Financial Reporting for Tax Reform

The enactment of the Tax Cuts and Jobs Act of 2017 (TCJA) has received a lot of attention over the last several months from individuals and companies, with the primary focus on how the new legislation will impact tax payments and future tax rates. Less emphasized is the impact the new legislation will have on financial reporting and deferred tax assets and liabilities in C corporation financial statements. The change will be significant in certain situations to both C corporation disclosures and balance sheets in the wake of this new law.

A key provision of TCJA was the reduction of the federal rate from 35 percent to 21 percent. As a reminder, the FASB Accounting Standards Codification (ASC) 740-10-35-4 requires that deferred tax assets and liabilities be adjusted to account for any change in tax laws or rates within the period that the enactment of these changes occurs and any adjustments to flow through income from continuing operations. It is worth noting that a company’s potential decrease in deferred tax assets is not considered an impairment under ASC 740; and therefore, would not require the disclosure of a material impairment of an asset. This reevaluation of deferred tax assets and liabilities with regards to the TCJA must take into consideration both the significant change in tax rates and a potential change in likelihood of realization of a deferred tax asset or liability.

Staff Accounting Bulletin (SAB) No. 118

Given the timing of enactment of the new tax legislation, accounting and finance teams have been quickly trying to determine the implications for 2017 filings and onward. As a response, the U.S. Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin (SAB) No. 118 (SAB 118) to help companies understand and provide a roadmap for the disclosure impact of the new standard, and what it expects to see disclosed in 2017 10-K filings.

With SAB 118, the SEC understands that corporations do not know all of the implications of the new tax law at this point in time. The SEC is allowing corporations to categorize their understanding of tax issues into three different scenarios, as discussed below:

SAB 118 is similar in purpose to FASB Accounting Standards Update (ASU) 2015-16. ASU 2015-16, Simplifying the Accounting for Measurement Period, effectively gave corporations who had recently accounted for a business combination, one year to true-up the accounting impacts of the acquisition. This provided relief from having to potentially restate prior periods in the event new facts came to light that would cause a change to the acquisition accounting. The purpose of SAB 118 is the emphasis that it is acceptable to disclose an estimable amount of a provisional item on a company’s financial statements. The SEC is emphasizing that requiring a precise number when all impacts are not known as of a filing date, is too much of a burden from both a cost and effort perspective. In the event there are subsequent measurement period adjustments, an entity can reflect adjustments to its provisional amounts upon obtaining additional information about facts and circumstances that existed at the enactment date, but were not known as of the financial statement reporting date. Any incremental provisional amounts or adjustments to provisional amounts included in an entity’s financial statements during the measurement period should be included in income from continuing operations as an adjustment to income tax expense or benefit in the reporting period the amounts are determined.

An example of where private C corporations may encounter uncertainty when determining the accounting for their tax provisions is the reassessment of valuation allowance positions. For instance, if there will be large nondeductible items that will cause the company to be a taxpayer, and therefore, utilize net operating loss carryforwards, should the valuation allowance be removed?

What does this mean for private C corporations thinking about their 2017 financial statements and the impact to their tax provisions and footnotes? The FASB has communicated that the application of SAB 118 would be considered in accordance with GAAP for private companies and not-for-profits. The FASB emphasized that if companies choose to apply SAB 118, all aspects of the SAB, including all disclosures, should also be applied. The FASB also believes that private companies should disclose a policy election when the company has applied SAB 118.

Disclosures

The disclosures needed for companies that are applying SAB 118 and conclude that the impact of the TJCA are unknown or incomplete are the following:

1. qualitative disclosures of the income tax effects of TJCA for which the accounting is incomplete,
2. disclosures of items reported as provisional amounts,
3. disclosures of existing current or deferred tax amounts for which the income tax effects of TJCA have not been completed,
4. the reason why the initial accounting is incomplete,
5. the additional information that is needed to be obtained, prepared, or analyzed in order to complete the accounting requirements under ASC 740,
6. the nature and amount of any measurement period adjustments recognized during the reporting period,
7. the effect of measurement period adjustment on the effective tax rate, and
8. when the accounting for the income tax effects has been completed.

In summary, the impact of TJCA will be different for each private company C corporation. In the event that the C corporation has significant, complex tax accounting issues, SAB 118 provides a useful tool for issuing financial statements in a timely fashion, as well as reducing the complexity of accounting for income taxes.