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5.3 Sources of taxable income
Publication date: 31 Dec 2023
us Income taxes guide
Taxable income of the appropriate character (e.g., ordinary or capital) within the carryback and carryforward periods available under the tax law is necessary to achieve future realization of deferred tax assets. ASC 740-10-30-18 identifies four sources of taxable income that may be available under the tax law to realize a tax benefit for deductible temporary differences and carryforwards. They are listed here in order of the most objective to the most subjective:
- Taxable income in prior carryback years if carryback is permitted under the relevant tax law (see TX 5.4)
- Future reversals of existing taxable temporary differences (see TX 5.5)
- Tax-planning strategies (see TX 5.6)
- Future taxable income exclusive of reversing temporary differences and carryforwards (see TX 5.7)
Reporting entities must consider each source of income in order to determine the amount of the valuation allowance that should be recorded against deferred tax assets. If one or more sources are sufficient to realize the deferred tax asset, no further consideration is required of the remaining sources. If, for example, existing taxable temporary differences are greater than deductible temporary differences and loss carryforwards, and the reversal patterns and taxable income limitations (if applicable) are such that offset is expected under the tax law, there is no need to consider the remaining sources of taxable income, even if future losses are expected.
Excerpt from ASC 740-10-30-18
Evidence available about each of those possible sources of taxable income will vary for different tax jurisdictions and, possibly, from year to year. To the extent evidence about one or more sources of taxable income is sufficient to support a conclusion that a valuation allowance is not necessary, other sources need not be considered. Consideration of each source is required, however, to determine the amount of the valuation allowance that is recognized for deferred tax assets.
5.3.1 Unrecognized tax benefits as a source of taxable income
Unrecognized tax benefits may be a source of taxable income for purposes of determining the expected realization of a deferred tax asset. Because settlement with the taxing authority is presumed to be at the recorded amount of the liability, the position’s resolution effectively amounts to additional taxable income over and above the taxable income expected on the “as-filed” or expected-to-be-filed tax return. Therefore, unrecognized tax benefits should be viewed as an additional source of taxable income and be considered as part of the assessment of whether a deferred tax asset is realizable.
Consistent with all sources of taxable income, and to the extent necessary under the relevant tax law, the character of the uncertain tax position should be considered. For example, in the United States, an unrecognized tax benefit on the recognition of capital gains may provide a source of income to realize capital losses that otherwise would not be realizable. In addition to character, an understanding of the period in which the taxing authority would assess the tax (to the extent the position was lost) also would need to be considered.
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