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Although most items fall within the definition of ordinary income, there are also items which should be excluded from the definition of ordinary income. In some cases, the standard is clear regarding items that should be excluded from the definition of ordinary income, and other times, judgment will be necessary.

16.3.1 Interim provision—significant unusual or infrequent items

ASC 270-10-45-11A states that “gains or losses from disposal of a component of an entity, and unusual or infrequently occurring items shall not be prorated over the balance of the fiscal year.” The definition of “ordinary income (or loss)” referred to in ASC 740-270-20 differentiates ordinary income from items that are unusual in nature or that occur infrequently.
An item does not need to be both unusual and infrequent to be excluded from the estimated annual effective tax rate calculation.
Additionally, consideration should be given to ASC 740-270-30-12 to 30-13, which provides that the tax effect of significant unusual or infrequently occurring items that are reported separately within income from continuing operations, or for items that will be reported net of their related tax effect, should be excluded from the estimated annual effective tax rate calculation and instead be recorded on a discrete basis in the period in which the item occurs.

ASC 740-270-30-12

Taxes related to an employee share-based payment award within the scope of Topic 718 when the deduction for the award for tax purposes does not equal the cumulative compensation costs of the award recognized for financial reporting purposes, significant unusual or infrequently occurring items that will be reported separately or items that will be reported net of their related tax effect shall be excluded from the estimated annual effective tax rate calculation.

ASC 740-270-30-13

As these items are excluded from the estimated annual effective tax rate, Section 740-270-25 requires that the related tax effect be recognized in the interim period in which they occur. See Example 3 (paragraph 740-270-55-24) for illustrations of accounting for these items in the interim period which they occur.

Deciding whether an item is unusual or infrequent is an area of significant judgment, and a company’s business model may be relevant to that evaluation. For example, catastrophe losses (e.g., losses resulting from natural disasters, such as hurricanes) are not unusual or infrequent for property and casualty insurance companies because those companies are in the business of insuring customers against those risks. However, the losses from a hurricane may well be unusual or infrequent for a manufacturing company with only one of its plants in a hurricane zone.
Example TX 16-1 illustrates the impact of a nondeductible goodwill impairment on an interim period tax provision.
EXAMPLE TX 16-1
Impact of nondeductible-goodwill impairment on interim period tax provisions
Company ABC recorded a financial statement impairment of nondeductible goodwill during the second quarter.
Would the impairment of nondeductible goodwill be considered an unusual or infrequent item that requires discrete treatment, or should it be considered a component of the estimated annual ETR?
Analysis
While judgment is necessary to determine whether a nondeductible goodwill impairment should be classified as an unusual or infrequent item, in circumstances in which there has been no history of goodwill impairments and there is presently no reasonable expectation of significant goodwill impairments in the future, the tax effect of the impairment might be able to be accounted for discretely in the period in which the impairment is recorded. Depending on facts and circumstances, a history of goodwill impairments or a reasonable expectation that there will be impairments in the future might indicate that the impairment is not unusual and should therefore be included in the estimated annual effective tax rate.

Figure TX 16-1 compares the year-to-date tax expense of a nondeductible goodwill impairment classified as a discrete item and a nondeductible goodwill impairment classified as an item that affects the estimated annual ETR calculation. Company ABC projected $200 of pre-tax book and taxable income and an ETR of 25% prior to the impairment. In the second quarter, Company ABC recorded an $80 impairment of its nondeductible goodwill. As a result of the impairment, Company ABC projects $120 of pre-tax book income.
Figure TX 16-1
The impact of including a goodwill impairment in the ETR
1Q YTD
2Q YTD
3Q YTD
4Q YTD
Pre-tax book income
  $50.0
  $20.0
  $70.0
  $120.0
Add back:
Nondeductible goodwill impairment
   80.0
   80.0
   80.0
Pre-tax income adjusted for permanent items
50.0
100.0
150.0
$200.0
YTD tax expense if impairment is considered unusual or infrequent
12.5
25.0 1
37.5 1
50.0
Reported YTD effective rate 4
25.0%
(125.0%)
53.6%
41.7%
YTD tax expense if impairment is considered ordinary
$12.5
$8.3 2,3
$29.2 3
$50.0 3
Reported YTD effective rate 4
25.0%
41.7%
41.7%
41.7%
1Calculated as YTD book income using 25% annual estimated effective tax rate, plus tax effect of non-deductible goodwill impairment at 25% statutory tax rate.
2Revised effective rate is 41.7% (total tax expense of $50 divided by revised forecasted annual book income of $120).
3YTD tax expense calculated on YTD book income using 41.7% effective rate.
4Reported effective rate is the rate derived from taking the reported total tax provision divided by unadjusted pre-tax book income (i.e., the rate implied from the reported financial statements).

