Executive Summary

The bill introduced as the Tax Cuts and Jobs Act (TCJA) will have a significant impact on taxes for businesses but it also comes with a host of accounting changes that are accounted for under guidance for income taxes (ASC Topic 740) that will affect interim and annual financial reporting that include the TCJA’s effective date, Dec. 22, 2017. Some of the accounting effects have been clarified by FAQs created by the FASB and a newly issued accounting standard ASU 2018-02 Income Statement—Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income.

These accounting changes will likely affect financial statements, so it's critical that entities understand where accounting changes will need to be made as well the impact to their financial statement in order to communicate the reason for the changes to their financial statement users. More than 150 provisions in existing tax law are affected, including corporate tax rate, the corporate alternative minimum tax (AMT), bonus depreciation, Section 179 deductions, net operating losses (NOLs), executive compensation, equity classified as stock compensation, changes to deductible expenses, revenue recognition conformity rules, and state income tax conformity rules.

Provisions on the international tax front will also bring changes to accounting, as the law moves the U.S. from a world-wide to a territorial system. Multinational companies should expect accounting challenges related to the repatriation tax, assertion of indefinite reinvestment of foreign earnings, the Base Erosion Anti-Abuse Tax (BEAT), and Global Intangible Low-Taxed Income (GILTI).

The combination of tax law changes will have a ripple effect on other areas of accounting, including valuation allowances, fair value measurements and net asset value measurements. All entities should closely examine the accounting impact of each of the major changes to be prepared for their 2017 financial statement filings. Disclosure or management discussion and analysis (MD&A) of the effects of the TCJA should be made in the financial statements when the effects of TCJA are material to the financial statements or expected to be material in future periods.

Table of Contents

Staff Accounting Bulletin 118 (SAB 118) and Measurement Period Elections

It may be a challenge to obtain the necessary information and complete the computation of the effects of the TCJA by the time financial statements need to be issued. Fortunately, there is some accounting relief available for entities under SEC Staff Accounting Bulletin 118 (SAB 118). The bulletin describes an interpretation of U.S. Generally Accepted Accounting Principles (U.S. GAAP) that permits a measurement period of up to one year for recognizing the effects of the changes in the new tax law similar to the measurement period for business combinations. The use of the measurement period is intended for those companies that after a good faith effort find that it is not possible to obtain the necessary information, prepare, or analyze the effects of the new tax law in reasonable detail to complete the measurement as required by U.S. GAAP.

The FASB issued an FAQ discussing whether private companies and not-for-profit entities could adopt a policy to follow SAB 118 and concluded that consistent with the longstanding practice of private companies electing to apply SABs, a non-registrant can adopt SAB 118 and still be in compliance with U.S. GAAP. The FASB staff emphasized that a private company or not-for-profit electing to apply SAB 118 should adopt all provisions in SAB 118, including the incremental disclosure requirements. Many private companies may find the provisions of SAB 118 helpful when preparing financial statements for periods ended Dec. 31, 2017.

Keep in mind that SAB 118 requires a good faith effort be made. Whether management has made a good faith effort may require significant judgement. If a conclusion is reached that a good faith effort has not been made, it would be treated as a departure from U.S. GAAP because the accounting for the TCJA would not have been ready in the period of enactment. SAB 118 must be evaluated for each tax effect, which we will cover in more detail below.

SAB 118 also requires certain disclosures for each tax effect for which measurement is not complete. All of the required disclosures should be included for material tax effects for any entity adopting SAB 118.

Internal control documentation will need to be updated as well for entities adopting SAB 118. These internal controls will help auditors gain an understanding of controls (or perform a test of operating effectiveness of controls when the controls will be relied upon or in an integrated audit) over the determination of when the measurement for tax effects of TCJA could finalized, reasonably estimated, or not estimated and the related SAB 118 disclosures.

Accounting for TCJA

TCJA creates, modifies, or deletes over 150 provisions in existing tax law, and it changes the U.S. federal tax system from a world-wide system to a territorial tax system. Numerous provisions will require clarification or rule making from the IRS over the coming year. As a result of the scale, timing, and uncertainty, it is expected that the complete impact will continue to develop over time. These issues due not eliminate the U.S. GAAP requirements to account for the effect of the change in tax law in the period of enactment, nor the requirements to make a good faith attempt to account for those changes for those entities adopting SAB 118.

Change in Corporate Tax Rate

Tax Law Change

TCJA decreases the corporate tax rate from progressive tax brackets with a top rate of 35 percent to a flat rate of 21 percent. All tax-paying entities should re-measure federal deferred tax items based on the new 21 percent rate.

