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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 of 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 in the determination of the applicable rate to apply to those temporary differences. The applicable rate is determined by reference to 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 even 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, 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.
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?
Analysis
Because $900 of the temporary difference reversals are expected to reduce taxable income in the post-change period, the post-change rate of 30% should be applied to those deductible temporary differences. As the remaining $100 of deductible temporary differences is expected to be carried back to a pre-change period, the pre-change rate of 35% should be applied to that portion of the deductible temporary differences.
A similar, but opposite, approach may be appropriate when a pretax loss (before consideration of reversing temporary differences) is expected for a post-change year but net reversing taxable differences are expected to result in taxable income. If a tax loss in a future year could otherwise be carried back to a pre-rate change year, the future rate would apply only to the extent of the estimated taxable income for the year of reversal, and the current rate would be applied to the balance of the temporary differences. If a tax loss in the reversal year would be carried forward (i.e., no carryback capacity), the post-change rate expected to be in effect in the carryforward years would be the applicable rate for all the reversals. This concept is illustrated in Example TX 7-2.
EXAMPLE TX 7-2
Determining the applicable rate when there are pretax losses and net reversing taxable temporary differences that create taxable income
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 loss and $1,000 of net reversals of taxable temporary differences that result in taxable income of $100 in the post-change period. Also assume that the entity has sufficient taxable income in the relevant carryback period to absorb losses.
What is the applicable tax rate to apply to temporary differences?
Analysis
Applying the incremental concept to deferred taxes, $900 of the $1,000 net reversing taxable temporary differences would be reflected using the pre-change rate (since they reduce a loss that would otherwise have been carried back to pre-rate change tax year). The post-rate change would be applied to the remaining $100.

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 (see Example TX 4-3).

7.3.1 Reclassification of stranded tax effects–ASU 2018-02

ASC 740 requires the remeasurement of deferred tax assets and liabilities as a result of a change in tax laws or rates to be presented in net income from continuing operations. Adjusting temporary differences originally recorded to other comprehensive income through continuing operations may result in disproportionate tax effects lodged in accumulated other comprehensive income (AOCI). In other words, the original deferred tax amount recorded through other comprehensive income at the old tax laws or rates will remain in AOCI despite the fact that its related deferred tax asset/liability will be reduced through continuing operations to reflect the new laws or rates. Typically, we believe that the disproportionate effect that remains in AOCI should be eliminated when the circumstances upon which it is premised cease to exist (see TX 12.3.3.3).
ASU 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, was codified in ASC 220, Income Statement — Reporting Comprehensive Income. This new guidance permits a company to reclassify the disproportionate income tax effects of the Tax Cuts and Jobs Act of 2017 (the "2017 Act") on items within AOCI to retained earnings. The FASB refers to these amounts as "stranded tax effects." ASU 2018-02 does not change the requirement to record the tax effect of the 2017 Act in continuing operations. ASU 2018-02 is not applicable to the impact of prior or future changes in tax laws or rates.

7.3.1.1 ASU 2018-02–scope of reclassification

Only the stranded tax effects resulting from the 2017 Act are eligible for reclassification. According to the new guidance, the reclassification amount should include:

Excerpt from ASC 220-10-45-12A (a)

The effect of the change in the U.S. federal corporate income tax rate on the gross deferred tax amounts and related valuation allowances, if any, at the date of enactment of the Tax Cuts and Jobs Act related to items remaining in accumulated other comprehensive income. The effect of the change in the U.S. federal corporate income tax rate on gross valuation allowances that were originally charged to income from continuing operations shall not be included.

While the above refers to the change in corporate income tax rate, the guidance goes on to say that companies may also choose to include in their reclassification other income tax effects related to the application of the 2017 Act on items remaining in AOCI (e.g., unrealized gains or losses of available-for-sale (AFS) securities, foreign currency translation adjustments, net gains or losses for defined benefit pension plans). If a company includes any such items in its reclassification adjustment, it must include a disclosure describing them.
Companies that elect to reclassify the stranded effects associated with the change in US federal corporate income tax rate must do so for all items within AOCI. They cannot choose to make the reclassification for certain effects and not others—for example, they cannot reclassify the stranded income tax effects for AFS securities while leaving the stranded income tax effects related to currency translation adjustments.

7.3.1.2 ASU 2018-02–disclosures

The new guidance requires several new disclosures. First, all companies must disclose a description of their accounting policy for releasing disproportionate income tax effects from AOCI (e.g., for AFS securities, the "aggregate portfolio" or "investment-by-investment" approach). This disclosure is an ongoing disclosure and is not specific to stranded tax effects resulting from the 2017 Act.
Additional disclosures required in the period of adoption are summarized in Figure TX 7-1.
Figure TX 7-1
ASU 2018-02 disclosure requirements in the period of adoption
Was a reclass entry made?
Required disclosures for transition
Yes, the company elected to reclassify the income tax effects of the 2017 Act
  • A statement that an election was made to reclassify the income tax effects of the 2017 Act from AOCI to retained earnings
  • A description of the income tax effects related to the application of the 2017 Act (other than the effect of the change in the US corporate income tax rate) that were reclassified from AOCI to retained earnings, if any.
  • The nature of and reason for the change in accounting principle
  • The effect of the change on the affected financial statement line items
  • If the new guidance is adopted retrospectively, a description of the prior-period information that has been retrospectively adjusted
No, the company did not elect to reclassify the income tax effects of the 2017 Act
A statement that the company did not reclassify the income tax effects of the 2017 Act from AOCI to retained earnings

7.3.1.3 ASU 2018-02–effective dates and transition

The guidance is effective for all companies for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Public business entities may early adopt the guidance for financial statements that have not yet been issued. All other entities may early adopt the guidance for financial statements that have not yet been made available for issuance.
Companies may adopt the new guidance using one of two transition methods: (1) retrospective to each period (or periods) in which the income tax effects of the 2017 Act related to items remaining in AOCI are recognized, or (2) at the beginning of the period of adoption.
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