Tax reform may require additional disclosures for Q1 2018

Authored by Carrie Small

As we turn the corner from accounting for the impacts of the Tax Cuts and Jobs Act (TCJA) within the statutory and U.S. generally accepted accounting principles (GAAP) financial statements of year-end Dec. 31, 2017, insurers must now implement the new provisions of the tax bill for Q1 2018 reporting. As companies incorporate the many changes into their tax provision calculations, some insurers may find significant changes from Dec. 31, 2017 to March 31, 2018, that may require additional disclosures for statutory and GAAP quarterly reporting.

Key provisions to consider in 2018

While all companies were required to remeasure deferred tax assets (DTAs) and deferred tax liabilities (DTLs) at the Dec. 22, 2017, enacted tax rate of 21 percent, Q1 of 2018 is the first time companies must work through many of the new provisions of the TCJA that were effective Jan. 1, 2018. Some of the key provisions that companies should be considering as they work through tax provision calculations for the first quarter of 2018 are as follows:

  • Net operating losses
    Life insurance companies and general C-corporations no longer have carryback capability and have an indefinite carryforward for losses arising after Dec. 31, 2017. In addition to these changes, such losses are limited to use against 80 percent of federal taxable income. The net operating loss provisions for nonlife insurance companies have not changed under the TCJA.
  • Loss reserve discounting
    The TCJA brought about changes to the discounting methods for both life and nonlife reserves. This has the general impact of decreasing tax reserves and increasing taxable income. A transitional adjustment must also be finalized by Dec. 22, 2018, which will be included in taxable income over eight years, beginning in 2018.
  • Policy acquisition expenses
    The capitalization percentages for policy acquisition expenses increased by approximately 20 percent under the TCJA, while the amortization period also increased from 120 months to 180 months.
  • Dividends received deduction
    The general 70 percent dividends received deduction was reduced to 50 percent effective Jan. 1, 2018. For dividends related to a 20 percent or more owned corporation, the dividends received deduction was reduced from 80 percent to 65 percent.
  • Proration
    The proration addback on the favorable adjustments for tax-exempt interest, as well as the dividends received deduction, increased from 15 percent to 25 percent.
  • 807(f) basis spread
    The basis spread period changed from a 10-year period to conform to the general provisions of an accounting method change, or 481(a) adjustment. A favorable adjustment is deducted in one year, whereas an unfavorable adjustment can be picked up over a four-year timeframe.
  • Meals and entertainment
    Entertainment expenses are no longer deductible as of Jan. 1, 2018, and most meals are limited to a 50 percent deduction. Companies should revisit their policies for, and tracking of, these different components.

Q1 2018 reporting

Tax disclosures for interim reporting periods can be relatively scarce if companies have not had to account for the tax effects of unusual or infrequent items, changes in estimates or provisions, or fluctuations in their effective tax rate. However, companies may want to take a closer look at their tax provision calculation for Q1 2018 and potential disclosure requirements, especially related to the following:

Significant or material changes

Large swings in a company’s effective tax rate or current or deferred tax provisions from Dec. 31, 2017, should be disclosed within the tax footnote for the period ending March 31, 2018. Companies should take a closer look at their interim period tax calculations due to the changes from the TCJA. This is especially true for companies that were in a net deferred tax asset position as of Dec. 31, 2017, as they were required to record a tax expense from the remeasurement of the deferred tax inventory, which likely increased the effective tax rate above the 35 percent enacted tax rate. Now, as companies are closing out Q1 of 2018, the enacted tax rate is at the lower 21 percent rate. With 21 percent as the starting point, and without the charge from the change in tax rate some companies experienced for the year ended Dec. 31, 2017, it is very possible to see a significant decrease in the effective tax rate during this three-month period.* Similarly, a company could see a significant decrease in current tax expense for the three-month period due to the lower 21 percent enacted tax rate.

Staff Accounting Bulletin (SAB) 118

Significant concerns were raised by companies regarding the enactment date of the TCJA and the limited timeframe available to accurately determine the impact of the tax changes within their annual and quarterly reports filed with the Securities and Exchange Commission (SEC). To help companies address the challenges arising out of the magnitude of the changes in the TCJA, the staff from the Office of the Chief Accountant and Corp Fin released Staff Accounting Bulletin (SAB) 118 on Dec. 22, 2017, to provide guidance on accounting and disclosures for the impact of the TCJA. The Financial Accounting Standards Board (FASB) released a Q&A shortly thereafter confirming that private companies may follow SAB 118, and the National Association of Insurance Commissioners (NAIC) later followed suit.

