As discussed above, the effect of a change in tax laws or rates on a deferred tax liability or asset must be reflected in the period of enactment.
When determining the effect of a tax law change, entities must consider the law change’s effect on the deferred tax balances existing at the enactment date and, to the extent the law change is retroactive, its effect on taxable income through the enactment date. For entities that prepare quarterly financial statements, estimating the effect of the law using the most recent quarter end, adjusted for known material transactions between the enactment date and the quarter end, usually is sufficient.
For other entities, calculating the effect of the law change may require additional work. The effect of reversals of beginning deferred tax balances for the period through the enactment date has to be considered, as well as the deferred tax effects of originating temporary differences. Computing this effect, however, requires measuring temporary differences and the related deferred taxes at an interim date, that is, the date of enactment. For determining the effect of a tax rate change, the deferred taxes actually accrued through the enactment date (by application of the estimated annual effective tax rate to year-to-date ordinary income and by discrete recognition of other tax effects) should be used (see more about computing deferred taxes for interim periods in TX 7.4.1
In the interim period in which a rate change is enacted, the tax used in computing the new estimated annual effective tax rate combines:
- Tax currently payable or refundable on estimated ordinary income for the current year, reflecting the effect of the rate change to the extent that it is effective for the current year.
- The deferred tax expense attributable to estimated ordinary income for the year (including changes in the valuation allowance that are reflected in the effective tax rate computation). This computation would be based on the newly enacted rate and would exclude the impact of the rate change on deferred taxes existing at the date of the rate change. The deferred tax balances used in computing the deferred tax expense would be after adjustment for the rate change.
Application of the new estimated annual effective tax rate to year-to-date ordinary income would inherently adjust the deferred taxes originating in prior interim periods in the current year. The adjustment of the beginning-of-year deferred tax balances for the rate change would be reflected as a discrete item in the interim period of the enactment. When items other than ordinary income have been reported in prior interim periods, both their current and deferred tax effects would be adjusted in the interim period of the enactment.
Regardless of whether they are a component of ordinary income or some other aspect of the annual tax provision, all adjustments to reflect a tax rate change are measured as of the enactment date and reflected in income from continuing operations.