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Federal Income Tax Reform and Immediate Impact on GAAP Financial Statements

On December 20th, 2017, Congress is expected to finalize the bill proposal through conference committee for tax reform.  Generally, corporations will see a decrease in income tax expense; however, the impact to financial statement reporting should not be ignored.  Although the tax law changes generally will not be in effect until January 1, 2018, financial statements must reflect the law change based on the date the law is enacted (i.e. when signed into law by the President of the United States).  If the proposed bill is signed into law prior to year-end, calendar-year corporations are required to account for the law change within the December 31, 2017 financial statements. We see the most significant financial statement implications of tax reform being the remeasurement of deferred tax assets and liabilities, deemed repatriation of foreign earnings, and new limits on utilizing net operating loss carryforwards in determining the need for a valuation allowance.

Deferred Tax Assets and Liabilities

A significant immediate impact of tax reform to the financial statements involves deferred tax assets (DTA) and deferred tax liabilities (DTL) recorded on a corporation’s balance sheet. As background, corporations are required to calculate deferred tax assets and liabilities to reflect temporary differences between financial statements and tax returns (for example, differences in depreciating long-lived assets between financial and tax records, among others).  Deferred tax assets and liabilities are valued based on the tax rate at which the deferred tax item is expected to reverse (currently 34% or 35% for most corporations).  With the proposed tax bill lowering the highest marginal corporate rate to 21%, a remeasurement of the DTA or DTL will need to be calculated based on the applicable marginal rate, or 21%.  Because the rate change adjusts the value of the DTA or DTL, the tax effect must be adjusted through current income tax expense.  Because many corporations maintain a net DTL within the GAAP financial statements, we expect many corporations to recognize an income tax benefit (income) in remeasuring deferred taxes under the proposed tax bill.  Furthermore, tax reform will provide additional deferred tax opportunities to corporations through accelerated depreciation of certain capital assets and expenditures for tax purposes, which will generally increase reported deferred tax liabilities for GAAP financial reporting.

Repatriation of Foreign Earnings

Corporations with a greater than 10% ownership interest in a foreign entity will also be impacted by tax reform. The current bill will implement a one-time tax of 8.0% – 15.5% on accumulated Earnings and Profits of foreign subsidiaries, which can be deferred over an eight-year period.  Any accumulated foreign taxes paid will be available to offset this tax as a Foreign Tax Credit.  Therefore, all corporations which have a 10% or greater ownership in a foreign subsidiary (that have not asserted indefinite reinvestment of foreign earnings under GAAP) will be required to calculate un-repatriated offshore earnings (if not already doing so) to determine the appropriate current tax liability, deferred tax liability, and the usage of any Foreign Tax Credit.  Valuation allowances on the Foreign Tax Credit should also be analyzed as the credit is subject to a ten-year carryover limit.

Net Operating Loss Carryforwards

Under current tax law, a corporation may offset 100% of regular taxable income with Net Operating Losses (NOLs) incurred in prior years. The current proposal limits the extent that NOLs can offset taxable income to 80% (ensuring that corporations in an operating loss position will still pay some level of minimum tax).  The current proposal also eliminates the carryback provision, which allowed taxpayers to apply current year operating losses to taxable income generated during the prior two most recent years.  As a result, corporations will need to reassess the recoverability of NOLs maintained and evaluate the need for valuation allowance for financial statement reporting purposes.  Certain corporations that previously concluded that operating losses were more-likely-than-not to be utilized in full may now be required to recognize a valuation allowance as the utilization of NOLs will change under the tax proposal.

This is just a very brief overview of tax reform changes affecting corporations. If you have any questions regarding the affect tax reform will have to your financial statements, please contact your GBQ advisor.

Contact
  • Jeff Harden
  • Director, Assurance & Business Advisory Services
  • (614) 947-5299
  • jharden@gbq.com
Contact
Contact
  • Cassie Shearer
  • Director, Tax & Business Advisory Services
  • (614) 947-5328
  • cshearer@gbq.com