Accounting Considerations

For entities that formerly applied the top tax rate this will result in a 40 percent decrease in federal deferred tax assets (DTA) and deferred tax liabilities (DTL) that will be recognized in current period earnings (i.e. through income tax expense/benefit). For many companies this is the single largest financial statement impact of the TCJA in the 2017 financial statements is the change in the corporate tax rate. Entities that had a net DTA, meaning they had expenses that were accelerated for tax purposes or revenues that were deferred, will have large tax expense because the "value" of DTA is reduced by TCJA. The opposite is true for entities that had a DTL as they will see a large income tax benefit as income tax expense that will be incurred in the future is reduced. Many will find it useful to track the specific effects of the TCJA so that financial statement users can back out the onetime charges that result from TCJA. These impacts can be described in a footnote for those interested in providing the financial statement user the ability to "normalize" the income statement.

When accounting for the change in the tax rate U.S. GAAP does not permit "backwards tracing." Backwards tracing is the process of recognizing the effects of changes in deferred tax amounts through the same line item in which deferred taxes originally were recorded (for example other comprehensive income or goodwill). The prohibition on backwards tracing means that all changes to the deferred tax assets and liabilities, including those recognized in accumulated other comprehensive income (AOCI), resulting from the TCJA must be recorded as a component of the current period tax provision.

The exclusion of backwards tracing means that companies with existing AOCI on the date enactment will retain the difference between the historical enacted tax rate (typically 35 percent) and the newly enacted tax rate (21 percent) in AOCI as a stranded amount. The FASB has issued ASU 2018-02 that permits an entity the election to reclassify the stranded amount from AOCI to retained earnings, see discussion below. If ASU 2018-02 is not elected the stranded amount would only be released when the underlying item is disposed, liquidated, or terminated, thus triggering recognition in current income.

The prohibition on backwards tracing also requires that the accounting for business combinations occurring before Dec. 22, 2017 be accounted for applying the previously enacted rate. Deferred taxes and goodwill should not be adjusted for the 21 percent rate included in the TCJA even if the measurement for the business combination is not complete.

The cutoff for items recognized in other comprehensive income will also be important when applying the change in the enacted tax rate and would be accounted for as follows:

  • Changes in available-for-sale securities, hedging activities, and foreign currency recognized through other comprehensive income (OCI) would generally be recognized at the previously enacted rate (typically 35 percent) prior to Dec. 22, 2017, and at 21 percent rate beginning Dec. 22, 2017. In practice, an entity may determine the amount of OCI recognized between Dec. 22, 2017, and Dec. 31, 2017, is immaterial and therefore the entire OCI may be measured at the previously enacted rate (i.e. 35 percent).
  • Pension and other postretirement benefits are not required by U.S. GAAP to be remeasured as a result of a change in the enacted tax rate. We believe adjustments to benefit obligations that result from the post Dec. 22, 2017 measurements should be recognized at 21 percent. However, deferred tax items existing on Dec. 22, 2017 should be remeasured at the 21 percent resulting in a stranded amount to the extent it was previously recognized through OCI at a previously enactment rate

Deferred taxes for state income tax purposes are not directly impacted by the change in rates. For entities that previously used a blended federal and state rate for the computation of deferred taxes, the blended rate should be reassessed. For entities that previously computed state deferred tax items separately from federal, the rate used for the state computation should not be impacted by TCJA except to the extent the deductibility of the state income tax expense for federal purposes was incorporated into the estimated state tax rate.

ASU 2018-02

Accounting considerations: ASU 2018-02 permits the reclassification of the stranded tax effect related to the tax effect of the TCJA between AOCI and retained earnings. These stranded tax effects arise from the prohibition on US GAAP for backwards tracing (discussed above). The prohibition on backwards tracing results in tax effect of remeasuring deferred tax items as a result of the TCJA being recognized in current earnings instead of OCI. As a result the amount of tax effect in AOCI and retained earnings do not reflect the tax effects of items in AOCI at the appropriate rate (i.e. 21 percent) Entities may desire to “correct” these to the appropriate rate in order to more accurately reflect the amount of retained earnings and AOCI for regulatory capital compliance or financial covenants, as well as, to prevent the reversal of the inappropriate tax rate in future period’s income.

Entities considering the adoption of ASU 2018-02 may want to carefully consider the impact of backwards tracing on capital accounts, the likely timing of reversal, the complexity of computing the reclassification amount, as well as the impact on regulatory or contractual capital requirements when deciding whether to adopt some or all of the provisions of ASU 2018-02. Entities with relatively straight forward amounts in AOCI, such as deferred taxes related to available-for-sale securities may find it easy to adopt ASU 2018-02, while entities with more complex amounts (for instance foreign currency effects) may find it impractical to adopt certain provisions. Any entity electing ASU 2018-02 is remains prohibited from adjusting stranded tax effects relating to prior and future tax law changes not associated with the TCJA.

