FASB Income Tax Disclosure Project: An Overview of Changes

The Financial Accounting Standards Board (FASB) establishes financial reporting standards for U.S. companies. In response to investor requests for greater clarity, the FASB issued Accounting Standards Update (ASU) 2023-09, “Improvements to Income Tax Disclosures,” in December 2023. The goal is to enhance the transparency of income tax information in financial statements. For years, investors indicated that existing disclosure rules, which had not seen significant changes for over a decade, lacked the detail needed to assess a company’s global tax risks, and feedback pointed to a need for more disaggregated information about a company’s operations across different tax jurisdictions. ASU 2023-09 addresses these concerns by overhauling disclosures in two main areas: the reconciliation of a company’s effective tax rate and the breakdown of income taxes paid.

Enhancements to Rate Reconciliation Disclosures

A rate reconciliation is a table that explains the difference between a company’s expected income tax expense, calculated using the statutory U.S. federal income tax rate, and its actual reported income tax expense, often referred to as the effective tax rate. This reconciliation provides insight into the various factors that cause a company’s tax rate to differ from the statutory rate.

Under ASU 2023-09, public business entities must now present their rate reconciliation using specific, prescribed categories, which replaces the previous approach where companies had more discretion. Required categories include:

• State and local income tax, net of any federal income tax benefit
• Foreign tax effects
• Tax credits
• Changes in valuation allowances
• The impact of changes in tax laws or rates

For entities other than public business entities, the new standard requires a qualitative disclosure describing the nature and effect of their significant reconciling items.

A significant change for public business entities is the introduction of a quantitative threshold. If the tax effect of any single reconciling item is equal to or greater than 5% of the amount computed by multiplying the company’s pre-tax income from continuing operations by the statutory federal rate, it must be separately disclosed. This ensures that company-specific tax matters are not aggregated into vague categories like “other.”

The new guidance also requires public business entities to provide certain qualitative disclosures about the rate reconciliation. This means companies may need to explain the nature and effect of specific reconciling items, particularly those that are individually significant or subject to uncertainty. For example, a company might need to elaborate on the tax effects of its foreign earnings or valuation allowances on deferred tax assets.

New Requirements for Income Taxes Paid

The new standard introduces a major change to how all entities must report the amount of income taxes they pay. Previously, companies disclosed only the total amount paid, but ASU 2023-09 mandates a more detailed breakdown of these cash tax payments. Under the new rules, all companies must annually disclose the amount of income taxes paid, net of any refunds received, disaggregated into three main categories: federal (national), state, and foreign. This offers users a better understanding of where a company’s tax payments are directed.

The standard goes a step further by requiring additional disaggregation for significant jurisdictions. A company must now separately disclose the amount of income taxes paid to any individual jurisdiction—a specific U.S. state or a foreign country—if that amount is 5% or more of the total income taxes paid. This disaggregated information on taxes paid is distinct from the rate reconciliation, which is based on the income tax expense and not on actual cash payments. The information can be disclosed either on the face of the statement of cash flows or within the notes to the financial statements.

Other Key Disclosure Amendments

ASU 2023-09 includes other targeted amendments, including changes to unrecognized tax benefits (UTBs). UTBs are potential tax benefits from a tax position that may not be sustained upon examination by a tax authority. To reduce disclosure complexity, the update eliminates the previous requirement for a company to disclose the nature and estimated range of any reasonably possible change in its UTB balance over the next 12 months.

Another amendment focuses on net operating loss (NOL) and tax credit carryforwards. These are assets that can offset future tax liabilities. The new standard requires all entities to disclose the total amount of federal, state, and foreign carryforwards. For each of these categories, companies must now also provide the expiration dates, or a range of expiration dates, for these tax attributes, which helps users assess the likelihood that a company will be able to realize their value.

The update also requires all entities to disclose the income or loss from continuing operations before income tax from both domestic and foreign sources. Similarly, the income tax expense or benefit itself must be broken down by federal, state, and foreign sources. This provides a clearer link between where a company generates its profits and where it incurs its tax expense.

Implementation and Effective Date

For public business entities, the amendments in ASU 2023-09 are effective for annual reporting periods beginning after December 15, 2024. For a public business entity with a calendar year-end, the new disclosures will first be required in its 2025 annual financial statements. For all other entities, including non-profit organizations and private companies, the effective date is delayed by one year, applying to annual periods beginning after December 15, 2025.

Companies are permitted to adopt the new standard early for any annual financial statements that have not yet been issued. The standard is to be applied on a prospective basis, meaning companies will apply the new rules to the current period’s financial statements without restating prior periods. However, the guidance provides an option to apply the standard retrospectively, which involves recasting prior-period disclosures to conform with the new rules, enhancing comparability.