Public business entities that issue audited financial statements under Generally Accepted Accounting Principals (GAAP) will be required to provide more specific information in their income tax provisions starting with their 2025 reports. The Financial Accounting Standards Board (FASB) released Accounting Standards Update (ASU) 2023-09, “Improvements to Income Tax Disclosures,” in late 2023, and the disclosure requirements in that update take effect for public entities with fiscal years that begin after Dec. 15, 2024. (Entities other than public business entities will be required to follow the guidance for periods beginning after Dec. 15, 2025.)
The FASB issued these amendments to Accounting Standards Codification (ASC) 740, “Income Taxes,” to “enhance the transparency and decision usefulness of income tax disclosures.” The board noted that investors had suggested possible enhancements to “ … better:
- Understand an entity’s exposure to potential changes in jurisdictional tax legislation and the ensuing risks and opportunities,
- Assess income tax information that affects cash flow forecasts and capital allocation decisions, and
- Identify potential opportunities to increase future cash flows.”
With these goals in mind, the main change that will result from ASU 2023-09 is the presentation of specific component amounts (or “disaggregation”) of the overall tax reconciliation figure.
Disaggregated components of the rate reconciliation under ASU 2023-09
Under ASU 2023-09, public entities continue to be required to disclose a detailed effective tax rate reconciliation, whereas private companies may choose to present a qualitative disclosure in lieu of the quantitative reconciliation. ASU 2023-09 focuses on breaking the rate reconciliation information presented in the financial statement tax provisions of public business entities into smaller, more specific components to provide investors with targeted information about tax positions that had previously been presented as more of a lump sum. This “disaggregation” applies to:
- State and local income taxes (net of federal benefit)
- Foreign tax effects*
- Effect of changes in tax laws
- Effect of cross-border tax laws*
- Tax credits*
- Changes in valuation allowances
- Nontaxable or nondeductible items*
- Changes in unrecognized tax benefits
Each of these categories must be presented in the reconciliation table with both the dollar amount and the percentage of pretax income. The items on the list denoted by asterisks (*) are subject to further disaggregation if the tax effect of the category exceeds 5% of the federal statutory tax rate. Categories subject to the 5% rule must provide these additional breakdowns of relevant information:
- Cross-border tax laws (e.g., GILTI, BEAT, FDII), tax credits (e.g., R&D, energy, WOTC), and nontaxable or nondeductible items must be separated out based on the nature of the component amounts.
- Foreign tax effects must be separated out by the jurisdiction and nature of component amounts.
In addition, any component of the tax reconciliation that crosses the 5% of pretax income from continuing operations threshold should also be disaggregated, categorized by nature, and the relevant dollar amount and percentage disclosed. The rules also require that the entity explain the nature, effect, underlying causes, and judgment applied to any reconciling item for which these components aren’t otherwise evident.
For most of the items in the eight disaggregation categories listed above, public business entities will be required to list only the federal effects of the items broken out. For state and local taxes and foreign taxes, entities will need to break out both the federal effects and the effects in each relevant jurisdiction.
Affected public business entities will have an additional classification process for the impact of state reconciliation items. The impact of all state adjustments must be ranked from largest to smallest according to their impact on the tax reconciliation and then the top 50% of states affecting the provision broken out and presented individually.
The FASB has presented an example of how this expanded rate reconciliation disclosure might appear following the adoption of ASU 2023-09. In this example, a public business enterprise with a U.S. parent corporation has operations in various foreign jurisdictions. In the United Kingdom and Ireland, individual reconciling items exceed the threshold of 5% of pretax income multiplied by the federal statutory rate. Switzerland and Mexico meet the threshold at a jurisdictional level, and other jurisdictions fall below the threshold. The table on page 16 of Accounting Standards Update (ASU) 2023-09, “Improvements to Income Tax Disclosures,” illustrates how a rate reconciliation for this entity’s comparative financial statements may appear.
Disaggregation of income tax amounts paid under ASU 2023-09
ASU 2023-09 also applies a disaggregation process to income tax amounts paid by both public and private entities. The guidance requires disclosure of the following information about income taxes paid on an annual basis:
- The amount of income taxes paid (net of refunds received) disaggregated by federal, state, and foreign taxes.
- The amount of income taxes paid (net of refunds received) disaggregated by individual jurisdictions in which income taxes paid (net of refunds received) is equal to or greater than 5% of total income taxes paid (net of refunds received).
The update also requires that all entities disclose:
- Income (or loss) from continuing operations before income tax expense (or benefit) disaggregated between domestic and foreign operations.
- Income tax expense (or benefit) from continuing operations disaggregated by federal, state, and foreign components.
While these provisions will eventually apply to all entities looking to release financial statements audited in accordance with GAAP, they’re in effect for fiscal years beginning in 2025 for public business entities while private entities aren’t subject to the new rules until fiscal years beginning after Dec. 15, 2025. Nevertheless, FASB does encourage early adoption for all entities where possible.
Increased transparency and usefulness of income tax disclosures
When discussing how this new guidance will affect an entity’s income tax provision, it’s helpful to remember that the FASB’s primary focus in creating ASU 2023-09 was to increase the transparency and usefulness of income tax disclosures in the financial statements. The fundamental difference that most businesses will experience related to the new guidance is a more detailed presentation of the information that they have already been compiling in order to prepare the tax provision.
To learn more about how ASU 2023-09 could affect the preparation of your company’s tax provision in 2025 and beyond, contact us today to get started.
