FASB improves income tax disclosures

The amendments in FASB ASU 2023-09, Improvements to Income Tax Disclosures, are designed to increase the transparency and decision-usefulness of income tax disclosures for financial statement users. Prompted by investors’ requests for additional information about jurisdictional tax exposures and increased granularity, the amendments revise the existing disclosure guidance in ASC 740, Income Taxes, related to (1) the rate reconciliation table, (2) income taxes paid in various jurisdictions, and (3) unrecognized tax benefits and certain temporary differences.

Definition of a ‘public business entity’

The existing disclosure requirements in ASC 740 distinguish between public and nonpublic entities in several different respects, utilizing a definition of “public entity” described in ASC 740-10-20 that is specific only to this Topic.  

The amendments replace the definition of a “public entity” that is unique to ASC 740 with the definition of a “public business entity” (PBE) commonly used elsewhere in the FASB Codification.

As the FASB noted in the ASU’s Basis for Conclusions, a subset of reporting entities that did not qualify as public entities as previously defined in ASC 740 may now qualify as PBEs, making them subject to the incremental disclosure guidance in ASC 740 applicable to public companies. 

Specifically, ASC 740 provides for incremental disclosure requirements for public companies compared to the requirements for nonpublic companies related to

• Temporary differences;
• Rate reconciliation; and
• Unrecognized tax benefits.

Additionally, the existing guidance requires public entities that are not subject to income taxes to include specific disclosures in the financial statements.

Rate reconciliation disclosure

The FASB considers the rate reconciliation table, which reconciles an entity’s effective tax rate to its statutory rate, to be one of the most useful tax disclosures for investors, providing them with an understanding of a reporting entity’s risks and opportunities. In ASU 2023-09, the FASB decided to enhance the rate reconciliation disclosures by providing an overall disclosure objective and prescribing greater disaggregation of information presented in the rate reconciliation table.

Objective of the rate reconciliation

In ASC 740-10-50-11A, the FASB added an overall objective for the rate reconciliation table to clarify that financial statement preparers may present more information than what is prescribed in ASC 740-10-50-12 through 50-13 if the reporting entity determines that such information is necessary for investors in understanding the drivers of differences between the entity’s current effective tax rate and its statutory tax rate. Accordingly, reporting entities should take care to ensure that they have considered whether additional information is necessary for financial statement users to obtain that understanding and should provide additional information if they determine it is necessary.

Disaggregation in the rate reconciliation

PBEs are required to provide a tabular rate reconciliation, while entities other than PBEs are required only to provide a qualitative, narrative disclosure describing the nature of the items driving a difference between the entity’s effective tax rate and its statutory rate. Prior to the amendments in ASU 2023-09, U.S. GAAP required reporting entities to use judgment when determining which categories of reconciling items to present in their rate reconciliation table. To enhance transparency, comparability and consistency, the amendments now require PBEs to disclose prescribed categories of reconciling items for each annual reporting period as part of the rate reconciliation between income tax expense (or benefit) and statutory expectations. 

Public business entities

The amendments require PBEs to disclose both the dollar amount and percentage for each item presented in the rate reconciliation table. The categories and related presentation and disclosure requirements under the amendments are summarized in the table below. In addition to the required categories, reporting entities are now required to disclose other reconciling items unique to the entity’s particular circumstances. Entities should consider whether they need to disclose additional categories of reconciling items to meet the new objective for the rate reconciliation disclosure. If a rate other than the U.S. federal corporate income tax rate is used, an entity should disclose the rate used and the basis for using such rate. 

Additionally, the amendments align the existing income tax disclosure guidance with the requirements of Rule 4-08(h)(2) of SEC Regulation S-X by requiring disclosure of any reconciling item, including other reconciling items not captured by the prescribed categories in 740-10-50-12A(a), whose absolute value is equal to or greater than 5 percent of the absolute value of the amount computed by multiplying the income (or loss) from continuing operations before income taxes by the applicable statutory federal or national income tax rate. The requirement for disaggregated disclosures is included in the “Disaggregation” column of the table above. The reporting entity must also explain the nature, effect, and underlying causes of individual reconciling items, as well as the judgment used in categorizing the items in the rate reconciliation table. Refer to an example rate reconciliation table below.

An entity should use judgment in determining materiality for purposes of disaggregation if either (1) the entity is domiciled in a jurisdiction with a tax rate significantly lower than the U.S. statutory tax rate, or (2) the entity operates at or near breakeven.

Entities other than public business entities

The amendments require entities other than PBEs to qualitatively disclose the nature and effect of the specific categories listed in the table above. Additionally, entities other than PBEs are required to disclose individual jurisdictions that have a significant difference between the statutory tax rate and the effective tax rate. Numerical rate reconciliation is not required but is permitted for entities other than PBEs.

Disclosure of income taxes paid by jurisdiction

All entities must now disclose income taxes paid (net of refunds received), disaggregated by federal (national), state, and foreign taxes for each annual reporting period. Further, all entities are required to disclose income taxes paid to individual jurisdictions if the income taxes paid (net of refunds received) are equal to or greater than 5 percent of total income taxes paid (net of refunds received) for each annual reporting period.

Other updates

The amendments also revise the disclosure guidance in ASC 740 for certain income statement amounts, unrecognized tax benefits, and temporary differences.

Income statement amounts

The amendments in the ASU require the following income statement–related disclosures for each annual reporting period for all reporting entities:

• Income (or loss) from continuing operations before income tax expense (or benefit) disaggregated between domestic and foreign.
• Income tax expense (or benefit) from continuing operations disaggregated by federal (national), state, and foreign taxes. Income taxes on foreign earnings that are imposed by the reporting entity’s jurisdiction of domicile should be included in the amount for the jurisdiction of domicile that is imposing the tax.

Unrecognized tax benefits

The amendments eliminate the requirement for all entities to disclose either (1) the nature and estimate of the range of reasonably possible changes in the unrecognized tax benefits within the next 12 months, or (2) include a statement indicating that an estimate of the range cannot be made.

Temporary differences

The amendments also eliminate 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 the comprehensive recognition of deferred taxes related to subsidiaries and corporate joint ventures. However, entities should consider whether additional disclosures apply under ASC 275, Risks and Uncertainties.

Materiality

The Board emphasized in the ASU’s Basis for Conclusions that the guidance in ASC 105-10-05-6, which states that entities need not apply U.S. GAAP to immaterial items, also applies to all disclosures required by ASC 740, including those introduced or amended by ASU 2023-09. As a result, a reconciling item that meets quantitative thresholds under ASC 740 but is immaterial to the financial statements does not require separate disclosure. Entities must consider, however, whether the disclosure objective in ASC 740-10-50-11A is met, especially if the entity uses judgment in determining that a reconciling item is immaterial.

Effective date and transition

The amendments are effective for public business entities for annual periods beginning after December 15, 2024 and for entities other than public business entities for annual periods beginning
after December 15, 2025. Early adoption is permitted for annual financial statements that have not yet been issued or been made available for issuance. 

Entities may use a prospective method to adopt the amendments in ASU 2023-09; however, retrospective application is also allowed.