Example TX 16-2 illustrates the impact of a capital gain on an interim period tax provision.
EXAMPLE TX 16-2
Impact of capital gains on interim period tax provisions
Company ABC is a manufacturing company that invests excess funds in a portfolio of debt securities, classified as available-for-sale securities under ASC 320, Investments - Debt and Equity Securities. The interest income generated from the portfolio has been consistent with management estimates since inception and is included in the development of Company ABC's annual effective tax rate. The portfolio, by design, contains low-risk investments, and the company has typically held the debt securities to maturity and therefore experienced minimal capital gains or losses.
During the third quarter, there is significant appreciation in one of the debt securities and Company ABC realizes a capital gain when the security is unexpectedly redeemed by the issuer prior to maturity. This gain will allow utilization of historical capital loss carryforwards for which Company ABC had previously recorded a full valuation allowance.
Company ABC determined that the redemption and resulting capital gain were unusual and/or infrequent, given their history of holding debt securities to maturity and presented the item as a separate component of income from continuing operations.
Should the related tax effect be included or excluded from the estimated annual effective tax rate calculation?
How should the benefit from the release of the valuation allowance on the historical capital loss carryforwards be reported?
Analysis
Because the redemption was deemed to be unusual and separately reported, Company ABC would not include the tax effect in the estimate of the effective tax rate. Since the gain (which is treated discretely) is triggering recognition of the deferred tax asset, the release of the valuation allowance should also be recognized discretely in the period of the redemption.
Even if Company ABC determined that the redemption did not need to be separately reported, and was not significant or unusual, it would still need to consider whether an estimate could be made of capital gains for purposes of determining the effective tax rate. In situations when capital gains and losses cannot be estimated, discrete treatment might be appropriate (see TX 16.5). However, in situations when an entity's business model and operations inherently include the generation of capital gains and losses, those expectations should be considered in determining the estimated annual effective tax rate.

Example TX 16-3 illustrates the interim period accounting when a parent company plans to purchase the noncontrolling interest in a partnership.
EXAMPLE TX 16-3
Interim period accounting when a parent company plans to purchase the noncontrolling interest in a partnership
Company ABC consolidates a 60%-owned partnership (a flow-through entity for tax purposes) and is preparing its first quarter tax provision. Company ABC expects to purchase the 40% noncontrolling interest (NCI) in the third quarter of the current year. The timing and terms of the expected acquisition are established, and pursuant to Company ABC’s rights under the partnership agreement, Company ABC concludes that the transaction is primarily within its control. The purchase of the NCI will increase Company ABC’s estimated annual ETR because Company ABC currently consolidates the partnership (i.e., includes 100% of the partnership’s results in pre-tax income), but only recognizes the tax expense associated with 60% of the partnership’s income. The tax on the remaining 40% is the tax obligation of the noncontrolling interest holder and is not recognized in Company ABC's consolidated financial statements.
Should the anticipated third-quarter purchase of the NCI have an impact on Company ABC's ETR in the first quarter?
Analysis
The first hurdle is whether a future purchase of an entity should ever be considered in the effective tax rate prior to consummation. In the case of most business acquisitions or dispositions between unrelated third parties, we believe those transactions should not be considered in the effective tax rate until they occur. However, in light of the fact that the anticipated purchase of the noncontrolling interest in this fact pattern is primarily within Company ABC’s control, we believe it may be appropriate to include the transaction in the estimate of the annual effective tax rate if Company ABC views the transaction as ordinary. If it is considered unusual/infrequent, it should be treated as discrete when the purchase of the NCI occurs. The nature of Company ABC’s business, their reasons for holding the partnership investment, and their relationship with the noncontrolling interest holder are all factors that Company ABC would consider in making that assessment.