ASU 2018-02 allows an entity to elect to correct the stranded tax effect through a reclassification adjustment between retained earnings and AOCI. If reclassification is elected two types of effects are reclassified:

  • Direct effect of the change in tax rates enacted by TCJA,
  • Indirect effects of TCJA, such as the effect of state income taxes, the change from a territorial tax system, and other indirect effects. Each of the indirect effects of the TCJA are elected to be reclassified on an item by item basis. An entity could elect to reclassify the indirect effects of the change to a territorial tax system, but not the effect of state income taxes related to TCJA.

ASU 2018-02 retains the prohibition on backwards tracing and does not allow for the reclassification of historical stranded amounts that arose from prior tax law changes. Even when adopting ASU 2018-02 the current earnings in the period of enactment will reflect the remeasurement of deferred tax items associated with AOCI that are related to the TCJA. It also does not permit reclassification for future tax law changes unrelated to the TCJA. However, the FASB has indicated it will research the issue for potential future standard making.

Tax effects related to valuation allowances that arose subsequent to the original accounting for the deferred tax item related to AOCI are also prohibited from reclassification. However, if the original recording of the tax effect in AOCI was recognized at a lower amount due to an initial valuation allowance (such as recognizing only 50% of the tax effect in OCI due to a valuation allowance), we believe the proportionate change in the stranded tax effect could be reclassified.

If reclassification is elected, AOCI and retained earnings are adjusted using either a modified retrospective method (adjust opening balances in the annual or interim period of adoption) or retrospectively (adjust prior periods beginning with the period of enactment). The reclassification will be presented as a separate line item in the statement of equity.

Disclosure is also required under ASU 2018-02 for entities electing reclassification and those that do not elect reclassification. Entities electing reclassification should disclose the following:

  • A description of the accounting policy for releasing income tax effects from accumulated other comprehensive income;
  • A statement that the election to reclassify the income tax effects of the TCJA from AOCI to retained earnings was made;
  • A description of other income tax effects related to the application of the TCJA that are reclassified from AOCI to retained earnings (if any);
  • The nature of and reason for the change in accounting principle;
  • The effect of the change on the affected financial statement line item; and
  • A description of the prior-period information that has been retrospectively adjusted, if any

An entity not electing to reclassify stranded amounts should disclose a description of the accounting policy for releasing income tax effects from accumulated other comprehensive income and that the election to reclassify the income tax effects of the TCJA from accumulated other comprehensive income to retained earnings was not made in the period of adoption.

Adoption of ASU 2018-02 is required in annual periods beginning after December 15, 2018, including interim periods within, and may be early adopted for any annual or interim period financial statements not yet issued or made available for issuance.

Fiscal Years Ends

Tax Law Change

Internal Revenue Code (IRC) 15 addresses the accounting for the effect of tax rate changes, which we believe will be administratively effective at the beginning of the fiscal year. As result the provisions of the TCJA are generally applicable Jan. 1, 2018 for fiscal year end entities; most significantly including the reduction of the corporate tax rate to a 21 percent flat rate. During the fiscal period that includes the enactment of the TCJA an entity with a fiscal period end will compute a blended rate to be applied. Under IRC 15 the blended rate is computed based on the number of days during the taxable year that each tax rate is applicable. Thus an entity with a June 30, 2018 fiscal period would have an effective tax rate of approximately 28 percent ((184 days * 35% + 181 days * 21%) / 365 days).

Accounting Considerations

Entities with a fiscal year end will need to account for the changes under the TCJA as of the date of enactment. To compute the income tax in the period of enactment different tax rates may be necessary for components of the computation. The most significant components to income tax expense are:

  • Current income tax provision computed using the blended tax rate based on IRC 15
  • Deferred tax items arising subsequent to the period of enactment that will reverse in future taxable years using the newly enacted tax rate of 21 percent
  • Remeasurement of deferred tax items that arose prior to Dec. 22, 2017 that are remeasured from the previously enacted rate (usually 35 percent) to the newly enacted rate (21 percent).

In addition, entities that report on an interim basis will also account for deferred tax items arising in an interim period that will reverse during the annual period that the TCJA was enacted using the blended rate computed under IRC 15.

Elimination of Corporate Alternative Minimum Tax (AMT)

Tax Law Change

Corporate AMT is eliminated for tax years beginning after Dec. 31, 2017. AMT credits are refundable for any taxable year beginning after 2017 and before 2022 in an amount equal to 50 percent (100 percent in the case of taxable years beginning in 2021) of the excess of the minimum tax credit for the taxable year over the amount of the credit allowable for the year against regular tax liability.

