Authored by Bruce Feinstein and David Johnson
The final reconciled tax reform legislation was voted on and passed in both the Senate and the House on Dec. 19 and 20, 2017, respectively.
Many provisions of the tax bill will significantly impact the application of ASC 740 (formerly known as Statement 109: Accounting for Income Taxes) with respect to 2017 corporate financial statements.
Main impacts to act on now
Companies will have little time to understand and react to the effects of the law. Planning should begin now to understand the potential impact to financial statements.
Tax reform may have a significant impact on your 2017 financial statements. ASC 740 requires that companies recognize the full financial effect of an enacted rate change on their deferred tax items in the interim period that the rates are enacted. For U.S. federal tax purposes, the enactment date is most often the date the President signs the bill into law. The cumulative change in deferred expense or benefit must be recognized in income from continuing operations in the interim period during which the law is enacted. This could result in large adjustments to net earnings after taxes.
For example, if a corporation recorded a $35M deferred tax asset relating to $100M of NOL carryovers that were based on a 35 percent tax rate, the deferred tax asset would have to be revalued to $21M using the new 21 percent tax rate. The $14M downward revaluation adjustment would directly impact net income after taxes.
Even if the President doesn’t sign the legislation into law until after the end of the year, 2017 financial statements will need to include disclosure of the estimated total effect of the legislation on deferred tax items if the changes are enacted prior to financial statement issuance. SEC filers should consider possible disclosure requirements in the Management’s Discussion and Analysis section of SEC Form 10-K regarding the impact on results of operations and analysis of financial condition.
Key corporate tax provisions and ways they could impact your organization
Some of the more significant provisions affecting corporations include:
- Corporate tax rate: The corporate tax rate is reduced from 35 percent to a flat 21 percent for tax years beginning after Dec. 31, 2017. Temporary differences recorded as deferred tax assets and liabilities will need to be revalued to reflect the reduced corporate tax rate. We suggest that companies review their deferred tax items as soon as possible.
- Corporate alternative minimum tax: The corporate AMT will be repealed for tax years beginning after Dec. 31, 2017.
- Repealed deductions and tax credits: Discuss these various changes to ensure you understand how they will impact your corporate tax provision and deferred tax items.
- Domestic production deduction: The domestic production activities deduction is repealed for tax years beginning after Dec. 31, 2017.
- Entertainment expenses: Most entertainment expenses would be disallowed for tax years beginning after Dec. 31, 2017.
- Indirect foreign tax credit: Effective for tax years beginning after Dec. 31, 2017, the indirect foreign tax credit will be repealed.
- Cash method of accounting, inventory requirements and UNICAP: Accounting methods applicable to small businesses will be loosened for tax years beginning after Dec. 31, 2017. Specifically, the use of the cash method of accounting and the requirement to keep inventories will be relaxed. In addition, UNICAP rules will no longer apply to certain small businesses.
- Corporate dividends received deduction: The 80 percent corporate dividends received deduction is reduced to 65 percent and the 70 percent dividends received deduction is reduced to 50 percent for tax years beginning after Dec. 31, 2017.
- Net operating loss (NOL) carryforwards: The use of NOL carryforwards will be limited to 80 percent of taxable income for losses arising in tax years beginning after Dec. 31, 2017. NOL carrybacks for losses arising in tax years beginning after Dec. 31, 2017 would not be allowed. NOL carryforwards would have an unlimited life.
- Business interest deduction: Effective for tax years beginning after Dec. 31, 2017, the amount allowed as a deduction for business interest may not exceed the sum of a taxpayer’s (A) business interest income and (B) 30 percent of its adjusted taxable income for the taxable year. The amount of any business interest not allowed as a deduction for any taxable year will be treated as business interest paid or accrued in the succeeding taxable year and can be carried forward indefinitely. The interest limitation rule will not apply to small businesses (less than $25 million in average gross receipts) and other specified business entities.
- International tax rules: If a corporation has in-bound or out-bound transactions with foreign related parties, consider the U.S. tax impact of the new international tax rules, especially the new base erosion regime.
- Repatriation: Effective for tax years beginning after Dec. 31, 2017, a territorial rather than worldwide system of taxation is implemented. Implementation requires in part a one-time transition tax on repatriation of previously deferred foreign earnings. The transition tax will apply to the last taxable year of certain specified foreign corporations which begins before Jan. 1, 2018. Repatriation rates will be 8 percent for foreign-earnings held in noncash assets and 15.5 percent for foreign-earnings held as cash. Taxpayers may elect to pay any resulting tax liability over an eight-year period. In addition, future foreign-source earnings would be permitted to be repatriated by U.S. corporate shareholders without additional U.S. taxes by permitting a 100 percent deduction for foreign-source dividends received.
- Base erosion: A minimum tax (5 percent in 2018 and 10 percent in 2019) on large corporations ($500 million or more of average gross receipts) based in part on deductible payments made to related foreign persons is enacted to curtail base erosion.
- Note: Many of the international provisions are highly complex in nature. Please consult your tax advisor to understand the impact on your organization. You can also reference our article, U.S. international tax reform: the new global tax landscape, for more information on how U.S. multinationals will be affected.
- Qualified assets: Full (100 percent) expensing is permitted for qualified property placed in service after Sept. 27, 2017, including used property. The full expensing rule is subject to a sliding phase-out schedule. This provision could affect 2017 tax provisions. Track qualified assets placed into service after Sept. 27, 2017, as they qualify for 100 percent bonus depreciation in 2017.
- Gross income: Effective for tax years beginning after Dec. 31, 2017, the all events test with respect to any item of gross income will not be treated as met any later than the tax year in which that item is taken into account as revenue in an applicable financial statement or other financial statement specified by the IRS. An exception would apply for any item of income for which a special method of accounting is used. In addition, the principles of Rev. Proc. 2003-34 will be codified. Rev. Proc. 2003-34 permits taxpayers to defer gross income inclusion of certain advance payments for goods and services until the end of the tax year following the year of receipt if such income is also deferred for financial statement purposes.
Consider your full picture
Aside from the new 21 percent flat corporate tax rate, carefully consider all of the business related provisions which will impact your organization’s effective tax rate. Examples include the proposed limitation or disallowance of many deductions, such as the repeal of domestic production activities deduction and elimination of most entertainment related expenses. In addition, many other provisions will be of a temporary nature and will affect the carrying value of deferred tax assets and liabilities. Also consider whether your deferred tax assets will ultimately be realizable.
The date that the President is expected to sign the legislation is not yet known. Whether the legislation is signed in 2017 or 2018 it will likely impact most corporate financial statements. You should discuss the impact of the legislation on your financial statements with your tax and accounting advisors as soon as possible and begin planning your new tax strategies immediately.
For more information on tax reform impacts on your organization, or to learn how Baker Tilly tax and accounting specialists can help, contact our team.
*This article was updated on Dec. 29, 2017 to reflect clarification on international tax rules.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.