16.3.2 Interim provision—discontinued operations

See ASC 205-20-45-1 for a discussion of what constitutes a discontinued operation. Under that guidance, the results of operations and the gain or loss from disposal of discontinued operations are presented net of tax and outside of continuing operations in the income statement. Pursuant to the guidance in ASC 740-270-30-12, items reported net of their related tax effect (e.g., discontinued operations) are excluded from the ETR calculation. The tax effect of the discontinued operation should be recognized when it occurs under ASC 740-270-25-2.

16.3.3  Interim provision—change in accounting principle

See ASC 250-10-45-3 through ASC 250-10-45-7 for guidance on how to account for the cumulative effect of changes in accounting principles when an accounting pronouncement does not provide specific transition adjustments. The cumulative effect of a change in accounting principle is presented net of its related tax effects outside of continuing operations. Therefore, pursuant to the guidance is ASC 740-270-30-12, these changes and their related tax effects are excluded from the ETR calculation and should be recognized when they occur under ASC 740-270-25-2.

16.3.4 Interim provision—limited exceptions for other items

In general, ordinary income is defined broadly under ASC 740-270 such that most items will be considered part of the effective tax rate calculation. However, there are a number of specific exceptions.

16.3.4.1 Interim provision—tax-exempt interest

Tax-exempt securities often form a portion of ordinary income of an entity that routinely invests in such securities and the related interest may be appropriately considered in the annual ETR calculation. However, it is also acceptable to exclude tax-exempt interest from the annual ETR calculation based on a specific discussion in the basis for conclusions in FASB Interpretation No. 18, Accounting for income taxes in interim periods, paragraph 80. The FASB acknowledged the then-common practice of excluding tax-exempt interest from the estimated annual ETR calculation and explicitly acknowledged their decision not to provide specific guidance on this issue.
Whichever approach is selected would constitute an accounting policy election that should be applied consistently.

16.3.4.2 Interim provision—investment tax credits

ASC 740-270-30-14 and ASC 740-270-30-15 provide guidance for the impact of investment tax credits (ITCs) on the estimated annual ETR. Whether investment tax credits are included or excluded in the ETR calculation depends, in part, on the accounting treatment selected for the credits—the flow-through method or the deferral method. As described in ASC 740-270-30-14, if the deferral method is elected, amortization of the deferred ITCs does not need to be considered in estimating the ETR. See TX 3 for additional guidance for the accounting for investment tax credits.

ASC 740-270-30-14

Certain investment tax credits may be excluded from the estimated annual effective tax rate. If an entity includes allowable investment tax credits as part of its provision for income taxes over the productive life of acquired property and not entirely in the year the property is placed in service, amortization of deferred investment tax credits need not be taken into account in estimating the annual effective tax rate; however, if the investment tax credits are taken into account in the estimated annual effective tax rate, the amount taken into account shall be the amount of amortization that is anticipated to be included in income in the current year (see ASC 740-10-25-46 and 740-10-45-28).