Although the AMT credits are fully refundable government sequestration rules could result in limitations on the amount of AMT credits that are refunded in cash. If an AMT credit refund is limited by sequestration it may not be recoverable. Recent budget deals reached by congress are expected to eliminate sequestration for two years.

Accounting Considerations

We believe the best approach to the classification of the amount of AMT credits expected to be realized as credits against income tax payable in future periods or to be refunded should be as a current and/or noncurrent income tax receivable based on the expectation of timing of their utilization. Alternatively, some may conclude that the AMT credits should continue to be classified as a DTA, for instance because they are expected to reduce income tax expense resulting from the reversal of deferred items in future periods rather than being refunded. The classification as a DTA would generally be appropriate when an accounting policy has already been established that results in including other refundable tax credits in deferred taxes. The accounting policy for refundable tax credits should be consistent for tax credits that have similar characteristics. The timing of utilization of the AMT credits is expected to remain a financial statement estimate because it is dependent upon future income.

While valuation allowances on AMT credits would generally no longer be appropriate, it may be necessary to estimate the amount of the AMT credit receivable that will be disallowed under the government’s sequestration rules. We would expect the estimate of AMT credits that are subject to sequestration to be accounted for in a manner similar to an allowance for doubtful accounts. We expect the estimate of AMT credits that are subject to sequestration to be accounted for in a manner similar to an allowance for doubtful accounts when the entity has an expectation that sequestration would apply to refundable AMT credits.

The required disclosures for AMT credits pursuant to ASC 740-10-50-3 would continue to apply whether the AMT credits are classified as an income tax receivable or a deferred tax item.

Consistent with discussions in the FASB FAQ, the AMT tax credit receivable should not be discounted for the impact of a financing component (i.e., imputation of interest).

Bonus and Section 179 Depreciation

Tax Law Change

Bonus depreciation will now be allowed for new and used property. The following is the enacted rates for bonus depreciation:

Placed in Service Qualified property Certain long production period property/aircraft
Sept. 28, 2017* – Dec. 31, 2022 100% 100%
2023 80% 100%
2024 60% 80%
2025 40% 60%
2026 20% 40%
2027 None 20%

*An election is permitted to elect 50 percent instead of 100 percent
bonus depreciation in the first tax year ending after Sept. 27, 2017.

In the final tax law legislation certain 15 year property was reclassified under tax law to 39 year property. This change is inconsistent with committee notes during the drafting process and it is uncertain if a correction will be made for the change. 39 year property is not permitted to take bonus depreciation.

Section 179 deduction limitations have risen to $1 million with phase-out beginning at $2.5 million of additions for tax years beginning after Dec. 31, 2017. Section 179 deductions have the advantage of being applicable to additional types of property, such as certain improvements to real property that is not available under bonus depreciation.

Accounting Considerations

Changes to bonus depreciation deductions and the likely election made by companies should be considered when 2017 income tax provisions are prepared. The effect of these conclusions should be considered when determining deferred taxes as per usual.

The reclassification of certain 15-year property to 39-year property will need to be monitored. We believe the appropriate interpretation is that the depreciable life of the property under tax law should be assessed to determine the appropriate classification under tax law as written at the date of enactment. Under this, the enactment of a future technical correction to the depreciable life of property would generally be accounted for at the time of enactment consistent with ASC 740-40-25-47.

State income tax law may or may not permit deductions for bonus depreciation. Potential differences in deferred taxes will generally need to be assessed for each individual state.

Deemed Repatriation Tax

Tax Law Change

To convert the U.S. from a worldwide tax system to a territorial system, TCJA mandates a tax on unrepatriated foreign earnings accumulated since 1986. The tax is generally applicable to at 15.5 percent on cash and cash equivalents and 8 percent for illiquid assets for controlled foreign corporations (for example: foreign subsidiaries of a U.S. corporation) and foreign corporations with greater than 10 percent U.S. corporate ownership. The tax is measured based on assets held on either Nov. 2, 2017 or Dec. 31, 2017, whichever results in a greater tax.

An election may be made to pay the tax over eight years: 8 percent of the liability in each of the first five years, 15 percent in the sixth year, 20 percent in the seventh year, and 25 percent in the eighth year.

Accounting Considerations

We believe the known or estimated amount of deemed repatriation tax should be classified as a current and noncurrent income tax payable.

Although not explicitly required by U.S. GAAP, when material, we believe the best practice is to disclose the expected amount and timing of payments of the deemed repatriation for the next five years consistent with the disclosure for noncurrent debt.

Consistent with the discussion in the FASB FAQ, the liability for the deemed repatriation tax should not be discounted for the impact of a financing component (i.e., imputation of interest).

