. These proposed changes are described in more detail below.

Rate Reconciliation

Public business entities (as defined in U.S. GAAP) would be required to provide more quantitative and qualitative disclosures about the rate reconciliation. Other entities would be required to provide more qualitative disclosures.

Rate Reconciliation Changes for Public Business Entities

Public business entities would be required annually to disclose a tabular reconciliation, using both percentages and reporting currency amounts, with the following categories (however, these will be further disaggregated as described below and as shown in the example in the Appendix):

These categories are more disaggregated than current requirements. In addition, ASC 740 currently requires an entity to disclose an amount or a percentage, but not both.

Under the proposal, separate disclosure (that is, a separate line item in the rate reconciliation) would be required for any reconciling item listed below in which the effect of the reconciling item is greater than or equal to 5% of the amount computed by multiplying the income (or loss) from continuing operations before tax by the applicable statutory federal income tax rate:

• Effects of cross-border tax laws, tax credits, and nontaxable or nondeductible items categories, which must be disaggregated by nature
• Effects of foreign tax effects, which must be disaggregated by country and by nature
• Other reconciling items, disaggregated by nature

When disaggregating reconciling items by nature, an entity should consider the reconciling item’s fundamental or essential characteristics, such as the event that caused the reconciling item and the activity related to the reconciling item.

The proposal would also require a public business entity to qualitatively describe:

• State and local jurisdictions that contribute to the majority of the effect of the state and local tax category (annually)
• The nature, effect, and significant year-over-year changes in the reconciling items, if not otherwise evident (annually)
• Any reconciling items that significantly change the estimated annual effective tax rate from the prior annual reporting period (quarterly)

BDO Insight

Under this proposal, foreign tax effects are calculated for each individual country, not net. For example, if the net impact of foreign tax effects is 2%, with Foreign Country A negatively affecting the rate by 10% and Foreign Country B favorably affecting the rate by 8%, then both Foreign Country A and Foreign Country B would be separately disclosed within the foreign tax effects category.

Additionally, individual reconciling items (for example, the effects of share-based payment awards and of changes in unrecognized tax benefits, both on the tax provision for Foreign Country A) would be disaggregated and separately disclosed by nature and by country, as shown in the example in the Appendix.

While stakeholders are generally expected to support these proposed changes, applying the new requirements may require more time and effort by both management and auditors. Management should consider whether changes are needed to implement internal controls over this information.

Rate Reconciliation Changes for Other Entities

Under this proposal, an entity other than a public business entity would be required to qualitatively (rather than quantitatively) disclose the nature and effect of significant reconciling items listed in the table above, and individual jurisdictions that result in a significant difference between the statutory tax rate and the effective tax rate. However, a numerical reconciliation is not required. The proposal includes an example of the required disclosure.

Income Taxes Paid

Under this proposal, all entities would be required to disclose:

• Year-to-date income taxes paid disaggregated by federal, state, and foreign taxes (annually and quarterly)
• Income taxes paid disaggregated by individual jurisdictions using a threshold of 5% of total income taxes paid (annually)

Entities would disclose amounts paid net of refunds received.

BDO Insight

Cash taxes paid should be readily available for most companies since the information is also needed for tax returns. However, management should consider whether it needs to change or implement internal controls over this information, since it will now form part of the disclosures in the financial statements.

Other Changes Previously Proposed

The FASB included certain amendments from the 2019 revised exposure draft in the current proposal. These changes include:

• Replacing the term “public entity” with the term “public business entity”
• Eliminating the requirement for all entities to disclose:
  • The nature and estimate of the range of the reasonably possible change in the unrecognized tax benefits balance in the next 12 months or
  • A statement that an estimate of the range cannot be made
• Removing the requirement to disclose the cumulative amount of each type of temporary difference when a deferred tax liability is not recognized because of the exceptions to comprehensive recognition of deferred taxes related to subsidiaries and corporate joint ventures

BDO Insight

Under this proposal, certain entities that today are considered “nonpublic entities” would be “public business entities” (as defined in U.S. GAAP) and would be required to make all the disclosures that are currently required for public entities in ASC 740, Income Taxes, in addition to the new disclosure requirements. Such entities include:

• Acquirees whose financial statements are included in a registrant’s SEC filing in accordance with Rule 3-05 of Regulation S-X
• Equity method investees whose financial statements or summarized financial information are included in a registrant’s SEC filing in accordance with Rule 3-09 or Rule 4-08(g) of Regulation S-X, respectively
• Certain financial institutions required to file financial statements with the Federal Deposit Insurance Corporation, the Federal Reserve, or the Office of the Comptroller of the Currency
• Certain insurance companies that file financial statements with state insurance regulators

These entities may need more time or incur more costs to implement the proposal and may need to design internal controls over the required information.

Additionally, even if an entity does not meet the definition of a public business entity today, management should consider the likelihood of becoming a public business entity and decide whether to proactively incur the time and costs now in case that happens.

Effective Dates and Transition

The effective date will be determined in the future. The changes would be effective retrospectively; that is, an entity would be required to make the income tax disclosures for all periods presented.

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For questions related to matters discussed above, please contact Steve Maniaci ([email protected] or 616-802-3508), Daniel Newton ([email protected] or 617-312-3740), Meredith Taylor ([email protected] or 571-461-6744), or another member of the Professional Practice Group.

Appendix

The following example, adapted from the FASB’s proposal, illustrates the application of the guidance on required categories and level of disaggregation in the rate reconciliation, assuming such amounts meet the quantitative and qualitative criteria for disaggregation described above

⁽¹⁾ State taxes in California and New York contributed to the majority of the tax effect in this category.