Under SAB 118, companies that have tax effects that are incomplete (i.e., the company did not have adequate time to prepare or analyze the tax effects in reasonable detail) will need to report a provisional amount based upon a reasonable estimate. The provisional amount would be subject to adjustment during the measurement period, not to exceed one year. The provisional amount (i.e., estimate) should be recorded in the first reporting period in which one is determined. The staff believes it would be inappropriate to exclude a reasonable estimate if one is determined.

If the company does not have the information available, prepared or analyzed that is necessary to make a reasonable estimate, the staff does not expect the company to include a provisional amount, and, in that case, the company “should continue to apply Accounting Standards Codification (ASC) Topic 740 (e.g., when recognizing and measuring current and deferred taxes) based on the provisions of the tax laws that were in effect immediately prior to the Act being enacted. That is, the staff does not believe an entity should adjust its current or deferred taxes for those tax effects of the Act until a reasonable estimate can be determined.”

Companies that either reported a provisional amount at Dec. 31, 2017, or continued to account for certain items under prior tax law, may have additional information available to further refine the calculations during Q1 of 2018. The nature and amount of the “measurement period adjustments” should be disclosed within the reporting period when recognized, as well as any impact they may have on the company’s effective tax rate.

Accounting Standards Update (ASU) 2018-02

On Feb. 14, 2018, the FASB released Accounting Standards Update 2018-02, Income Statement – Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects form Accumulated Other Comprehensive Income. The guidance allows a company to elect to reclassify from accumulated other comprehensive income (AOCI) to retained earnings the stranded tax effects from the adoption of the newly enacted federal corporate tax rate as a result of the TCJA. The amount of the reclassification is calculated as the difference between the amount initially charged to other comprehensive income (OCI) at the time of the previously enacted tax rate that remains in AOCI and the amount that would have been charged using the newly enacted tax rate, excluding any valuation allowance previously charged to income. The ASU only applies to the stranded tax effects resulting from the enactment of the TCJA and does not address the current prohibition in GAAP on backwards tracing which may have resulted in prior stranded tax effects.

The ASU is effective for fiscal years beginning after Dec. 15, 2018 and interim periods within those fiscal years. Companies are allowed to early adopt the guidance, and were able to do so for the year ended Dec. 31, 2017 if their audited financial statement had not yet been issued as of Feb. 14, 2018. Companies that early adopt ASU 2018-02 within Q1 of 2018 should include certain disclosures within their quarterly filings.

NAIC Spring 2018 National Meeting tax update

During the NAIC Spring 2018 National Meeting, the Statutory Accounting Principles Working Group (SAPWG) adopted and exposed various revisions to statutory accounting guidance, including certain tax items. The SAPWG adopted Interpretation (INT) 18-01: Updated Tax Estimates Under the Tax Cuts and Jobs Act to provide a limited-time, limited-scope exception to Statement of Statutory Accounting Principles (SSAP) No. 9 – Subsequent Events to not require recognition of changes in reasonable estimates as Type 1 subsequent events after the issuance of statutory financial statements. The INT also provided instruction for reporting changes in deferred taxes.

Nonsubstantive revisions to SSAP No. 101 – Income Taxes were exposed to update proposed edits in response to the TCJA, including new or updated footnote disclosures to provide clarification on the recording of changes in tax rate, the different provisions for companies taxed as either a life or nonlife company, and minor changes to the Q&A to conform with the new tax provisions. These revisions have been exposed for a shortened comment period ending Apr. 23, 2018. In addition, comments were specifically requested on the assessment of reversal patterns of deferred tax items under the TCJA. NAIC staff were also directed to draft separate agenda items on global intangible low taxed income (GILTI) and alternative minimum tax credit carryforwards under the TCJA.

Continued guidance likely

It is expected that the U.S. Treasury and Internal Revenue Service (IRS) will release further clarification and additional guidance over the coming months. We recommend consulting with your Baker Tilly tax and accounting advisors to understand all of the implications for your organization. Please also visit our website for an overview of the impact of the TCJA on insurance organizations.

For more information on the accounting implications of tax reform, or to learn how Baker Tilly professionals can help, contact our team.

*Health insurance companies will have to ensure the nondeductible 9010 fee is accounted for within Q1 2018 as that is no longer in moratorium and will have the effect of increasing the effective tax rate.