The computation of the amount of deemed repatriation tax will likely be a good candidate for SAB 118, as calculations will depend significantly on the complexity of the foreign entity structures, the availability of foreign tax credits, and the ability to obtain information for the foreign corporations at the two required dates.

S-Corporation Recognition and Disclosure of the Deemed Repatriation Tax

Tax Law Change

To convert the U.S. from a worldwide tax system to a territorial system, TCJA mandates a tax on unrepatriated foreign earnings accumulated since 1986. The tax is 15.5 percent on cash and cash equivalents and 8 percent for illiquid assets for controlled foreign corporations (for example: foreign subsidiaries of a U.S. corporation) and foreign corporations with greater than 10 percent US corporate ownership. The tax is measured based on assets held on either Nov. 2, 2017, or Dec. 31, 2017, whichever results in a greater tax.

Under the tax law, a special rule exists for the shareholders of an S corporation that allows the shareholder to elect to defer payment of the tax liability arising from the deemed repatriation tax until the taxable year of a triggering event, such as the sale of the interest in the foreign corporation. If the shareholder makes this election, the S corporation becomes jointly and severally liable for the tax payment and any associated penalties.

Accounting Considerations

We believe that the deemed repatriation tax for an S corporation is an income tax on the stockholders since it is initially assessed against the stockholder, the stockholder has the opportunity to elect to defer the taxes due, and if the S corporation makes payments of the tax liability, it would relieve the stockholders' obligation. Therefore, the S corporation would not account for the deemed repatriation tax under ASC Topic 740 and would not recognize income tax expense.

It is our belief that the guidance of ASC Subtopic 405-40 Obligations Resulting from Joint and Several Liability Arrangements should be applied. ASC Subtopic 405-40 includes several scope exceptions including for Income Taxes under ASC Topic 740, however, the tax liability of the stockholder is not within the scope of ASC Topic 740 as discussed above and therefore the liability is not scoped out.

In addition, although the amount of the tax lability paid may change upon the future resolution of tax positions of the stockholder (such as earnings and profits from foreign subsidiaries or the reduction of the tax for foreign tax credits), we believe that changes to the amount due as a result of future events do not preclude the tax from being considered fixed based on the tax attributes existing as of the reporting date. Therefore, once the tax liability has been deferred by the stockholder the liability meets the two criteria to be in the scope of ASC Subtopic 405-40:

  • Joint and several liability arrangement
  • The total amount of the obligation is fixed at the reporting date

An S corporation applying the guidance of joint and several arrangements to the tax liability jointly and severally held with its stockholder would recognize a liability based on the amount it has agreed to pay based on its arrangement with its co-obligors (i.e. stockholders), plus any additional amount it expects to pay on their behalf. Applying this guidance will require significant judgement on the part of management and will likely involve discussions with the stockholders to determine whether the tax has been deferred and the stockholders' intent to pay. It may also involve updates to the measurement each reporting date. Accruing for the liability, updating estimates, and the payment of the tax by the S corporation would be reflected as transactions with the stockholders that might be described as dividends, contributions, or in some similar manner. We do not believe the ability to indefinitely defer payment until a triggering event occurs exempts the obligation from these requirements.

Consistent with the discussion in the FASB FAQ, any liability recognized related to the deemed repatriation tax should not be discounted for the impact of a financing component (i.e., imputation of interest).

As a joint and several obligation certain disclosure requirements in ASC Subtopic 405-40 would apply, including:

  • How the liability arose
  • The relationship with the co-obligors
  • Terms and conditions of payment
  • Total amount due outstanding
  • Carrying amount of liabilities and receivables related to the arrangement
  • Any arrangements permitting recourse against the co-obligors
  • The amount initially recognized, or the amount of change recognized in the financial statements, including where the liability and corresponding entries are presented

In addition, related party disclosures in ASC Topic 850 Related Party Disclosures should be applied to the extent they are not addressed by the disclosures required under ASC Subtopic 405-40.

The computation of the amount of deemed repatriation tax will depend significantly on the complexity of the foreign entity structures, the availability of foreign tax credits, and the ability to obtain information for the foreign corporations at the two required dates. Some S corporations may utilize the provisions of SAB 118 in scenarios where they cannot complete measurement of the tax to determine the amount of the joint and several obligation that should be recognized or disclosed in the financial statements (i.e. they will recognize a reasonable estimate or not be able to make a reasonable estimate). We do not believe the inability to finalize the measurement of the tax as of the period end would result in a conclusion that the joint and several obligation is not fixed as of the reporting date, therefore the inability to measure does not eliminate the requirement to apply ASC Subtopic 405-40.

Assertion of Indefinite Reinvestment for Foreign Earnings

Tax Law Change

The transition to a territorial tax system and the one-time deemed repatriation tax will reduce the U.S. federal tax burden applicable to the ownership of foreign corporations.

