Accounting for income taxes is more confusing than it sounds. Why? The amount of pretax income reported on your company’s income statement may differ from the taxable income reported on its tax return. This results largely from book-to-tax differences, for example, in revenue recognition, depreciation methods and allowances for bad debts and warranties. Here’s a closer look at financial reporting requirements under Accounting Standards Codification Topic 740, Income Taxes.

Pretax vs. Taxable Income

The difference between pretax income and taxable income comes from the differing objectives of financial reporting (to report your company’s economic activities) vs. tax reporting (to raise tax revenue to run the government). Lawmakers’ policy agendas may also factor into the latter.

Income taxes reported on the income statement may or may not be equal to the amount of taxes actually paid by your business. The difference can be substantial for larger businesses that engage in more complex business transactions — such as stock compensation, intra-entity transfers, business combinations and uncertain tax positions — or are subject to international and/or multi-state tax laws. Some of these book-to-tax differences are temporary, but others may be permanent.

Deferred Tax Assets and Liabilities

In general, when an expense (such as a bad debt write-off) is higher for accounting purposes than it is for tax purposes, a company reports a deferred tax asset on its balance sheet. That is, the company has reported less tax expense to investors than it has actually paid to the IRS, resulting in a future tax benefit. It’s also common for companies to report deferred tax assets for net operating losses that may be carried forward to future periods.

Conversely, when an expense is higher for tax purposes than it is for accounting purposes, the company carries a deferred tax liability on its balance sheet. This may happen, for example, when a company takes advantage of Section 179 and first-year bonus depreciation deductions for fixed asset purchases in the current year.

Long-term deferred tax items may require adjustments to the amount initially recognized, depending on how tax laws and other circumstances change over time. For example, a reduction in corporate tax rates in subsequent periods might require companies with long-term deferred tax liabilities to reduce the amount reported on the balance sheet.

Disclosures

Footnote disclosures help investors, lenders and other stakeholders understand the nature of tax-related items on your financial statements. In recent years, the Financial Accounting Standards Board (FASB) has discussed beefing up the disclosure requirements for income taxes.

In July, the FASB proposed adding new disclosure requirements about such items as foreign earnings and global tax strategies. And, in October, a final update was released that will require companies to immediately recognize the income tax consequences of intracompany asset transfers other than transfers of inventory.

Need Help?

Our accounting and assurance services team is atop the latest developments in financial reporting for income taxes. Contact us for help with the initial recognition and ongoing evaluations of tax-related items on your year-end financial statements.