16.3.4.3 Interim provision—income from equity method investments

It is typically appropriate to record an investor’s equity in the net income of a 50% (or-less) owned investee on an after-tax basis (i.e., the investee would provide taxes in its financial statements based on its own estimated annual ETR calculation). It may be appropriate to exclude any incremental tax incurred at the investor level (e.g., the deferred tax liability for unremitted earnings) from the calculation of the investor’s overall ETR calculation. Instead, this incremental tax would be calculated based on a separate ETR calculation related to the investee (i.e., the amount of incremental tax expected to be incurred in the annual period divided by the estimated annual amount of equity method income). We are aware of diversity in practice in this area and, to the extent material, recommend disclosure of the selected method.

16.3.4.4 Interim provision—changes in uncertain tax positions

Pursuant to ASC 740-10-25-14 through ASC 740-10-25-15, the existence of new information that results in a change in judgment that causes subsequent recognition, derecognition, or a change in measurement of a tax position taken in a prior annual period is to be recognized as a discrete item (including interest and penalties) in the period in which the change occurs. For example, if an event during an interim period (e.g., a court case or tax ruling related to another taxpayer with a similar exposure) prompts a change in the assessment of the sustainability of a tax position taken in a prior year (i.e., based on the technical merits of the tax position), the effect of the change should be recorded discretely in the period in which the assessment changes.
However, pursuant to ASC 740-270-35-6, if the event results in a change in the assessment with respect to a current-year tax position that is considered part of ordinary income, the new assessment should generally be incorporated into the revised ETR that will be applied to the year-to-date ordinary income. If the tax uncertainty relates to a pretax item that is accounted for discretely, such as discontinued operations, then the change in assessment would simply be part of the calculation of the tax effect of that item.
Figure TX 16-2 summarizes the interim accounting treatment for changes in unrecognized tax benefits.
Figure TX 16-2
Requirements for recording changes in unrecognized tax benefits in interim periods
Change related to:
Interim accounting treatment
Prior year uncertain tax position
Discrete
Current year uncertain tax position related to ordinary income
Include in ETR
Current year uncertain tax position related to income excluded from ETR calculation (e.g., discontinued operations)
Discrete

16.3.4.5 Interim provision—interest and penalties

ASC 740-10-25-56 requires accrual of interest on the liability for unrecognized tax benefits from the first period in which the interest would begin accruing according to the provisions of the relevant tax law. Therefore, interest expense should be accrued as incurred and should be excluded from the estimated annual ETR calculation. ASC 740-10-25-57 indicates that a penalty should be recorded when a tax position giving rise to a penalty is taken or anticipated to be taken on the tax return, or when the entity’s judgment about whether the position gives rise to a penalty changes. Therefore, penalties should also be accrued as incurred and should be excluded from the estimated annual ETR calculation. Interest and penalties should be accounted for discretely as they occur under ASC 740-10-25-2 since they are not related to ordinary income.

16.3.4.6 Interim provision—change in tax law or rate

New guidance
In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. The guidance removes certain exceptions to the general principles of ASC 740 and simplifies several other areas. ASU 2019-12 is effective for public business entities for annual reporting periods beginning after December 15, 2020, and interim periods within those reporting periods. For all other entities, it is effective for annual periods beginning after December 15, 2021, and interim periods within annual periods beginning after December 15, 2022. Early adoption is permitted in any interim or annual period, with any adjustments reflected as of the beginning of the fiscal year of adoption. If an entity chooses to early adopt, it must adopt all changes as a result of the ASU. The transition provisions vary by amendment.
One of the amendments within ASU 2019-12 clarifies that all effects of an enacted change in tax law or rate, both deferred and current, should be accounted for in the interim period that includes the enactment date. This amendment should be applied on a prospective basis. This section includes applicable guidance before and after adoption of ASU 2019-12.
Interim provision — change in tax law or rate (after adoption of ASU 2019-12)
ASC 740-270-25-5 through ASC 740-270-25-6 discuss when to recognize the effect of changes in tax laws.