Accounting Considerations

Under the accounting guidance for Subpart F Income, an entity is able to assert that it will indefinitely reinvest foreign earnings and therefore indefinitely defer the attributable income tax. When this assertion is made the entity does not account for the deferred tax effects created by the foreign earnings.

The switch to a territorial tax system and one-time deemed repatriation tax eliminates most, but not necessarily all, of the taxable items that the assertion applied to. It is likely that companies will continue to assess the assertion when evaluating deferred taxes related to items such as Section 986(c) currency gains/losses, foreign withholding taxes, and nonconforming state income taxes.

The elimination of the worldwide tax system, and thus the significant tax penalty associated with repatriating earnings will eliminate one of the key considerations many companies utilized to justify an indefinite deferral (based on the economic incentive to not repatriate earnings). Companies will need to carefully reassess their analysis of the assertion of indefinite reinvestment when the assertion is still applicable.

Base Erosion Anti-Abuse Tax (BEAT)

Tax Law Change

BEAT is an alternative minimum tax on corporations that have annual gross receipts for the three prior years of at least $500 million and make payments to foreign related parties in excess of a threshold amount. These include payments deductible against U.S. taxable income such as interest, royalties, and service fees (but do not include costs of goods sold). The BEAT tax rate is 5 percent for tax years beginning in 2018, 10 percent for tax years 2019 through 2025, and 12.5 percent thereafter.

An outbound transfer of goodwill, going concern value, or in-place workforce to a foreign corporation in an otherwise tax-free transaction will be subject to U.S. taxation (either through current gain recognition or deemed annual royalties).

Payments of BEAT do not result in tax credit carryforwards.

Accounting Considerations

Consistent with discussions in the FASB FAQ, BEAT should be accounted for in the period the tax is incurred in a manner similar to Alternative Minimum Tax (AMT). As a result, entities that may be subject to BEAT should not consider BEAT when determining the tax rate to apply when computing deferred taxes.

Global Intangible Low-Taxed Income (GILTI)

Tax Law Change

A U.S. shareholder of a CFC includes in current income its share of the GILTI earned by the CFC. For this purpose, GILTI is defined as the excess of the U.S. shareholder's "net CFC-tested income" over the shareholder's "net deemed tangible income" return. The net CFC-tested income is the excess of:

  • The aggregate of the U.S. shareholder's pro rata share of tested income over
  • The aggregate of the U.S. shareholder's pro rata share of tested loss of each CFC owned by the U.S. shareholder.

Tested income (or loss) for a CFC equals the difference between of all of the CFC's gross income and the CFC’s properly allocable deductions (including taxes) to such gross income. The net deemed tangible income return (the second part of the main equation in determining a CFC's GILTI) is the excess of:

  • 10 percent of the U.S. shareholder's pro rata "qualified business asset investment" of each CFC over
  • The U.S. shareholder's interest expense taken into account previously in measuring tested income (but only to the extent interest income associated with the expense is not part of tested income).

U.S. corporate shareholders of CFCs can deduct 50 percent of GILTI income for tax years beginning in 2018 through 2025 and 37.5 percent of GILTI thereafter. U.S. corporate shareholders of CFCs can also claim a foreign tax credit with respect to included GILTI amounts, but such credit is limited to 80 percent of the foreign tax paid, and any unused foreign tax credits cannot be carried forward or carried back to other tax years.

Accounting Considerations

Consistent with discussions in the FASB FAQ, each entity will elect an accounting policy on whether to account for GILTI when it is incurred or to include it in the determination of deferred taxes.

We believe the best practice is to include GILTI in the computation of deferred taxes when an entity anticipates indefinitely being subject to GILTI. This may occur when an entity has a CFC with minimal tangible assets located in a low tax country (for example Ireland). Where an entity is not expected to be subject to GILTI, because its CFCs have significant tangible assets or are in high-tax countries, it would best account for GILTI when it is incurred.

The FASB anticipates continued monitoring of GILTI as practice develops and may provide guidance in the future.

Net Operating Losses

Tax Law Change

Net operating losses (NOLs) can no longer be carried back two years, but may be carried forward indefinitely. The carryforward deduction is limited, however, to 80 percent of taxable income (determined without regard to the deduction) for losses arising in taxable years beginning after Dec. 31, 2017.

