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evaluation of the other two sources of taxable income ― Vol. 3
Financial reporting in an uncertain economy
A closer look at income tax valuation allowances October 2009
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Additional text goes here. Notwithstanding early signs that the global recession may be waning, the uncertain economic future continues to constrict corporate America. As companies continue to incur losses, focus has heightened on income tax valuation allowance assessments by companies and their auditors, as well as the Securities and Exchange Commission staff, through the issuance of ...view middle of the document...
e., deferred tax liabilities) Future taxable income exclusive of reversing temporary differences and carryforwards Tax-planning strategies that would, if necessary, be implemented
evaluation of the other two sources of taxable income ― projections of future taxable income and the identification and assessment of available tax planning strategies ― requires significant judgment. This paper explores these sources of taxable income, as well as other considerations relevant to valuation allowance assessments in today's turbulent economic environment.
Weighing available evidence
In the valuation allowance world, not all available evidence related to deferred tax asset realizability is created equal. ASC 740 requires the weighing of positive and negative evidence. For example, consider a company that experiences current operating losses that are attributable to today's economic environment. This presents negative evidence indicating deferred tax assets may not be realized. However, when forecasting its future taxable income, the company projects a return to profitability in 2010 ― an indication of positive evidence. In addition, prior to the economic downturn, the company has historically been profitable.
The existence of taxable income in carryback years and future reversals of existing taxable temporary differences are generally matters of fact. However, the
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In this case, the operating losses that have most recently occurred would likely carry more weight in the analysis of the need for a valuation allowance than either the historic profitability or the projection of future taxable income. What has recently occurred is generally more verifiable than what may occur in the future, or what has occurred in the more distant past.
Tax planning strategies
Tax planning strategies may also provide a source of taxable income when deciding whether a valuation allowance is necessary. ASC 740 gives characteristics of tax planning strategies. Specifically, tax planning strategies are: • Actions that an enterprise ordinarily might not take, but would take to prevent an operating loss or tax credit carryforward from expiring unused Actions that would result in realization of deferred tax assets Actions considered both "prudent" and "feasible"
Cumulative losses in recent years
In ASC 740, cumulative losses in recent years are cited as an example of significant negative evidence that is difficult to overcome. While not defined by ASC 740, practice has generally been to consider the most recent three years when assessing cumulative losses. Positive evidence of sufficient quantity and quality would be needed to overcome this significant negative evidence and conclude that a valuation allowance is not warranted. As with all elements of available evidence, a cumulative loss is simply one data point — it is not a "bright line" test that is in and of itself determinative of the...