Summary of key provisions of the Tax Cuts and Jobs Act
The Tax Cuts and Jobs Act (the Act) was signed by President Trump on 22 December 2017. The Act makes the following key changes to US taxation of businesses:
- Establishes a flat corporate income tax rate of 21% to replace current rates that range from 15% to 35% and eliminates the corporate alternative minimum tax (AMT)
- Creates a territorial tax system rather than a worldwide system, which will generally allow companies to repatriate future foreign source earnings without incurring additional US taxes by providing a 100% exemption for the foreign source portion of dividends from certain foreign subsidiaries
- Subjects certain foreign earnings on which US income tax is currently deferred to a one-time transition tax
- Creates a “minimum tax” on certain foreign earnings and a new base erosion anti-abuse tax (BEAT) that subjects certain payments made by a US company to a related foreign company to additional taxes
- Creates an incentive for US companies to sell, lease or license goods and services abroad by effectively taxing them at a reduced rate
- Reduces 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, allows any NOLs generated in tax years beginning after 31 December 2017 to be carried forward indefinitely and generally repeals carrybacks
- Eliminates foreign tax credits or deductions for taxes (including withholding taxes) paid or accrued with respect to any dividend to which the new exemption (i.e., the 100% exemption for the foreign source portion of dividends from certain foreign subsidiaries) applies, but foreign tax credits will continue to be allowed to offset tax on foreign income taxed to the US shareholder subject to limitations
- Limits the deduction for net interest expense incurred by US companies
- Allows businesses to immediately expense the cost of new investments in certain qualified depreciable assets made after 27 September 2017 (but would be phased down starting in 2023)
- May require certain changes in tax accounting methods for revenue recognition
- Repeals the Section 199 domestic production deduction beginning in 2018
- Eliminates or reduces certain deductions (including deductions for certain compensation arrangements, certain payments made to governments for violations of law and certain legal settlements), exclusions and credits and adds other provisions that broaden the tax base
Key accounting issues raised under the Act
The Act is the most significant change to US tax law since 1986 and raises significant accounting implications for many companies. We discuss certain of those implications and the actions of regulators and standard setters below.
SEC and FASB guidance on the Act
On 22 December 2017, the Securities and Exchange Commission (SEC) staff issued Staff Accounting Bulletin (SAB) 118 to provide guidance for companies that are not able to complete their accounting for the income tax effects of the Act in the period of enactment. In doing so, the SEC staff acknowledged the challenges companies may face in accounting for the effects of the Act by their financial reporting deadlines.
SAB 118 provides that a company that hasn’t completed its accounting for the effects of the Act by its financial reporting deadline may report provisional amounts based on reasonable estimates for items for which the accounting is incomplete. Those amounts will be subject to adjustment during a measurement period of up to one year. A company that does not have the necessary information to determine a reasonable estimate to include as a provisional amount for certain items, should not account for those items until it can make an estimate. SAB 118 also includes specific disclosure requirements.
The Financial Accounting Standards Board (FASB) staff has expressed certain views on implementation issues related to the accounting for the effects of the Act in the form of staff question and answer guidance, and the FASB has proposed an Accounting Standards Update to address issues resulting from the effects of a lower corporate income tax rate on items initially accounted for as part of other comprehensive income. Companies should continue to monitor the FASB’s website for updates and guidance.
Timing of accounting for enacted tax law changes
Accounting Standards Codification (ASC) 740, Income Taxes, requires the effects of changes in tax rates and laws on deferred tax balances (including the effects of the one-time transition tax discussed below) to be recognized in the period in which the legislation is enacted. US income tax laws are considered enacted on the date that the president signs the legislation. The enactment date and the significance of the change in tax law results in unique challenges for most companies.
Effects of a lower corporate income tax rate
The Act established a flat corporate income tax rate of 21% to replace previous rates that ranged from 15% to 35%. Companies need to apply the new corporate tax rate when calculating the effects of the tax law change on their deferred tax balances as of the enactment date.
One-time transition tax
Foreign earnings on which US income taxes were previously deferred are subject to a one-time tax when the company transitions to the new dividend-exemption system. The portion of the foreign earnings and profits comprising cash and other specified assets is taxed at a 15.5% rate, and any remaining amount is taxed at an 8% rate. While a company can elect to pay its tax liability over a period of up to eight years based on the payment schedule included in the law, it is accounted for at the enactment date.
New territorial system
The Act created a territorial tax system that allows companies to repatriate certain foreign source earnings without incurring additional US tax by providing for a 100% dividend exemption. Companies will need to carefully consider taxes that may need to be provided on an outside basis1 and how certain accounting exceptions may apply.
Changes to NOL carryback and carryforward rules
The Act limits the amount taxpayers are able to deduct for NOL carryforwards generated in taxable years beginning after 31 December 2017 and generally repeals all carrybacks. However, any NOLs generated in taxable years beginning after 31 December 2017 can be carried forward indefinitely. Losses arising in taxable years beginning before 31 December 2017 may still be carried back two years and are subject to their current expiration periods. Companies need to evaluate the realizability of any NOL carryforwards.
Repeal of the corporate alternative minimum tax
The corporate AMT was repealed. Taxpayers with AMT credit carryovers can use the credits to offset regular tax liability for any taxable year, and the unused credits can become refundable in certain years.
Companies are able to claim bonus depreciation to accelerate the expensing of the cost of certain qualified property acquired and placed in service after 27 September 2017 and before 1 January 2024. Companies need to implement processes to identify eligible capital expenditures and revise tax depreciation to properly measure deferred tax liabilities related to qualified property.
