Impact of Tax Reform on Current Year Financial Statements

Most of the provisions in the newly passed Tax Cuts and Jobs Act (“Act”) are effective for years beginning after December 31, 2017. However, Accounting Standards Codification (“ASC”) 740 (Accounting for Income Taxes) takes a balance sheet approach, requiring tax-related assets or liabilities existing as of the date of enactment to be revalued at the future reversal tax rate.

Revaluing Deferred Tax Assets and Liabilities

Beginning January 1, 2018, the federal corporate tax rate moves from being a progressive rate (with most companies previously subject to a 34 percent or 35 percent rate) to a flat 21 percent rate. According to U.S. generally accepted accounting principles (“GAAP”), the rate impact of revaluing a company’s deferred tax assets and liabilities is to be recorded discretely as a component of the income tax provision related to continuing operations as of the date of enactment. Non-calendar year-end companies will need to utilize a blended rate (based on a prorated number of days under the 2017 rate and the new 21 percent 2018 rate) for current expense in addition to revaluing their deferreds.

NOTE: U.S. GAAP provides that the revaluation of all deferreds is allocated to continuing operations, regardless of whether or not the deferred was established through a financial statement component other than continuing operations, such as other comprehensive income or goodwill.

Changes to NOLs and the Need for Valuation Allowances

The Act includes significant changes for net operating losses (“NOLs”). Currently, NOLs have a two-year carryback period and a 20-year carryforward period. Absent other limitations, NOLs could offset up to 100 percent of taxable income. Under the Act, all NOLs generated in tax years ending on or after January 1, 2018, will have no carryback period but an indefinite carryforward. Additionally, NOLs arising in tax years beginning on or after January 1, 2018, will be limited to 80 percent of current period taxable income.

The corporate Alternative Minimum Tax (“AMT”) has been repealed as part of the Act for tax years beginning on or after January 1, 2018. Existing AMT credits may still be utilized with 50 percent of the credits allowed each year from 2018 through 2020 and any remaining credits allowed in 2021.

Due to these changes, companies will need to reassess the need for valuation allowances related to both NOLs and AMT credit carryforward. Separately, since NOLs arising in 2018 have an indefinite life, the need for a naked credit may be reduced or eliminated. Any change in valuation allowance would also be a discrete item running through expense for continuing operations.

Changes to Deductions for Business Expenses

The tax deductibility of several business expenses has changed under the Act, which may have impacts on financial statements. These changes include, but are not limited to:

  • Capital expenditures: 100 percent immediate expensing of the cost of qualified property allowed through 2023
  • Interest expense: Current deductibility (except for small corporations) limited to the sum of current year interest income and 30 percent of adjustable taxable income (similar to earnings before interest, taxes, depreciation and amortization, or EBITDA, through 2021) with excess to be carried forward indefinitely
  • Executive compensation: Deduction still limited to $1 million but expands which companies are subject to the limit, expands the definition of compensation to include performance-based compensation, and now includes CFOs in definition of “covered employees”
  • Research and experimentation expenses: Must be capitalized and amortized over a five-year period beginning in 2023 (currently a company may elect to expense instead of capitalize)
  • Domestic Production Activities Deduction (under Internal Revenue Code section 199): Repealed for tax years beginning on or after January 1, 2018
  • Expenses no longer deductible beginning in 2018: Entertainment, amusement and recreation expenses; membership dues for clubs; expenses incurred for the use of facilities in connection with these items and activities

State Tax Accounting Considerations

We are currently waiting for additional guidance regarding several conformity considerations, including, but not limited to:

  • Mandatory Federal tax on previously unremitted foreign earnings (i.e., whether includible in state taxable income)
  • 100 percent Federal bonus depreciation (i.e., immediate expensing) for qualified property

Foreign Activity and Accounting Principles Board (“APB”) 23 Assertions

Perhaps the most material and complicated changes to Federal income tax rules as part of the Act are in the area of foreign activity, where we are transitioning from a worldwide system to a modified territorial system. One of the biggest impacts of this change is the mandatory deemed repatriation of post-1986 undistributed foreign earnings and profits (“E&P”). Complicating this calculation are two new rules: different toll rates apply depending on the nature of the E&P assets and two measurement dates are involved.

The toll tax expense and liability need to be recorded in the year assessed (i.e., on the 2017 return). However, a taxpayer may elect to pay the tax in installments over eight years, so there could be a current and non-current portion of the tax obligation.

Other big changes in foreign activity worth highlighting include:

  • APB 23 assertions, which still exist, but the tax cost of repatriation for C corporations may be less material (i.e., withholding, currency translation and state taxes)
  • Global intangible low-taxed income (“GILTI”) of controlled foreign corporations
  • The Base Erosion Anti-Abuse Tax, often referred to as “BEAT,” which establishes a parallel tax system imposing a minimum tax on adjusted tax base
  • Deduction of foreign-derived intangible income and GILTI
  • Elimination of indirect foreign tax credits

Other Considerations

The Securities and Exchange Commission has provided guidance to public companies under Staff Accounting Bulletin (“SAB”) 118 regarding reasonable estimates, a measurement period for refining calculations and related disclosures. The Financial Accounting Standards Board (“FASB”) addressed implementation issues at its January 10, 2018, board meeting, including the application of SAB 118 for private companies and not-for-profit entities. Additionally, FASB proposed a one-time reclassification of disproportionate tax effects trapped in accumulated other comprehensive income resulting from the lower corporate tax rates.

Action Steps

As you begin to review your financial statements and supporting documents, questions are sure to come up. When they do, don’t hesitate to call your Cherry Bekaert advisor or the advisor in your area just to start the conversation. We’re here to help make the transition easier on you.