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 and could potentially increase the risk of misstating financial results. 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, commonly called 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 would 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.
Will the Securities and Exchange Commission (SEC) or 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.
Today, some public companies are asking the SEC to provide a one-year delay to complying with the rule. That way, if a rule falls through or gets reinterpreted, public companies wouldn’t be required to restate their results or report a material Sarbanes-Oxley deficiency. Andrew McMaster, Chairman of the FASB’s Financial Accounting Standards Advisory Council (FASAC), has also suggested that the SEC consider some kind of relief to make the implementation of tax changes on financial statements “practical.”
The SEC is considering these requests. But it’s making no promises. One potential solution would be for the SEC to acknowledge the significance of the undertaking and then provide companies with the option to do a best estimate in the quarter of the law’s enactment and continue to refine the number in subsequent periods as the company collects more information.
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.
If you have any questions, please contact a Briggs & Veselka representative at (713) 667-9147.