CORPORATE – Tax Reform and Financial Statement Reporting – What You Need to Know

By March 6, 2018 July 8th, 2019 March Tax Newsletter

Shortly after the Tax Act was enacted, SEC staff issued SAB 118, which provides guidance for accounting for tax reform.  SAB 118 provides, with regard to matters for which the accounting is not completed, that the business entity affected by tax reform would recognize a provisional amount to the extent that a reasonable estimate can be made.  These estimates would then be adjusted over time as more information becomes available.  The amounts that were recorded as provisional and subsequent updates to these amounts would be disclosed in the financial statements.

There are several items that a company should be aware of when preparing their 2017 financial statements with regard to tax reform.  Although not exhaustive, we have provided an overview of some of the more common items to consider.

Change in corporate tax rate.  The Tax Act reduces the federal corporate income tax rate from a maximum rate of 35% to a flat 21% effective on January 1, 2018.  This will require the deferred tax balances of a company to be remeasured as of the enactment date of December 22, 2017.  This remeasurement will affect the overall tax provision expense or benefit as a discrete item for the reporting period that includes the enactment date.  For a fiscal year taxpayer whose year spans the January 1, 2018 effective date of the rate change, the current tax will be calculated using a blended rate which is calculated by prorating the number of days in the tax year at each rate.  The deferred tax balances at the end of the tax year would be recorded at the new 21% rate. However, if there are interim periods reported before year end, an analysis would need to be performed to determine at what rates each component of deferred tax will reverse.

Repeal of AMT Tax.  Effective with tax years beginning after December 31, 2017, the corporate AMT is repealed, and existing AMT credits can be used to offset regular tax.  Any remaining AMT credits will become partially refundable in 2018-2020, with the remainder refunded in 2021.  For tax accounting purposes, these AMT credits could be reclassified from deferred taxes to taxes payable or receivable, depending on the circumstances of their expected future recovery.

Foreign repatriation toll charge. The bill imposes a one-time deemed repatriation of post-1986 foreign earnings of specified foreign corporations on their US shareholders.   This is reported as additional Subpart F income and is effectively taxed at two different rates depending on the types of assets that generated the earnings.  This repatriation tax should be recorded as taxes payable at the end of the last taxable year of the specified foreign corporation that starts before January 1, 2018 (for a calendar year foreign corporation this would be December 31, 2017).  In addition, if a company has recorded deferred taxes for its prior foreign earnings, it may need to adjust these balances accordingly.

Deferred taxes recorded through OCI or Equity. For deferred tax balances that were originally recorded as an adjustment to other comprehensive income or equity, the effect of changes of these balances would be recorded as a component of tax expense from continuing operations at the date of enactment.  This would result in debits or credits related to income taxes being stranded in OCI or equity.  The FASB has proposed an update to ASC 220 which would require a reclassification of the tax rate change from OCI to retained earnings.  This is currently still proposed, but would be effective with years beginning after December 15, 2018, and could be early adopted.

There are other aspects of tax reform that will affect financial statements going forward after 2017, including but not limited to:

  • Changes to NOL carryover and carryback provisions
  • Interest expense limitation
  • Immediate expensing of tangible property
  • Limits on employee compensation for certain companies
  • Restrictions of or elimination of deductions, exclusions and credits
  • 100% dividend exemption on foreign source dividends from certain foreign corporations.
  • Other international provisions (global intangible low-taxed income (GILTI), base erosion and anti-abuse tax (BEAT), export incentive on foreign-derived intangible income (FDII)

Please look for updates relating to these provisions in a future installment of the newsletter, or call Shawn Kato at 949.222.2999 to discuss.