Impacts of Tax Reform on GAAP Financials

The sweeping tax reform bill, widely known as the Tax Cuts and Jobs Act (TCJA), affects not only tax reporting for businesses, but also financial reporting.  The bill was signed into law on December 22, 2017 and companies are still navigating its waters.

The SEC wasted no time in providing guidance related to financial reporting as a result of the TCJA and issued Staff Accounting Bulletin No. 118 (SAB 118).  As with other SEC guidance, non-public companies not bound by this pronouncement can still use it as a means of reporting financial information on GAAP (Generally Accepted Accounting Principals) basis financials.  Knowing the complexity of the TCJA, SAB 118 states that companies may essentially report the effects of tax reform in stages.  Some changes that could easily be quantified should have been reported during the period which contained the date of enactment of the TCJA.  Other items that could only initially be estimated should have been reported at the estimated amounts and the use of the estimate disclosed.  For items in which no reasonable estimate could initially be made, the company should have continued to use pre-TCJA law and standards until the information was finalized or an estimate could be made and disclosed.  We are fast approaching one year after enactment of the TCJA, at which time companies should be quantifying and disclosing any final changes relating to tax reform.

One fairly easy way to quantify change, that also happened to be one of the major provisions of the TCJA, was the reduction of the top corporate tax rate of 35% to a flat corporate tax rate of 21%.  Most companies should have already revalued net deferred tax assets or liabilities at the lower 21% for U.S. GAAP financial statements for the period which included the date of enactment.  This would have resulted in the recognition of deferred income tax expense or benefit due to the change in tax rates.  Valuation allowances should also have been reassessed taking the TCJA into account.  For 2018 financials, we will begin to see the current federal tax rate drop to 21% and likewise a reduction to the benefit for state income tax deductions.

Companies with foreign operations may have had items landing in the estimate or unable to estimate categories for 2017 financials.  They have some new taxes to account for and, given the December 22, 2017 enactment date, they may have needed more time to gather information and perform calculations. One new tax is a deemed repatriation tax.  The tax applies to foreign earnings and profits accumulated abroad from 1986 through 2017.  If elected, the tax on the deemed repatriated earnings may be paid over eight years, so a payable should be set-up for this liability.  Another new tax is referred to as BEAT, base erosion anti-abuse tax.  This tax functions somewhat like the alternative minimum tax by assessing an alternative tax in which certain related party transactions are disallowed.  Like the AMT (Alternative Minimum Tax), it is a year-to-year calculation and it is accounted for by recognition in the year the tax occurs—no deferred tax is recorded.  Finally, companies must decide how to account for the new tax on global intangible low-taxed income, known as GILTI.  GILTI is the excess of a U.S. entity’s foreign income over a specified return on tangible assets.  The Financial Accounting Standards Board has indicated that companies may account for GILTI by setting up deferred tax items or by recognizing the tax in the current period only on a year-to-year basis.  The company’s policy for accounting for GILTI must be disclosed in the financial statements.  After monitoring the way companies account for GILTI, the FASB may issue guidance or set a standard for reporting in the future.

Also noteworthy is the repeal of the corporate alternative minimum tax.  Due to the repeal, any existing AMT credit carryforwards may be used to offset a company’s regular tax liability for 2018 through 2020.  In 2021, any unused credits are fully refundable.  Companies must assess whether a deferred tax asset or receivable should be set-up for any unused AMT credits.

Another consideration relates to an update issued by the FASB in February 2018 related to reporting comprehensive income due to the TCJA.  It states that an entity may make a one-time reclassification to retained earnings for items within accumulated other comprehensive income which were previously recognized at the higher 35% tax rate.  The adjustment amount is the residual amount in AOCI (Accumulated Other Comprehensive Income) exclusively related to the change in tax rates from 35% to 21%.  Companies must disclose in their financial statements whether or not this reclassification was made.  The guidance on the one-time reclassification is effective for tax years beginning after December 15, 2018, but early adoption is permissible. 

This is just the tip of the iceberg for changes to GAAP financials due to tax reform.  The Tax Cuts and Jobs Act is a game changer for tax changes, financial reporting, and even general business decisions. 

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