Accounting Considerations

Indefinite-lived NOLs may be identified in 2017 financial statements during the projection of future taxable income and future reversal of DTAs and DTLs when evaluating the need for a valuation allowance. Two significant accounting considerations apply to the indefinite-lived NOLs:

  • When assessing the need for a valuation allowance, entities must have a source of taxable income that is projected to utilize the indefinite-lived NOL, otherwise the NOL should have a valuation allowance recorded against it. Sources of income that would utilize an indefinite-lived NOL are those four identified in ASC 740-10-30-18, of which only the following three would be expected to be applicable:
    • Future reversals of existing taxable temporary differences
    • Future taxable income exclusive of reversing temporary differences and carryforwards
    • Tax-planning strategies that would, if necessary, be implemented
  • An indefinite-lived DTL, such as one arising from an indefinite-lived intangible asset, can be a source of income arising from the future reversal of temporary differences that can be offset against post 2017 indefinite lived NOLs. Therefore, if the indefinite-lived DTA and DTL arise in the same tax paying entity (or consolidated group), in the same jurisdiction, and with appropriate characters of income to be utilized then the indefinite-lived NOL can offset the indefinite-lived DTL up to the 80 percent limitation for NOLs generated subsequent to January 1, 2018. This would be permitted when the reversal of the DTL, for instance through a sale, would be expected to trigger income in the year of the reversal that would utilize the NOL.

Executive Compensation

Tax Law Change

For publicly held companies, principal executive officer, principal financial officer and the three highest-paid employees compensation in excess of $1 million are non-deductible, including commissions and performance-based pay. In addition, once an employee meets the criteria of being one of the highest paid employees, he or she retains that designation in future periods. Written binding contracts in effect on Nov. 2, 2017, including plans where the right to participate in the plan is part of a written contract with an executive, are grandfathered. Grandfathered performance-based arrangements lose their deductibility if they are materially modified on or after that date.

For not-for-profit entities, the TCJA introduces a 21 percent excise tax on compensation in excess of $1 million on compensation of the five highest paid employees. In addition, once an employee meets the criteria of being one of the highest paid employees, he or she retains that designation in future periods.

Accounting Considerations

Future taxable income may be impacted by the deductibility of compensation expense, which may impact the scheduling out of future taxable income.

To the extent a DTA or DTL relates to existing compensation plans that do not qualify for grandfathering, the DTA or DTL will likely require remeasurement for the nondeductible portion of compensation expense.

Equity Classified Stock Compensation

Tax Law Change

The top U.S. federal individual income tax rate was reduced from 39.6 percent to 37 percent.

Accounting Considerations

U.S. GAAP permits a withholding (cash settlement) for the payment of an employee's federal income tax liability up to the maximum applicable rate while retaining equity classification for the award. Companies withholding at 39.6 percent will need to adjust their withholding beginning Jan. 1, 2018, down to 37 percent, or they could cause a reclassification of the award to a liability due to inadvertent cash settlement provisions.

Changes in Deductible Expenses

Tax Law Change

TCJA contains numerous provisions impacting the deductibility of expenses. Some items impacted include:

  • Interest expense limitation (initially limits of 30 percent of EBITDA for companies unless they meet the $25 million gross receipts test; after 2021 EBTI is used for the calculation)
  • Elimination of Domestic Production Activities Deduction (DPAD)
  • Entertainment expenses (disallowed deductions)
  • Amortization of research and experimental expenditures
  • Limitations on like-kind exchanges

Accounting Considerations

Changes in deductions related to future years should be accounted for through the income tax provisions in future periods and would generally not impact the Dec. 31, 2017, financial statements. However, the changes to deductions may need to be considered when scheduling out future taxable income when assessing the need for a valuation allowance on deferred tax assets.

Revenue Recognition Conformity Rules

Tax Law Change

TCJA includes a provision that requires a new "Earlier of Test" with respect to the taxation of gross income. An item of gross income (i.e., revenue) is included in the gross income of a taxable year at the earliest of the time when the "All Events Test" is met, or when such revenue is taken into account as revenue for financial accounting purposes in either:

  • An applicable financial statement of the taxpayer, or
  • Such other financial statements as the secretary may specify for purposes of this subsection

Examples of applicable financial statements include annual filings with the Securities and Exchange Commission (SEC) (e.g., 10-K), audited financial statements prepared under generally accepted accounting principles (GAAP), financial statements filed with an agency of a foreign government using International Financial Reporting Standards (IFRS), and other financial statements filed with a regulatory or government body.

TCJA provides an exception to the new Earlier of Test in the case the taxpayer utilizes a special method of accounting, such as the deferral method for certain advance payments, the installment method for gain recognition where not all payments are received during the tax year, or the completed contract method for certain long-term contracts with customers. Regarding the completed contract method, effective for contracts entered into after Dec. 31, 2017, TCJA allows taxpayers with average gross receipts of less than $25 million (indexed for inflation) for the prior three taxable years an exemption from the requirements to use the percentage-of completion accounting method for long-term construction contracts that are to be completed within two years. Taxpayers that meet such exception would be permitted to use the completed-contract method (or any other permissible exempt contract method).

