Improve tax planning by understanding the impacts of ASC 740 trends

Evolving regulations and other trends that emerged ahead of 2024 tax season could provide insights for ongoing focus areas into Q2 2024, as well as for future income tax provisions and filings.

Navigate potential tax law changes and their impact to help improve your tax planning strategies, particularly those trends impacted by Financial Accounting Standards Board Accounting Standards Codification®(ASC) Topic 740.

ASC 740 trends for Q4 2023 provisions

When reflecting on 2023 ASC 740 trends, the following key points should be considered:

• Valuation allowances
• Naked credits
• R&D expenses

Valuation allowances

Valuation allowances loomed large due to changing economic conditions and the interaction of several Tax cuts and jobs acts provisions. In its second year of limitation without adjustment for depreciation, disallowed interest expense under Internal Revenue Code Section 163(j) continued to create significant carryforwards.

Entities without sufficient taxable income to deduct interest expense often also generated net operating losses (NOLs). These deferred tax assets (DTAs) are analyzed independently and often require more in-depth scheduling to calculate valuation allowances and adjustments.

Naked credits

Tax treatment of NOLs and limited business interest expense also caused an uptick in the need to schedule hanging deferred tax liabilities (DTLs) or naked credits. Naked credits result when an entity has indefinite-lived DTLs, which won’t be able to be offset by the reversal of DTAs, resulting in the need to record a valuation allowance in excess of its net DTAs.

The 30% limitation to adjusted taxable income and depreciation recapture rules under Section 163(j), and the 80% taxable income limitation on post-2017 NOLs, decrease the amount of indefinite-lived deferred tax liabilities (DTLs) that could be included in valuation allowance analyses. This also contributed to the increased need for deferred scheduling.

R&D expenses

Section 174 treatment of specified research and experimental expenditures (SREs) was another common theme of the season. Beginning in tax periods after Dec. 31, 2021, domestic SREs can no longer be expensed but instead must be amortized over five years. Passage of the Tax Relief for American Families and Workers Act of 2024 would retroactively restore the ability to expense through tax year 2025.