Navigating income tax disclosures in 2025 can feel like walking through a maze, especially with the new guidance introduced by the Financial Accounting Standards Board (FASB) in late 2023. If you’re managing tax reporting for your business or just want to understand what’s changing, this step-by-step guide will help you get a solid grip on the updates and practical ways to comply, avoiding common pitfalls along the way.
Let’s start with the big picture: In December 2023, FASB issued Accounting Standards Update (ASU) 2023-09, which significantly revamps how entities disclose income tax information under ASC 740. This update affects public business entities (PBEs) starting with annual periods after December 15, 2024—meaning your 2025 disclosures will need to follow these new rules. Other entities have until 2026, with early adoption permitted. The goal is to make tax disclosures more detailed and transparent, especially for companies operating across multiple tax jurisdictions[1][4].
One of the most important changes is in the way you reconcile your effective tax rate to the statutory tax rate. Previously, many companies reported reconciling items either by amounts or percentages, but now you must disclose both. The ASU requires breaking down the reconciling items into specific categories and further disaggregating those items that meet a 5% threshold of the expected income tax expense. For example, if “foreign tax effects” or “tax credits” represent 5% or more of your expected tax expense, you need to disclose them separately with clear explanations[1][4][6].
So how do you practically approach this?
Gather Your Tax Data Early and Organize by Category
Start by collecting all relevant tax data, especially details about your pretax income, statutory tax rates, and the different factors affecting your tax expense. Break down these factors into categories such as cross-border tax laws, tax credits, nondeductible items, and foreign tax effects. These are common reconciling items that the ASU highlights for separate disclosure if they meet the 5% threshold[4][6].Calculate the Expected Income Tax Expense
Multiply your pretax income by the statutory tax rate to get your expected income tax expense. This number becomes your baseline for measuring reconciling items. For instance, if your pretax income is $1 million and your statutory tax rate is 21%, your expected tax expense is $210,000[4].Identify and Quantify Reconciling Items
List all items that cause your effective tax rate to differ from the statutory rate. Maybe you have $15,000 in foreign tax credits or $20,000 from nondeductible expenses. Check if these amounts meet or exceed 5% of the expected tax expense (in this example, 5% of $210,000 is $10,500). If they do, you’ll need to disclose these separately, including both their dollar amount and percentage of pretax income[4][6].Apply Judgment on Materiality
The ASU doesn’t rigidly define materiality, so you must use professional judgment to decide if an item is material enough to disclose. Both quantitative thresholds (like the 5% rule) and qualitative factors (such as the nature of the tax item or its potential impact on users of financial statements) play a role. It’s worth having a conversation with your auditors or tax advisors to ensure consistent application of materiality in your disclosures[1].Prepare Clear Explanations for Each Reconciling Item
For any reconciling item disclosed, you need to explain its nature, effect, and underlying causes. This isn’t just a box-ticking exercise; the goal is to provide financial statement users with meaningful insights into why your effective tax rate differs from the statutory rate. For example, if foreign tax credits reduce your tax expense significantly, explain whether this is due to specific jurisdictions or recent changes in tax law[6].Disclose Income Taxes Paid with Greater Detail
Another new requirement is disaggregating income taxes paid (net of refunds) by jurisdiction or category. This means you should provide information that lets users see where the cash outflows for taxes are occurring, adding transparency, especially for multinational companies[1][5].Apply Retrospective Disclosure for Comparative Periods
If you adopt the ASU in 2025, you’ll need to apply these new disclosure rules retrospectively to prior periods presented in your financial statements. This means revisiting your prior tax data and re-preparing disclosures to align with the new format and thresholds. While this can be time-consuming, it ensures consistency and comparability across reporting periods[6].
Beyond these technical steps, it helps to keep a few practical tips in mind:
Use Software Tools Wisely: Many tax and accounting software platforms are updating their modules to incorporate ASU 2023-09 requirements. Leveraging these tools can save time and reduce errors in reconciling tax items and calculating thresholds.
Communicate Early with Stakeholders: Your investors, board, and audit committee may have questions about the more detailed tax disclosures. Preparing clear narratives and examples can help them understand what the numbers mean and why disclosures are changing.
Stay Alert to Legislative Changes: The tax environment is always evolving. For example, new U.S. tax legislation enacted in 2025 may affect interim and annual reporting requirements, including additional disclosures about material events or uncertainties related to taxes[9]. Keeping up-to-date ensures your disclosures remain accurate and compliant.
Document Your Judgment Calls: Since materiality and categorization require judgment, maintain thorough documentation explaining how you reached decisions. This is invaluable during audits or regulatory reviews.
To put this into perspective with a brief example: Imagine a U.S.-based multinational company with $10 million pretax income and a 21% statutory tax rate, expecting $2.1 million in income tax expense. Suppose the company has $150,000 in foreign tax credits, $120,000 from nondeductible expenses, and $90,000 related to cross-border tax laws. Since each of these exceeds the 5% threshold ($105,000), the company must disclose each reconciling item’s amount and percentage, along with a clear explanation of their origins. They also need to show how much cash income tax was actually paid in each country where the company operates[4][6].
In summary, the 2025 income tax disclosure changes are about more transparency and granularity. While they add complexity, approaching them step-by-step with early preparation, clear categorization, and thoughtful explanations will help you produce disclosures that not only comply with the new rules but also provide valuable insights to users of your financial statements. Keeping a practical, organized approach will make this transition manageable and keep your reporting on solid ground.