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Unintended Tax Reform Consequences: Impact to GAAP Financial Statements

Economic

from Carr, Riggs & Ingram

The GOP Tax Reform was signed into law on December 22, 2017. Many companies are scouring how those new tax law changes will impact their corporate tax returns. However, companies should also consider how these tax law changes may also impact their GAAP financial statements. Since the Tax Reform was signed into law in 2017, corporations will need to reflect these changes in their 2017 financial statements. Therefore, time is of the essence to assess how the Tax Reform impacts your deferred tax assets and liabilities.

Current accounting guidance requires entities to make a reasonable effort in estimating and disclosing the potential impact of the new law; however, given the sweeping changes ushered in by the new law, an entity may not have all of the necessary information available, prepared, or analyzed (including computations) in reasonable detail to meet the current requirements. For public companies, these estimates will be required in financials that will be issued relatively quickly. The SEC has provided its views in Staff Accounting Bulletin No. 118 (https://www.sec.gov/interps/account/staff-accounting-bulletin-118.htm) and Compliance and Disclosure Interpretation 110.02 (https://www.sec.gov/divisions/corpfin/guidance/8-kinterp.htm#110.02). While similar guidance is not available for private companies, we believe this guidance may be helpful to management of private organizations, also.

It’s All in the Rate

The biggest driver of how Tax Reform impacts financials is the reduction of the corporate income tax rate from 35% to 21%. Corporations value their deferred tax assets and liabilities by multiplying the gross book to tax differences by the enacted income tax rate. That means corporations have previously booked these deferred tax items at a 35% tax rate. When those companies compute their 2017 deferred tax assets and liabilities, those will be re-measured at the 21% tax rate. That re-measurement will be part of the company’s income tax expense as a part of continuing operations.

Companies carrying large deferred tax assets may have a large income tax expense due to that re-measurement. Likewise, companies with large deferred tax liabilities will see their income tax expense shrink from the re-computing at the lower tax rate.

Beyond the Rate

While the tax rate will be the largest single impact to the financial statements, there are also other Tax Reform changes that companies will want to watch to see if they impact their deferred tax calculations.

TAX REFORM CHANGE ACCOUNTING FOR INCOME TAXES IMPLICATIONS
Repeal of corporate AMT and refund of AMT credit carryforward A corporation  would have previously booked a deferred tax asset for the AMT credit carryforward generated in a prior year. That deferred tax asset related to the AMT credit carryforward may need to be re-classed as a receivable.
Allows full expensing of qualified propertyplaced into service between 09/27/2017 and 12/31/2022 For capital intensive companies taking advantage of full expensing, they may amass large deferred tax liabilities on those assets because they will be depreciating the assets over their useful life under GAAP but be fully expensed for tax.CRInsight: Many states will likely not follow federal law for full expensing.
Eliminates the net operating loss (NOL) carryback and limits the deduction of theNOL carryforward to 80% of taxable income. Additionally, NOLs can be carried forward indefinitely. Companies generating a loss won’t be able to book a receivable for the portion that they previously were allowed to carryback. Instead, a deferred tax asset will be booked for the entire NOL generated.  Since NOLs can be carried forward indefinitely, they may need to reassess whether a valuation allowance is needed for that deferred tax asset.Companies with an NOL carryforward and generating income will need to book a payable for the tax on 20% of that taxable income that can’t be offset with the NOL carryforward.
Limits the interest expense deduction to 30% of tax EBITDA (earnings before interest, taxes, depreciation and amortization) through 2021.After 2021, the interest deduction will be limited to 30% of tax EBIT (earnings before interest and taxes). Any interest expense that is suspended due to the 30% limitation will generate a deferred tax asset for that suspended interest expense. While the suspended interest can carryforward indefinitely, companies may need to assess whether a valuation allowance may be needed for this new deferred tax asset.
Eliminates deduction of 50% of entertainment expenses (i.e., no entertainment expenses can be deducted). Companies typically have a single general ledger account for “meals and entertainment.”  Since most meals are still deductible for 50% of their costs, companies should consider bifurcating those accounts so that meals and entertainment are segregated going forward.In computing the provision, 50% of the meal expense and all of the entertainment expense will be a permanent addback impacting the rate reconciliation.

CRI Can Help Relieve Tax Reform Strategy Burdens

The change in the corporate tax rate has an immediate, impactful result on financial statements, but the other changes in the Tax Reform will also cause some headaches in the upcoming years. The CRI team can alleviate those headaches. Call us to help you work through how the Tax Reform changes impact your company’s financials. And meanwhile, be sure to stay tuned to CRI’s Tax Reform Resources Centerfor all of our latest details.

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