Tax Alert: Tax Accounting Implications of Tax Cuts and Jobs Act

The Tax Cuts and Jobs Act has now been signed by the President on Friday December 22, 2017. The Act makes sweeping changes to many parts of the tax law for both individuals and businesses. The changes that most affect businesses include the reduction in the corporate tax rate, changes in business deductions, and many international provisions. This alert reviews some of the implications of the Act under ASC 740, with a particular emphasis on the reporting period that includes the enactment date of December 22, 2017.

We also note that for SEC registrants, there may be a requirement to file Form 8-K within four business days of enactment of this Act to report any material impairment of deferred tax assets as a function of the reduced corporate tax rate.

Enactment Date

ASC 740-10-35-4 requires the effect of a change in tax law or rates to be recognized as of the date of enactment, which is officially December 22, 2017.  As a result of the timing of the enactment of this Act, Companies will include the tax impact in the financial reporting period (including interim periods) that encompasses the enactment date.

Corporate Rate Reduction

The Act will reduce the corporate tax rate from a top rate of 35% to a flat rate of 21%.  For calendar year corporations, this will require a revaluation of the deferred tax assets or liabilities as of December 31, 2017 to reflect the reduced rate of tax over which temporary items will reverse, with the resulting impact of the rate change included in income from continuing operations pursuant to ASC 740-20-45-8.  In almost all cases, the impact of the rate reduction applied to temporary differences (including those related to OCI or acquisition accounting still within the measurement period) is recorded in income from continuing operations. In the case of unrealized gains or losses in OCI, this could result in a disproportionate effect left in OCI (“dangling debits or credits to OCI”) as a result of the prohibition of the backwards tracing of unrealized gains and losses on available-for-sale securities, pursuant to ASC 740-20-45-3.

Fiscal year entities will have an added layer of complexity in evaluating temporary differences that may reverse before or after the date the new rates go into effect, and temporary differences will therefore need to be scheduled for reversal to determine the tax rate impact.

Repeal of Corporate Alternative Minimum Tax

The repeal of the corporate AMT affects both the current tax provision on a prospective basis as well as the deferred tax asset for the period coinciding with the enacted date. Under the new law, the minimum tax credit can be used to offset regular tax, and 50% of any excess can be used in any year as refundable credit (100% in 2021 if not already used by then). As a result of the changes to the AMT regime, if a valuation allowance has historically been recorded against an AMT credit deferred tax asset, the valuation allowance position should be reassessed and potentially released as part of the accounting for the change in tax law. Companies will also need to consider reclassifying an AMT carryforward deferred tax asset as a tax receivable to reflect the refundable nature of the credit.

Expensing of Fixed Assets, Bonus Depreciation

The Act generally allows 100% expensing of qualified depreciable assets acquired and placed in service after September 27, 2017 and before January 1, 2023. Full expensing may result in creating additional taxable temporary differences for depreciable assets, which may impact an assessment of the realizability of other existing deferred tax assets, including any net operating losses generated by the immediate expensing of depreciable property.

Interest Expense Limitations

The Act repeals the current Section 163(j) which limits interest expense paid to foreign related parties and replaces it with a much more expansive limitation that could apply to any taxpayer. Treatment of previous 163(j) carryforwards will most likely be subject to transition rules, not yet known, which could require an adjustment to existing deferred tax assets. A new interest expense limitation of 30% of ‘adjusted taxable income’ will apply to taxpayers with annual average gross receipts in excess of $25 million, beginning in tax years starting on or after January 1, 2018. Highly leveraged companies are likely to be impacted, and as a result of the limitation, these companies will set up new deferred tax assets for any excess disallowed interest with an indefinite carryforward period, subject to assessment for realizability.

Net Operating Losses

For existing net operating losses, it will be necessary to reassess the realizability of these deferred tax assets, particularly in light of the changes to tax reform that will impact the 2018 tax year and beyond. Under the Act, for tax years beginning on or after January 1, 2018, Federal net operating losses generated will possess an indefinite carryforward period (with no carrybacks permitted).  Future NOLs with indefinite carryforward periods will also need to be assessed for realizability, especially when a company also has indefinite-lived deferred tax liabilities, as there are views that suggest a company may utilize indefinite-lived deferred tax liabilities as a source of income to support the realizability of indefinite-lived deferred tax assets.

