Factoring tax reform into year-end financial statements

December 28, 2017

By Scott Levy, CPA

In December, significant changes to the federal income tax system were signed into law. Now companies must apply the effect of the tax law changes to their fourth-quarter financial statements. For many companies, that will be a complex task. Here are the details.

Rush to comply

Companies are required to reflect the effect of new laws in the quarter they’re enacted, under the Financial Accounting Standards Board’s (FASB’s) Accounting Standards Update No. 2009-06, Income Taxes (Topic 740). Because President Trump signed the reconciled tax reform bill, the “Tax Cuts and Jobs Act of 2017” (TCJA), before the end of 2017, companies now must scramble to determine the effect of the changes for their fourth-quarter financial statements.

This task will be especially daunting for multinational companies. These entities will be faced with a complex set of new rules as the United States switches to a more competitive “territorial” system of taxing foreign earnings and requires a one-time tax on the repatriation of foreign earnings of U.S. companies.

Major sticking points

Companies and their auditors are especially concerned about two provisions in the new tax law. First, reducing the top corporate tax rate from 35% to 21% will require companies to re-evaluate their deferred tax assets. That sounds like a relatively simple undertaking. But there are certain temporary differences and some credits don’t have to be remeasured, such as the research and development or alternative minimum tax (AMT) credits.

Second, the new law introduces a one-time tax on overseas earnings and profits. Under current law, foreign income is subject to U.S. tax when it is brought back to the United States. The new law calls for companies to pay a one-time tax even if the income isn’t repatriated. Companies will have to quantify the final tax liability on repatriated earnings, which will require countless calculations and iterations.

Relief efforts

Will the FASB offer relief to ease the burden of quickly applying tax law changes to fourth-quarter financial statements? It’s happened before.

For example, in 2004, when President Bush signed the American Jobs Creation Act into law, U.S. companies were temporarily allowed to repatriate foreign profits at a reduced tax rate for a year. Two months after the President signed the bill, the FASB issued a staff position that included guidance on disclosing a range of reasonably possible amounts of unremitted earnings that could be considered for repatriation as a result of the law and a potential range of income tax effects on such a move. In addition, the staff position required companies to disclose any conditions that prevented management from reasonably estimating the effect by the time financial statements were filed.

On December 22, 2017, the Securities and Exchange Commission (SEC) offered some relief. SEC Staff Accounting Bulletin (SAB) No. 118 and an addition to its Compliance and Disclosure Interpretations (C&DIs) for Form 8-K filings will permit public companies to use “reasonable estimates” and “provisional amounts” for some of their line items for taxes when preparing their fourth-quarter and year-end 2017 financial statements and regulatory filings. The SEC also said that companies may not be able to accurately measure their taxes until the end of 2018 because of the new law.

The staff guidance also instructed companies to provide disclosures in their financial statement footnotes about:

  • The law’s effect on their taxes,
  • The items reported as provisional amounts,
  • Other amounts for which they couldn’t calculate the effect on their taxes,
  • An explanation for their inability to calculate some tax payments,
  • Additional information needed to complete the accounting to comply with Accounting Standards Codification Topic 740,
  • The nature and amount of the adjustments during the reporting period, and
  • The adjustments’ effect on their tax rate.

“Allowing entities to take a reasonable period to measure and recognize the effects of the act, while requiring robust disclosures to investors during that period, is a responsible step that promotes the provision of relevant, timely, and decision-useful information to investors,” SEC Chief Accountant Wes Bricker said. SAB 118 says that “in no circumstances should the measurement period extend beyond one year from the enactment date” of the tax law.

Don’t delay

The Tax Cuts and Jobs Act of 2017 is the biggest tax reform effort in more than three decades. It will have a wide variety of effects on all types of businesses, so it’s important to discuss with your CPA how the new law will impact your specific company. Most of the changes don’t go into effect until the 2018 tax year, but it’s quite possible that the effects could spill over to your 2017 financial statements.