ASC 740-270-25-5

The effects of new tax legislation shall not be recognized prior to enactment. The tax effect of a change in tax laws or rates on taxes currently payable or refundable for the current year shall be reflected in the computation of the annual effective tax rate beginning in the first interim period that includes the enactment date of the new legislation. The effect of a change in tax laws or rates on a deferred tax liability or asset shall not be apportioned among interim periods through an adjustment of the annual effective tax rate.

ASC 740-270-25-6

The tax effect of a change in tax laws or rates on taxes payable or refundable for a prior year shall be recognized as of the enactment date of the change as tax expense (benefit) for the current year. See Example 6 (paragraph 740-270-55-44) for illustrations of accounting for changes caused by new tax legislation.

In accordance with ASC 740-270-25-5 through ASC 740-270-25-6, adjustments to deferred tax assets and liabilities as a result of a change in tax law or rates should be accounted for discretely in continuing operations at the date of enactment. Similarly, the effects of a retroactive change in tax rates should be accounted for discretely in continuing operations in the interim period in which the law is enacted. However, the prospective effects of a change in tax law or rates on tax expense for the year of enactment should be reflected in the estimated annual ETR calculation. See TX 7.4 (including Example TX 7-3) for more information on the accounting for changes in tax law.
Interim provision — change in tax law or rate (before adoption of ASU 2019-12)
ASC 740-270-25-5 through ASC 740-270-25-6 discuss when to recognize the effect of changes in tax laws.

ASC 740-270-25-5

The effects of new tax legislation shall not be recognized prior to enactment. The tax effect of a change in tax laws or rates on taxes currently payable or refundable for the current year shall be reflected in the computation of the annual effective tax rate beginning in the first interim period that includes the enactment date of the new legislation. The effect of a change in tax laws or rates on a deferred tax liability or asset shall not be apportioned among interim periods through an adjustment of the annual effective tax rate.

ASC 740-270-25-6

The tax effect of a change in tax laws or rates on taxes payable or refundable for a prior year shall be recognized as of the enactment date of the change as tax expense (benefit) for the current year. See Example 6 (paragraph 740-270-55-44) for illustrations of accounting for changes caused by new tax legislation.

In accordance with ASC 740-270-25-5 through ASC 740-270-25-6, adjustments to deferred tax assets and liabilities as a result of a change in tax law or rates should be accounted for discretely in continuing operations at the date of enactment. Similarly, the effects of a retroactive change in tax rates should be accounted for discretely in continuing operations in the interim period in which the law is enacted. However, the prospective effects of a change in tax law or rate on tax expense for the year of enactment should be reflected in the estimated annual ETR calculation. See TX 7.4 (including Example TX 7-3) for more information on the accounting for changes in tax law.

16.3.4.7 Interim provision—change in tax status

As specified in ASC 740-10-25-32 through ASC 740-10-25-34, the effect of a voluntary change in tax status should be recognized discretely on (1) the date that approval is granted by the taxing authority or (2) the filing date, if approval is unnecessary. The entire effect of a change in tax status should be recorded in continuing operations in accordance with ASC 740-10-45-19. TX 8 offers more information on the accounting for changes in tax status.

16.3.4.8 Interim provision—change in valuation allowance

The need for a valuation allowance must be reassessed at each interim reporting date. Under the guidance in ASC 740-270-25-4 and depending on the circumstances that lead to a change in valuation allowance, the change may be reflected in the estimated annual ETR or recognized discretely in the interim period during which the change in judgment occurred, or both.

ASC 740-270-25-4

The tax benefit of an operating loss carryforward from prior years shall be included in the effective tax rate computation if the tax benefit is expected to be realized as a result of ordinary income in the current year. Otherwise, the tax benefit shall be recognized in the manner described in paragraph 740-270-45-4 in each interim period to the extent that income in the period and for the year to date is available to offset the operating loss carryforward or, in the case of a change in judgment about realizability of the related deferred tax asset in future years, the effect shall be recognized in the interim period in which the change occurs.

