Tax & Accounting Blog

The “With and Without” Method for Allocating Income Tax

Best Practices, Blog, Corporate Income Tax, Global Tax Compliance, ONESOURCE, Tax Provision June 26, 2013

‘Twas the night before press release and all through the proof

Nothing was open and there weren’t any goofs

When all of sudden you awake with a fit

You forgot intraperiod allocations and a deficiency you may get

As the above cringe-inducing verse demonstrates, it is easy to think the tax provision is complete when the tax line is proven out and the footnote filled in;  however, an important consideration remains… intraperiod

allocation of tax expense to items other than continuing operating income.  Examples of items other than continuing operations include: discontinued operations, extraordinary items, and amounts included in other comprehensive income, such as unrealized gains or losses on available for sale securities or cumulative translation adjustments.  Intraperiod allocations are covered in ASC 740-20-45-12 through 14.  While the authoritative guidance discusses intraperiod allocations only briefly, complicating scenarios would suggest the need for a full treatise on the subject.  However, a few basics can help the practitioner avoid the more common pitfalls.

A key premise to keep in mind is the “with-and-without” approach to allocating income taxes.  In general, the “with and without” method includes:

  1. Calculating the overall tax provision for the period including all financial statement components (i.e., the total income tax expense / benefit)
  2. Calculating the tax provision based on the pre-tax results of continuing operating income.
  3. Allocating the difference to items other than continuing operations.

If the financial statements only have a single financial statement component other than continuing operations, then, typically, the entire difference would be allocated to that other item.

It is more interesting when there are multiple other items.  If there are two or more other items, the difference between #1 and #2 will need to be allocated pro-rata to each one, subject to certain limitations and exceptions.  This becomes a challenge when the individual impact of each item does not equal the total of the “with-and-without” amounts calculated above (i.e., the difference between #1 and #2).  ASC 740-20-45-14 provides the following guidance:

  1. Determine the effect on income tax expense or benefit for the year of the total net loss for all net loss items.
  2. Apportion the tax benefit determined in (A) ratably to each net loss item.
  3. Determine the amount that remains, that is, the difference between the amount to be allocated to all items other than continuing operations and the amount allocated to all net loss items.
  4. Apportion the tax expense determined in (C) ratably to each net gain item

This relatively simple “ratable” approach allocates income tax expense or benefit to all items impacting the overall provision.

Be aware that, in the not-uncommon case of discontinued operations, prior periods should be recast for each year presented.  And now you are fretting over the prior period’s tax allocations! Thankfully ASC 740-270-45-8 saves the day and effectively simplifies the analysis for previously reported periods to:

  1. Comparing the previously reported income tax from continuing operations to the income tax calculated on the revised continuing operations (after reclassifying the discontinued operations)
  2. Allocating the difference to prior years’ discontinued operations.

The following topics are beyond the scope of this post but are important considerations: changes in valuation allowances, windfall tax benefits, and non-reversing inclusions in OCI. These items greatly complicate the calculations. In addition, exceptions can apply in certain fact patterns (including limitations when other components of comprehensive income have gains and continuing operations have losses).  Practitioners beware.