The total effect of changes in tax laws or rates on deferred tax balances is recorded as a component of the income tax provision related to continuing operations for the period in which the law is enacted, even if the assets and liabilities relate to other components of the financial statements, such as discontinued operations, a prior business combination, or items in accumulated other comprehensive income.

As discussed in ASC 740-10-55-23 and ASC 740-10-55-129 through ASC 740-10-55-135, an enacted change in future tax rates often requires detailed analysis. Depending on when the rate change becomes effective, some knowledge of when temporary differences will reverse will be necessary in order to estimate the amount of reversals that will occur before and after the rate change.

As discussed in TX 4, the timing of reversals of temporary differences may not be the only consideration when determining the applicable rate to apply to those temporary differences. The applicable rate is the rate expected to be in effect in the year in which the reversal affects the amount of taxes payable or refundable. For example, assume that reversals are expected to occur in a future year after a change in enacted tax rates takes effect. Also assume an expectation that taxable results for that year will be a loss that will be carried back to a year before the rate change takes effect, and that the reversals will increase or decrease only the amount of the loss carryback. In those circumstances, the applicable rate is the rate in effect for the carryback period. Similarly, if rates changed in a prior year and carryback of a future tax loss to pre-change years is expected, then the pre-change tax rate will be the applicable rate for reversals, the effect of which will be to increase or decrease the loss carryback.

The calculation is more complicated if the reversing temporary differences reduce current-year taxable income and generate losses that are expected to be carried back to a pre-change year. Assuming graduated rates are not a significant factor, the tax effects of the reversals ordinarily should be determined on an incremental basis. Specifically, if the net reversing difference—the excess of deductible over taxable differences included in the expected tax loss—was less than or equal to the projected amount of the tax loss (before consideration of reversing temporary differences), the applicable rate would be the pre-change rate. The post-change rate would be applied to the amount of the net reversal that exceeded the projected tax loss. This concept is illustrated in Example TX 7-1.

In some cases, enacted tax legislation may involve a phase-in of several different rates over a period of time. The key questions in the analysis will be (1) when will the temporary differences reverse, and (2) will the reversals reduce taxes payable in the years of reversal or will they result in a carryback or carryforward that will generate a tax refund from an earlier year or reduce a tax payable in a future year, each of which has a different tax rate. ASC 740-10-55-129 through ASC 740-10-55-130 provides an example of a phased-in change in tax rates. Example TX 4-2 illustrates how to measure deferred taxes when there has been a change in tax rates and the applicable tax rate depends on whether temporary differences will be realized via carryback refund or by offsetting taxable income earned in future years.

EXAMPLE TX 7-1
Determining the applicable rate when the reversal of temporary differences is expected to both reduce taxable income and generate losses expected to be carried back

Assume that as a result of new tax legislation, the statutory tax rate drops from 35% to 30% and that an entity estimates $900 of pretax book income and $1,000 of net reversals of deductible temporary differences resulting in a net tax loss of $100 in the post-change period. Also assume that the entity expects to carry back this loss to a pre-change period.

What is the applicable tax rate to apply to the existing temporary differences?