Deferred tax asset valuation allowance

Article

Deferred tax asset valuation allowance

Jan 10, 2021

To determine whether a valuation allowance should be recognized for deferred tax assets under U.S. generally accepted accounting principles, entities need to discern whether it is more likely than not that some or all of their deferred tax assets will not be realized. Subtopic 740-10-30 of the Financial Accounting Standards Board’s Accounting Standards Codification (ASC) addresses this determination and requires consideration to be given to all available evidence, both positive and negative. ASC 740-10-30-23 emphasizes that the weight given to each piece of evidence should be commensurate with the extent to which it can be objectively verified, and specifically notes that a cumulative loss in recent years is a significant piece of negative evidence that is difficult to overcome.

While ASC 740 does not define how to determine whether a cumulative loss in recent years exists, most interpretive guidance generally uses a “three-year” convention. The three-year convention is described as pretax book income/loss from all sources (i.e., including discontinued operations and other comprehensive income or loss) for the current year plus the previous two years, adjusted for certain permanent differences. In addition to adjusting for permanent differences, the only other item that generally should be excluded from the computation of cumulative income/loss is the cumulative effect of a change in accounting principle. However, the impact of profitable discontinued operations and true one-time events should be carefully considered when evaluating the other positive and negative evidence.

The recent pandemic has had a negative financial impact on many industries. This negative impact will likely result in more entities being in a cumulative loss position. Significant judgment is required in considering the positive and negative evidence when determining whether a valuation allowance for deferred tax assets is necessary. As previously noted, the amount of weight given to the evidence must be commensurate with the extent to which it can be objectively verified. Since estimates of future income are inherently subjective, they are given less weight in the valuation allowance assessment than objectively verifiable negative evidence presented by cumulative losses.

Let’s Talk!

Call us at (325) 677-6251 or fill out the form below and we’ll contact you to discuss your specific situation.

  • Topic Name:
  • Should be Empty:

This article was written by RSM US LLP and originally appeared on 2021-01-10.
2022 RSM US LLP. All rights reserved.
https://rsmus.com/insights/financial-reporting/deferred-tax-asset-valuation-allowance.html

The information contained herein is general in nature and based on authorities that are subject to change. RSM US LLP guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. RSM US LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.

RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each is separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/about us for more information regarding RSM US LLP and RSM International. The RSM logo is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.