ASC 740-270-25-4

Paragraph 740-20-45-3 requires that the manner of reporting the tax benefit of an operating loss carryforward recognized in a subsequent year generally is determined by the source of the income in that year and not by the source of the operating loss carryforward or the source of expected future income that will result in realization of a deferred tax asset for the operating loss carryforward. The tax benefit is allocated first to reduce tax expense from continuing operations to zero with any excess allocated to the other source(s) of income that provides the means of realization, for example, discontinued operations, other comprehensive income, and so forth. That requirement also pertains to reporting the tax benefit of an operating loss carryforward in interim periods.

As prescribed by ASC 740-270-25-7, the effect of a change in the beginning-of-the-year balance of a valuation allowance caused by a change in judgment about the realizability of the related deferred tax asset that results from changes in the projection of income expected to be available in future years should be recognized discretely in the interim period in which the change in judgment occurs. A change resulting from changes in estimates of current-year ordinary income and/or deductible temporary differences and carryforwards originating in the current year should be considered in determining the estimated annual effective tax rate.

ASC 740-270-25-7

The effect of a change in the beginning-of-the-year balance of a valuation allowance as a result of a change in judgment about the realizability of the related deferred tax asset in future years shall not be apportioned among interim periods through an adjustment of the effective tax rate but shall be recognized in the interim period in which the change occurs.

Pursuant to ASC 740-270-25-7, any change in valuation allowance that results from a change in judgment about the realizability of the related deferred tax assets resulting from changes in the projection of income expected to be available in future years is reported in the period during which the change in judgment occurs. No portion of the effect should be allocated to subsequent interim periods through an adjustment to the estimated annual ETR for the remainder of the year.
The following changes in valuation allowance should be considered in determining the ETR for the year:
  • A change in the valuation allowance related to deductible temporary differences and carryforwards that are expected to originate in ordinary income in the current year
  • A change in the valuation allowance for beginning-of-year deferred tax assets that results from a difference between the estimate of annual ordinary income (which includes the year-to-date amount) for the current year and the estimate that was inherent in the beginning-of-year valuation allowance.
If there is a reduction in the valuation allowance for beginning-of-year deferred tax assets that results from income other than ordinary income (e.g., discontinued operations), the benefit should be reflected discretely in year-to-date results (presuming, of course, that current-year continuing operations and projections of future income could not have supported the realization).
Example TX 16-4 illustrates a change in the assessment of the realizability of beginning-of-year deferred tax assets as a result of changes in projections of future income.
EXAMPLE TX 16-4
Change in assessment of the realizability of beginning-of-year deferred tax assets as a result of changes in projections of future income
At the end of the second quarter, a company determines that future taxable income for the current year and for future years will be higher than estimated at the end of the previous year due to an increase in sales orders. This will permit a decrease in the valuation allowance against deferred tax assets related to NOL carryforwards that existed at the beginning of the year.
The company had $3,000,000 of NOL carryforwards available at the beginning of the year. At that time, the enacted tax rate was 33.5%. Management established a valuation allowance of $1,005,000 for the full amount of the deferred tax asset related to the NOL carryforward at the end of the prior year. Although the company broke even for the first three months of the current year, a second quarter increase in net income and sales orders has prompted the company to (1) revise its estimate of current-year income from zero to $200,000 and (2) change the expectation regarding income in future years to be sufficient to allow recognition of the entire deferred tax asset. This will permit a full reversal of the valuation allowance for NOL carryforwards that existed at the beginning of the year.
Should this change in judgment be recorded as a discrete event that is accounted for in the second quarter, or should the change be allocated to subsequent interim periods as part of the estimated annual ETR calculation?
Analysis
The decrease in the valuation allowance is the result of a change in judgment about income in both the current and future periods. Thus, the release of the valuation allowance has two components: (1) the portion related to a change in estimate regarding current-year income and (2) the portion related to a change in estimate about future years’ income.
The first component is recognized in income by adjusting the estimated annual ETR for the current year (i.e., the reduction in the valuation allowance is spread over the current year-to-date results and subsequent quarters through the revised ETR). The second component is recognized entirely in the second quarter as a discrete item.
As a result of revising the estimate of future profitability at the end of the second quarter, the company calculates current-year income taxes as follows:
Estimated full-year pretax income
$200,000
Tax expense:
Tax on current-year income at 33.5%
67,000
Reversal of valuation allowance related to current year income
(67,000)
        Total current tax
$—
Estimated ETR at end of second quarter [$0 / $200,000]
0.0%
Reversal of valuation allowance based on future years’ income
(938,000)
        Total tax provision (benefit)
(938,000)
Net income
$1,138,000

