Financial Statements: Impact of Tax Reform on Deferred Taxes

Audit|Tax|Tax Reform

By Brittany Becker

The Tax Cuts and Jobs Act of 2017 (the Act) was signed into law on December 22, 2017 by President Trump. While everyone has been concerned with tax planning opportunities, don’t forget the financial statement impact.

The most anticipated change has been the establishment of a flat corporate tax rate of 21% replacing previous tax rates that ranged from 15%-35%. The new tax rate is in effect as of January 1, 2018; therefore, current taxes payable for calendar year-end companies will be calculated using the previous rates. However, deferred taxes will have to be remeasured.

Accounting Standards Codification (ASC) 740, Income Taxes, requires companies to recognize the effect of tax reform on deferred income taxes in the enactment period’s financial statements. The impact of these changes should be recognized in income from continuing operations for the year ended December 31, 2017. Changes in the tax laws or rates may also require a revaluation of a valuation allowance for deferred tax assets.

For example, companies that have federal deferred tax liabilities will recognize a reduction in the liability and additional tax income as a direct result of lowering their tax rate to 21%.

There are also certain deferred tax balances that were recorded as direct adjustments to shareholders’ equity or other comprehensive income (OCI) for which the offsetting tax adjustment was also recorded as an equity or OCI adjustment, respectively. The effect of tax law changes for deferred tax amounts initially recorded to equity or OCI is recorded as a component of tax expense from continuing operations in the period the tax law is enacted. This treatment is consistent with ASC 740-20-45, which prohibits backward tracing, or considering where the previous tax effects were recorded in the financial statements.

Other key changes to the tax law are as follows:

  • Elimination of the corporate alternative minimum tax (AMT) for years beginning after December 31, 2017. However, AMT credits will be refundable and can offset regular tax liability in an amount equal to 50% (100% for tax years beginning in 2021).
  • Reduction of the maximum deduction for net operating loss (NOL) carryforwards arising in tax years beginning after 2017 to a percentage of the taxpayer’s taxable income. NOLs generated in tax years after 2017 can be carried forward indefinitely although generally, the new law does not permit carrybacks.
  • Limitation of the deduction for interest expense incurred by U.S. corporations
  • Repeal of the Domestic Production Activity Deduction (DPAD)
  • Subjects foreign earnings on which U.S. income tax is currently deferred to a one-time tax
  • Creation of a territorial tax system rather than a worldwide tax system
  • Creation of a new base erosion anti-abuse tax (BEAT) and new minimum tax on certain intangible foreign earnings

ASC 740 requires companies to disclose the effect of adjustments of a deferred tax liability or asset for enacted changes in tax laws or rates. Companies will also need to consider other aspects of the Act and the disclosure requirements for each, such as the one-time transition tax on deemed repatriation.

As companies continue to assess the impact of tax reform on their future tax position, companies should involve their auditors and financial statement preparers to ensure that the impact is reflected within the measurement of deferred taxes and that the change in accounting is completely and accurately disclosed within their financial statements.

Please visit the Our Thoughts On...Energy and Resources blog for more articles, or contact a member of the Schneider Downs Energy & Resources Industry Group if you have any questions.

Material discussed is meant for informational purposes only, and it is not to be construed as investment, tax, or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice.

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