One area of U.S. GAAP that often challenges accountants and auditors is accounting for income taxes under ASC 740. A particularly difficult section of guidance deals with the intraperiod tax allocation. The good news is that the FASB has been looking for ways to simplify certain aspects of the accounting for income taxes and has issued ASU 2019-12 which is effective this year for most public business entities (PBEs) and next year for most non-PBEs. This ASU simplifies part of the guidance on the intraperiod tax allocation as well as a few other areas of income tax accounting. This post will outline the simplification related to the intraperiod tax allocation.
The purpose of the intraperiod tax allocation is to allocate total income tax expense (or benefit) to the different components of comprehensive income and shareholder’s equity (e.g., continuing operations, discontinued operations, other comprehensive income (OCI), and items charged or credited directly to shareholder’s equity). Sounds pretty simple, right? Well, the basic model is fairly simple, however, the application guidance (and issues that arise in practice) can be complex and, at times, counterintuitive. The basic approach is referred to in practice as the “incremental” or “with and without” approach and is summarized in the chart below. The allocation is only performed once the overall tax provision is computed and does not change the overall tax provision.
When it comes to the intraperiod tax allocation, the devil is in the details. Numerous special rules, practice issues, and exceptions to the general principle outlined above exist. Let’s take a look at an example of one of the exceptions to the general principle that created complexity but was recently removed by ASU 2019-12.
Let’s start with the second question first. Do any special rules or exceptions from the general principles exist? Historically, yes. This example illustrates one of the exceptions to the general allocation guidance in ASC 740-20. That exception states that when an entity has a loss from continuing operations, all items (i.e., discontinued operations, other comprehensive income, etc.) are considered when determining the amount of tax benefit from the loss from continuing operations. Remember, the general rules state that those items are not considered (i.e., the amount allocated to continuing operations is determined exclusive of the effects of other items). This longstanding exception is one of the complexities to the intraperiod tax allocation guidance. Stakeholders indicated that this exception is not only complicated, but difficult to apply and does not provide any benefit to the users of the financial statements because often the outcome is counterintuitive. ASU 2019-12 eliminates this exception. Going forward, companies will follow the general guidance for the allocation, even when there is a loss from continuing operations. Let’s take a look at the first question and illustrate the answer under legacy guidance and under the new guidance in ASU 2019-12.
How should the total income tax expense or benefit be allocated under the guidance for the intraperiod tax allocation?
The calculation of total income tax expense is the same under the legacy guidance and the new guidance:
Pretax loss from continuing operations $(15,000)
Pretax income from discontinued operations $20,000
Pretax income $5,000
Tax rate 21%
Total income tax expense $1,050
Allocation under legacy guidance
Since there is a loss from continuing operations with income from other items, the exception to the general allocation principle applies, meaning the $20,000 income from discontinued operations IS considered in determining the tax benefit that is allocated to continuing operations:
Income tax benefit allocated to cont. ops. (pretax loss $15,000 x 21%) $(3,150)
Income tax expense allocated to disc. ops. ($1,050 – ($3,150)) $4,200
Total income tax expense $1,050
In this particular example, the entire tax benefit from the loss from continuing operations is allocated to continuing operations, however, this may not always be the case. Because the company was required to consider the income from discontinued operations in its allocation, it was able to realize the benefit of the NOL carryforward.
Allocation under new guidance (ASU 2019-12)
Under the new guidance there will no longer be an exception to the general allocation guidance. This means that the company will no longer be able to consider the pretax income recorded in other categories when determining the tax benefit to allocate to continuing operations:
Income tax benefit allocated to cont. ops. (other sources NOT considered) $0
Income tax expense allocated to disc. ops. ($1,050 - $0) $1,050
Total income tax expense $1,050
Since the company is not allowed to consider income from other categories, it is unable to realize the benefit from the NOL carryforward. This means it cannot allocate any tax benefit to continuing operations and the entire amount of tax expense is allocated to discontinued operations.
In addition to eliminating this onerous exception to the general intraperiod tax allocation guidance, ASU 2019-12 made several other simplifications income tax accounting. Want to learn more about ASU 2019-12 and other new guidance applicable for the first time in 2021? Come check out our FREE, CPE-eligible webinar on ASUs Effective in 2021 on Thursday, May 6 at 11:00 AM EST! Register here.
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