Repatriation Tax

Probably the most significant item that will impact the 2017 financial statements is the deemed repatriation tax. The Act provides for a one-time tax on the deemed repatriation of earnings previously deferred in foreign corporations in preparation for the move to a more territorial tax system.

The repatriation tax is essentially a “toll-charge” on undistributed earnings and profits of U.S.-owned foreign corporations. This represents a current tax liability on unremitted foreign earnings of 15.5% (liquid assets) or 8% (illiquid assets), which is achieved by permitting a deduction against the unremitted earnings amounts. The inclusion in income will be based on the E&P at the higher of November 12, 2017 or December 31, 2017.  Determination of each foreign subsidiary’s E&P and previously taxed income “PTI” as of the applicable measurement dates will be essential. Stringent record-keeping of PTI both under old law and the toll-charge in both U.S. dollars and functional currency will be important for purposes of calculating foreign currency gains and losses as well as foreign taxes on repatriation of cash.

Since foreign tax credits (“FTCs”) will generally be allowed to the extent the distribution is not excluded (based on an equivalency calculation), foreign tax pools will also have to be calculated. These FTCs will be available, both from carryforwards and as released from tax pools.  It will also be necessary to have sufficiently detailed financial information to bifurcate assets into cash/liquid assets and non-cash/illiquid assets. At the election of the taxpayer, NOL carryforwards may be allowed to offset the toll-charge which will impact the tax rate.

The computed toll-charge will be a current tax expense in the period of enactment, with 8% of the tax to be recorded as a current tax payable and the remainder recorded as a long-term tax payable, assuming a company elects to pay the tax over the afforded installment period. Companies will need to assess whether there will be state tax liabilities on the repatriations, as well as consider treaty implications, if any.

Participation Exemption

The move to a territorial system of taxation through the participation exemption is effected through the application of a 100% dividends received deduction (“DRD”) from specified foreign corporations after implementation of the one-time repatriation tax. While future distributions from applicable specified foreign corporations will receive a full exclusion from US income tax, Companies will still need to consider foreign withholding taxes and state taxes for states which do not conform to the 100% dividend received deduction.

This participation exemption does not eliminate the need to assess outside basis differences and the indefinite reinvestment assertion and whether deferred taxes need to be recorded for such differences, including foreign withholding taxes.

Companies will need to consider indefinite reinvestment position regarding initial investment and earnings to which the 100% DRD is applicable. If not asserting indefinite reinvestment, deferred tax liabilities may need to be recorded for the U.S. and foreign tax consequences of any outside basis difference. The company will need to continue to assess and evaluate company’s intentions with respect to outside basis, and the US character and source of income from recovery of basis.

Global Intangible Low Taxed Income (“GILTI”) and other Base Erosion Anti-Abuse Provisions (“BEAT”)

The GILTI tax, along with other base-erosion provisions will most certainly impact ASC 740 calculations.  Because these new provisions will impact tax years after December 31, 2017 (with the exception of including any analysis required for deferred scheduling), we are not including a significant discussion on this topic in this Alert.  Additional guidance on these provisions, including the tax accounting implications of it, are expected in the near future.

Foreign Tax Credits

The Act repeals the Section 902 indirect foreign tax credit. Companies will need to evaluate their deferred tax assets for unused FTCs to assess whether there are any such credit carryovers which will expire unused. Additionally, Companies should assess whether any of their existing foreign tax credits can be used to offset the one-time repatriation tax, thereby reducing the impact to current tax expense.

Other Provisions

The Act also contains many other changes, including elimination of numerous deductions and credits, which have not been discussed in this Alert. These items – such as the repeal of the Section 199 deduction and tightening of the exclusions under 162(m) – will likely impact the future effective tax rates of Companies. Other items may result in a timing difference (such as the interest rate limitation).  We believe that particular focus and care should be paid to scheduled reversals of deferred tax assets and liabilities as a result of these changes, as these new provisions can potentially have a material impact to the assessment of the realizability of existing deferred tax assets as of December 31, 2017, pursuant to ASC 740-10-55-9.

We Can Help

If you have questions about any of the provisions in the Tax Cuts and Jobs Act, or need help in understanding how it may affect your business, please contact your Elliott Davis tax advisor.