Companies will also need to carefully determine the appropriate rate to apply when calculating their deferred taxes and current taxes at the enactment date when claiming the bonus depreciation. Given the retroactive nature of this provision, a calendar year-end company should record deductions in the 2017 current tax provision calculation at 35%, while measuring the related deferred tax liability at the newly enacted rate.
The Act has other important provisions that impact multinational companies, including anti-deferral and anti-base erosion provisions applicable to both US-based and foreign based multinational companies that will need to be considered and evaluated.
Non-calendar year-end companies
The Act raises special considerations for non-calendar year-end companies, especially relating to the effects of a lower corporate income tax rate. For companies with fiscal years that don’t end on 31 December, the new lower corporate rate is applied by determining a blended tax rate for the fiscal year that includes the enactment date.
Additional SEC reporting considerations
When the effects of the tax law changes are or will be material to a registrant, the registrant should consider the disclosure implications in preparing its management’s discussion and analysis (MD&A) under Item 303 of Regulation S-K, including its discussion of results of operations and liquidity and capital resources.
The remeasurement of deferred tax assets and liabilities, recording the one-time transition tax and any reassessment of the realizability of deferred tax assets may have a material effect on many registrants’ tax provisions.
In addition, the Act will likely result in changes to a registrant’s effective tax rates in future periods. When disclosing results of operations, registrants should disclose and explain the effect of the new tax law on the 2017 tax provision as well as the expected effects on the effective tax rate in future years.
Registrants’ MD&A must consider any material liquidity implications of paying the required one-time transition tax. Registrants should also include their one-time transition tax liability in the table of contractual obligations based on the estimated installments and describe any related uncertainties.
Form 8-K reporting considerations
The SEC staff issued Compliance and Disclosure Interpretation (C&DI) 110.02 to clarify whether the remeasurement of a deferred tax asset (DTA) to reflect the new tax rates or other Act would trigger an obligation to file a Form 8-K under Item 2.06, Material Impairments. The C&DI states that the remeasurement of a DTA to reflect the effect of a change in tax rate or tax laws is not an impairment under ASC 740 and wouldn’t trigger the reporting requirement. However, the enactment of new tax rates or tax laws could have financial reporting implications, including whether it is more likely than not that the DTA will be realized.
In the C&DI, the SEC staff also noted that registrants employing the measurement period approach described in SAB 118 and concluding that an impairment has occurred (e.g., a valuation allowance) for the period that includes the enactment date due to changes resulting from the enactment of the Act may rely on the Instruction to Item 2.06, which exempts registrants from filing a Form 8-K if the conclusion is made in connection with the preparation, review or audit of financial statements to be included in the next periodic report to be filed. In those situations, registrants must disclose the impairment, or a provisional amount with respect to that possible impairment, in that next timely filed report. Companies should consult with legal counsel to determine compliance with any Form 8-K filing obligations.
Internal control considerations
Companies need to evaluate whether changes to their existing processes and controls are necessary to address the financial reporting effects of implementing both the Act and SAB 118. That is, companies need effective internal controls to make sure that the accounting implications of the transition and future tax provision calculations are accurately recorded in their financial statements.
Audit committee considerations
Audit committees should make sure management teams are executing a plan to address the Act, including:
- Calculating changes to federal deferred tax balances
- Calculating the one-time transition tax on previously deferred foreign earnings and its accounting implications
- Evaluating whether NOL and foreign tax credits are available to offset the transition tax and whether any remaining carryforwards are realizable
- Estimating which outside basis differences related to foreign subsidiaries exist after considering any one-time transition tax
- Evaluating whether AMT credit carryforwards are realizable
- Evaluating which assets qualify for immediate expensing
- Evaluating compensation plans
- Evaluating the impact upon current and deferred state taxes
The tax calculations and considerations relating to the new tax legislation are complex with significant estimates, and will require a thoughtful and thorough approach. Additionally, many companies may also need to revisit their internal controls to make sure that the accounting implications of the transition and future tax provision calculations are accurately recorded in their financial statements.
As tax continues to be an area of frequent financial restatements, audit committees should continue to closely monitor the related accounting and internal control implications arising from such tax changes.
Questions for the audit committee to consider
Questions for management
- Does the organization have the appropriate resources (both internal resources and external advisors) to address the effects of the tax legislation as well as the implementation efforts relating to the adoption of other accounting standards (e.g., revenue recognition, credit losses and leases)?
- Does the company adequately address the additional disclosures required in MDA, liquidity and resources, risk factors and critical accounting policies?
- Has a process been established between tax executive management and the audit committee to stay abreast of any issues and changes arising from the implementation of the tax legislation?
- Has the organization revisited its approach to tax planning in light of the new tax legislation? What are the significant changes to the company’s tax planning?
- Has the company evaluated whether changes to their existing processes are necessary to address the financial reporting effects of implementing both the Act and SAB 118?
- What changes to internal control over financial reporting have been designed, and what key actions have been taken by management to address the tax legislation?
- Has the organization considered the tax accounting effects of the new tax law on the adoption of new accounting standards (e.g., revenue recognition, leases and credit losses)? What disclosures has management provided or considered on these changes?
Questions for the external auditor
- What additional audit procedures have been performed as a result of the tax legislation? Have there been any additional audit risks identified by the engagement team? If so, how were those addressed?
- How will the audit firm respond to the significant increase in audit effort associated with the enactment of the tax legislation as well as the adoption of other accounting standards? Does the audit firm have the appropriate resources to address these significant changes?
- Were there any difficulties or challenges posed to the audit team arising from auditing the tax balances and related disclosures from the Act?
- Are there any unique accounting or tax ramifications to the company arising from the new tax legislation?