Keep This Income Tax Accounting Simplification on Your Radar
A recent accounting standards update could have a significant impact on your accounting department. The changes in the update attempt to “solve for” some of the complexity in accounting for income taxes, which was heighted by the changes released under the 2017 tax reform law known as the Tax Cuts and Jobs Act. How much the accounting standards update (ASU) to ASC Topic 740, Income Taxes affects your organization will depend on the nature of your business.
The following provides a closer look at the core provisions of the standard.
Summary of the Core Changes to Income Tax Accounting
The Financial Accounting Standards Board (FASB) released its Accounting Standards Update 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes (ASU 2019-12) in December 2019.
Updates to ASC Topic 740 have long been on the Simplification Initiative’s agenda, and this update aims to improve the accounting standards codification by removing some of its exceptions. The exceptions ASU 2019-12 eliminates affect the following scenarios:
Business Losses and Gains
If your organization experiences a loss from continuing operations and income or a gain from discontinued operations or other comprehensive income, you will be able to use the incremental approach for intra-period tax allocation.
When a year-to-date loss exceeds the anticipated loss for the year, you will still be able to apply the general methodology for calculating income taxes in an interim period.
When a foreign subsidiary becomes an equity method investment, you will recognize a deferred tax liability for the outside basis of that equity method investment if you are no longer able to assert that reversal of the liability is indefinite. Conversely, if an equity method investment becomes a subsidiary, you will derecognize a deferred tax liability for the outside basis if you assert indefinite reversal of the liability.
Additionally, the changes to ASC Topic 740 make other changes to streamline the accounting for income taxes.
Your organization will be required to recognize a franchise (or similar type of) tax that is partially based on income as an income-based tax and account for any incremental tax as a non-income-based tax.
Goodwill in Business Combinations
Your organization will be required to evaluate when a step up in the tax basis of goodwill should be accounted for as part of a business combination in which the book goodwill was originally recognized. In some instances, you may need to account for the step up in the tax basis of goodwill as a separate transaction.
Allocation of Income Tax to a Subsidiary’s Financial Statements
The update clarifies that your organization will not be required to allocate the consolidated amount of its current and deferred tax expense to a legal entity that is not subject to tax in its standalone financial statements. Your organization may elect to do so (an election made on an entity-by-entity basis) for a legal entity that is both not subject to tax and disregarded by the taxing authority.
Tax Reform Effects
Your organization will be required to reflect the effect of an enacted change in tax laws or rates in the annual effective tax rate computation in the interim period that includes the enactment date. This aligns consideration of newly enacted changes in tax laws with how they are considered when computing deferred tax assets and liabilities.
Employee Stock Ownership Plans
ASU 2019-12 makes minor adjustments to the accounting for income taxes related to employee stock ownership plans (ESOPs) and investments in qualified affordable housing projects that use the equity method of accounting.
Effective Dates & Transition Requirements
Public business entities will adopt ASU 2019-12 for fiscal years and interim periods beginning after Dec. 15, 2020 (2021 calendar year). All others will adopt for fiscal years beginning after Dec. 15, 2021 (2022 calendar year) and interim periods beginning after Dec. 15, 2022 (2023 calendar year).
Early adoption is available for any interim period for which a financial statement has not yet been issued (or made available for issuance in the case of private entities).
Organizations will mostly apply ASU 2019-12 on a prospective basis in the year of adoption. Adoption and transition may come with a few nuances, however, depending on your circumstances.
Interim Period Adoption
If your organization adopts the standard early and during an interim period, you should make an adjustment in that interim period as if the changes had been in effect as of the beginning of the annual period that includes the interim period.
Elections to Allocate Income Tax to a Subsidiary’s Financial Statements
For legal entities not subject to tax, your organization will apply the changes to the separate financial statements of those legal entities on a retrospective basis for all periods presented.
Your organization will apply any accounting changes related to the ownership of foreign equity method investments and subsidiaries on a modified retrospective basis through a cumulative-effect adjustment to retained earnings as of the beginning of the fiscal year of adoption.
If your organization has income-based taxes, such as franchise taxes, you can apply the updates either on a retrospective basis for all periods presented or on a modified retrospective basis (by taking a cumulative-effect adjustment to retained earnings).
The Implications of the Changes
Multinational organizations, organizations that experienced a significant impact from the tax reform law, and franchisees are likely to be affected the most by the accounting update to income taxes. If your organization already has significant income tax accounting considerations, you should consider meeting with your accounting provider to discuss the potential ramifications of the changes in more detail.
For comments, questions, or concerns about ASU 2019-12, you can contact us. You can also view the recording of our Fourth Quarter Accounting and Financial Issues Update webinar, which included a discussion of the accounting standards change.