Search within this section
Select a section below and enter your search term, or to search all click Income taxes
Favorited Content
16.4 Computing the estimated annual ETR
Publication date: 31 Mar 2023
us Income taxes guide
The estimated annual effective tax rate should represent the best estimate of the composite tax provision in relation to the best estimate of worldwide pre-tax book ordinary income. The composite tax provision should include federal, foreign, and state income taxes, including (but not limited to) the effects of credits, special deductions, capital gains taxed at different rates, effects of uncertain tax positions related to the current year, and valuation allowances for current-year changes in temporary differences and losses or income arising during the year. The estimated annual ETR is then applied to year-to-date ordinary income to compute the year-to-date interim tax provision on ordinary income. The tax effect of discrete items is then added to compute the total year-to-date interim tax provision.
The difference between the current quarter’s year-to-date interim tax provision and the year-to-date interim tax provision as of the preceding interim period constitutes the tax provision for that quarter. Because of this, the ETR for any particular quarter may not have a predictable relationship to pre-tax income for the quarter or the current estimated annual ETR.
There are certain circumstances when the basic ETR approach cannot be applied or must be modified. See TX 16.4.2 for discussion of when the tax benefit of interim losses may be limited, and TX 16.5 for exceptions to the ETR approach.
ASC 740-270-55 contains numerous examples that illustrate the application of the estimated annual ETR approach to a variety of fact patterns. Examples address:
- Income fluctuations from quarter to quarter
- Valuation allowance considerations
- Losses projected for the year or incurred on a year-to-date basis
- Calculations involving multiple jurisdictions
- Tax law changes
- Discontinued operations
- Significant unusual or infrequent items
Use of the ETR approach, as required by ASC 740-270, could yield results that are materially different from a discrete calculation of the year-to-date provision. The two approaches are applicable in specific situations and are not interchangeable and not subject to a policy choice.
16.4.1 Best current estimate of the annual ETR
ASC 740-270 requires companies to make their best estimate of the annual ETR for ordinary income. At the end of each period, companies should make the best estimate for the full fiscal year; however, there may be instances when the year-to-date actual ETR during the period represents the best estimate of the annual ETR.
Estimates of the annual ETR at the end of interim periods are, of necessity, based on evaluations of possible future events and transactions and may be subject to subsequent refinement or revision. If a reliable estimate cannot be made, the actual ETR for the year to date may be the best estimate of the annual ETR.
16.4.1.1 Treatment of nonrecognized subsequent events on the ETR
At times, a significant pre-tax nonrecognized subsequent event may occur after the interim balance sheet date but before financial statement issuance. If the subsequent event is not of a nature that would inherently be treated as a discrete item for interim tax accounting purposes, a question arises about whether the company’s estimate of annual pre-tax ordinary income should be updated. For example, subsequent to the interim balance sheet date, a significant new customer contract could be signed or severe hurricane losses may be suffered by an insurance company. In both instances, the subsequent event significantly changes the company’s current estimate of its annual pre-tax ordinary income and thereby its estimated annual ETR.
ASC 740-270-35-3 requires that the estimated annual ETR be revised, if necessary, at the end of each interim period during the fiscal year to reflect the company’s best estimate. Relying on this guidance, it is reasonable to conclude that the company’s best current estimated annual ETR should be based on information available prior to the date of issuance, even though some of that information did not exist at the interim balance sheet date.
Conversely, ASC 855-10-25-3 indicates that nonrecognized subsequent events should not be reflected in the financial statements. If an entity were to incorporate a significant nonrecognized subsequent event into the development of an updated ETR, some of the subsequent event’s indirect effects would be recorded in the balance sheet date that precedes the nonrecognized event. Following that guidance, it would be reasonable to conclude that the effects of a nonrecognized subsequent event should be excluded from the interim calculation of the ETR.
Given that either approach can be supported by a reasonable interpretation of existing guidance, we believe that both are acceptable.
Regardless of the approach chosen, it is important to distinguish those items whose tax effects are required to be recognized discretely in the period that they occur, such as: (1) changes in tax laws or rates, (2) new information received after the reporting date related to the assessment of uncertain tax positions (as discussed in ASC 740-10-35-2, TX 15.5.4, and TX 16.3.4.4), (3) taxes related to an employee share-based payment award within the scope of ASC 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 (as discussed in ASC 740-270-30-12), and (4) discontinued operations, and other significant unusual or infrequent items (as discussed in TX 16.3.1).
When there is a significant time lag from the interim date to the date of the issuance of the financial statements (as may be the case with a company reporting on a prior interim period for the first time in connection with an initial public offering), it may become increasingly difficult to assert that an event in the extended period should affect the estimated annual ETR applied to the interim period. We generally believe that the delayed issuance of the financial statements should not result in a different assessment of the estimated annual ETR than would have been the case had the financial statements been issued on a timely basis.
16.4.2 Limitation on benefits of losses in interim periods
The income tax provision/benefit reflected in interim financial statements is generally based on the company's estimated annual ETR. However, ASC 740-270-30-30 through ASC 740-270-30-34 modifies the ETR approach in certain instances when a company incurs losses in interim periods and the tax benefit of those losses may be limited.
Generally, the amount of income tax benefit recognized should not exceed the tax benefit the company expects to (a) realize during the year (e.g., when losses incurred earlier in the fiscal year are expected to be offset by income during the remaining periods of the fiscal year), or (b) recognize as a deferred tax asset or a tax receivable (if the company expects to carryback the loss to offset income taxes paid previously) at the end of the fiscal year. In applying this guidance in interim periods, companies need to assess the realizability of forecasted end-of-year deferred tax assets. A company should consider if it expects a valuation allowance to be necessary at year end, including any expected change in the valuation allowance during the balance of the year.
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
Link copied