In addition to requiring the new Earlier of Test, TCJA also dictates that contract price allocations between multiple performance obligations must be made for tax purposes in the same manner as such allocations are made in the applicable financial statements.

Accounting Considerations

Future taxable income may be impacted by the timing and allocation of revenue for tax purposes.

To the extent a DTA or DTL relates to existing revenue the scheduling of the reversal of the DTA or DTL related to revenue may be different then under prior tax law.

The cash tax impact of TCJA may be a significant concern for entities that recognize revenue faster for financial reporting purposes then for tax purposes. In addition, the potential acceleration of revenue once the adoption of ASC Topic 606 Revenue from Contracts with Customers occurs may be a significant concern to discuss during preparation for the transition to ASC Topic 606.

State Income Tax Conformity

Tax Law Change

Each state may have separate conformity rules with changes in federal income tax law which may include adoption of all, some, or none of the provisions on the deductibility or taxability of items.

Accounting Considerations

Analysis of the effect of the TCJA on the computation of deferred income taxes and the income tax provision will be necessary. Significant considerations include:

  • Accelerated depreciation
  • Taxability of foreign income
  • Deductibility of certain expenses
  • Changes to the timing and allocation of revenue

Valuation Allowance

Tax Law Change

The analysis of a valuation allowance will be impacted by many of the changes resulting from the TCJA including:

  • Deemed repatriation tax
  • NOLs
  • Deductibility of expenses
  • Revenue recognition conformity

Accounting Considerations

ASC Topic 740 remains applicable and has not changed. The measurement of DTAs is reduced, if necessary, by the amount of any tax benefits that, based on available evidence, are not expected to be realized on a more likely than not basis. The future realization of tax benefits is based on four possible sources of taxable income that may be available under the tax law:

  • Future reversals of existing taxable temporary differences
  • Future taxable income exclusive of reversing temporary differences and carryforwards
  • Taxable income in prior carryback year(s) if carryback is permitted under the tax law
  • Tax-planning strategies that would, if necessary, be implemented to, for example:
    • Accelerate taxable amounts to utilize expiring carryforwards
    • Change the character of taxable or deductible amounts from ordinary income or loss to capital gain or loss
    • Switch from tax-exempt to taxable investments.

The computation of a partial valuation allowance may be a candidate for the application of the concepts in SAB 118 due to the complexity of the analysis of the various changes in the TCJA and how they will impact the scheduling out of the reversal of deferred tax items and the effect on the amount of projectable taxable income.

In circumstances where a company does not have projectable taxable income and has previously required a full valuation allowance against DTAs, it is likely that the measurement can be completed and that a full valuation allowance will continue to be required except for the potential offsetting of indefinite DTLs against indefinite-lived NOLs projected from the reversal of deferred taxes, the offsetting of foreign tax credits against the deemed repatriation tax, or the reclassification of AMT tax credits to a receivable.

Fair Value Measurements (Including Impairment Analysis and Business Combinations)

Tax Law Change

The changes in tax rates, taxability of foreign earnings, refundable AMT tax credits, and deductibility of expenses, among other changes may impact the after-tax cash flows and cost of capital of companies.

Accounting Considerations

Valuation procedures based on after-tax cash flows or the weighted average cost of capital will need to consider the impact of the changes caused by TCJA in their related modeling.

Generally, the TCJA should would not be a triggering event for an impairment analysis as it is expected to be favorable for the future cash flows of companies.

Net Asset Value (NAV) Measurements

Tax Law Change

Investments that are measured at net asset value (NAV) may be taxable and therefore require consideration of the impact of TCJA.

Accounting Considerations

Investments reporting NAV are permitted to utilize the concepts in SAB 118. When the measurement of the effects of TCJA are incomplete it is supposed to be disclosed to investors via press releases, website disclosures, or other reasonable manner.

Disclosures required by SAB 118 may be necessary related to investments measured at NAV. These disclosures may be applicable for both taxable and nontaxable entities measuring investments at NAV. A qualitative analysis of the materiality of the disclosure will likely be necessary to assess whether omission of the SAB 118 disclosures for an investment measured at NAV that applied SAB 118.

Impact on 2017 Financial Statement Audits

The financial statement audit itself should not be affected by the TCJA, but preparing the financial statements may be more complicated. Entities will need to incorporate the effects of the TCJA into the computation of their tax provision and deferred taxes. Analyzing the impact will not be easy. Auditors will be paying close attention to entities’ income taxes accounting procedures, particularly in regards to current tax provisions, deferred tax positions, and valuation allowances.

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For More Information

If you have specific questions regarding the accounting implications of the TCJA, please contact Mark Winiarski of MHM's Professional Standards Group or your MHM service provider.

Published on February 20, 2018