The $938,000 valuation allowance release attributable to future year’s income would be accounted for as a discrete event in the second quarter.
The tax benefit associated with the income from the current year would be incorporated into the annual ETR calculation and would offset the current tax expense on the income generated during the current year resulting in a 0.0% effective tax rate for the six-month period. At the end of the year, assuming no other temporary differences arising during the year, the deferred tax asset account would have a balance of $938,000, and there would be no valuation allowance. The following is a summary of activity by quarter, which demonstrates the release of the valuation allowance.
Tax (or benefit)
Reporting period
Quarterly income/
(loss)
Year-to-date income/
(loss)
Est. annual effective tax rate
Year-to-date
Less previously provided
Reporting period amount
ETR
Discrete
First quarter
$ —
$ —
0.0%
$ —
$ —
$ —
$ —
Second quarter
50,000
50,000
0.0%
$(938,000)
(938,000)
Third quarter
50,000
100,000
0.0%
(938,000)
(938,000)
Fourth quarter
100,000
200,000
0.0%
(938,000)
(938,000)
Fiscal year
$200,000
$(938,000)

The 0.0% ETR consists of the current tax provision of $67,000 on the current year income of $200,000, fully offset by the deferred tax benefit of the corresponding release of the valuation allowance. Based on the second quarter year-to-date income of $50,000, essentially $16,750 ($50,000 x 33.5%) of the valuation allowance is released in Q2. The remaining $50,250 of valuation allowance release ($67,000 - $16,750) will be reflected in the financial statements as the remaining $150,000 of planned income for the year is earned in subsequent quarters.
If, in the third quarter, Company A revises its forecast of current year ordinary income to $500,000, the annual ETR remains zero (because there is sufficient NOL to shelter current year ordinary income). Company A would record a discrete period adjustment in the third quarter to reflect the effect of the change to the amount expected to reverse in future years. This would effectively reverse a portion of the discrete period benefit recognized in an earlier interim period because more of the valuation allowance reversal is being attributed to current year earnings.

16.3.4.9 Interim provision—indefinite reinvestment assertion

A company may change its intentions or the facts and circumstances may change, which may impact whether it will indefinitely reinvest undistributed earnings of foreign subsidiaries, or of corporate joint ventures that are essentially permanent in duration, and thus whether deferred taxes need to be recognized. In these situations, the tax effect of the change in judgment for the establishment (or reversal) of the deferred tax liability related to an outside basis difference that had accumulated as of the beginning of the year should be excluded from the annual effective tax rate calculation and recognized in the interim period during which the intention or assertion changes.
The tax effect of a change in intention or assertion related to earnings (ordinary income) generated during the current year should be included in the company’s estimated annual ETR calculation.

16.3.4.10 Change in estimate related to a prior-year tax provision

As discussed in TX 16.2, the language in ASC 740-270-25-2 provides that the estimated annual effective tax rate approach should only be used to record the tax effect of ordinary income for the period. A change in estimate in the current year that is related to a prior-year tax provision does not constitute a tax effect of current-year income. Therefore, the effects of this type of change should be recorded discretely in the interim period during which the change in estimate occurs. TX 2.6 presents guidance for determining whether a change in the prior-year tax provision is an error or a change in estimate.
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