Accounting Implications of Tax Reform

The GOP Tax Reform was signed into law on December 22, 2017. While tax reform provides opportunities for tax planning, it also has significant impacts on companies’ financial statements. Since the regulation was signed into law in 2017, current accounting standards require that the impact from the changes in tax laws be reported in the period it was enacted. Companies are required to use reasonable efforts to account for the impact from the new law. However, given the scope and the timing of these changes, companies may not have all the necessary information to meet the current requirements. The SEC has issued Staff Accounting Bulletin No. 118 (SAB 118) to provide public companies with more guidance. The FASB also stated that it would not object to private companies and not-for-profit entities applying SAB 118 and they would be in compliance with GAAP. The FASB staff believes, however, that if these entities apply SAB 118, they should apply all relevant aspects of the SAB in its entirety.

Here are some of the changes that could have significant impact on companies’ financial statements.

Reduction in Corporate Income Tax Rate

The most significant change in this tax return package is the reduction of corporate income tax rate from 35% to 21%. Current accounting standards require companies value their deferred tax assets and liabilities using the enacted income tax rate. This would require companies to re-measure their 2017 deferred tax items using the new tax rate and the re-measurement will be part of income tax expense in continuing operations.

Fully Expense of Qualified Property

Companies placing qualified property in service between 9/27/17 and 12/31/22 can expense fully the cost of the assets. This will increase companies deferred tax liabilities due to accelerated depreciation expense under tax reporting.

Changes in Net Operating Loss Utilization

Previously, NOL can be carried back 2 years and carried forward 20 years. New rules state that NOL carry back is no longer allowed but it can be carried forward indefinitely. Companies with deferred tax asset may need to reassess whether a valuation allowance is necessary. In addition, new rules also limit the utilization of NOL to 80% of taxable income. As such, companies will owe tax in profitable years and will need to record a tax payable on the 20% of taxable income that cannot be offset by carrying forward NOL.

Limit on Interest Expense Deduction

Interest expense deduction will be limited to 30% of tax EBITDA through 2021. Any non-deductible interest expense can be carried forward indefinitely and therefore will generate a deferred tax asset. Companies will need to determine the likelihood of utilizing the deferred tax asset and whether a valuation allowance is necessary.

Entertainment Expense Deduction

Previously, entertainment expense was treated as 50% deductible, much like business meal expense. However, new rules prohibit deduction of entertainment expense all together. Companies should consider tracking entertainment expense separately from business meal expense on their books. The new rules do not change the deductibility of business meal expense which remains at 50%.

If you have questions as to how these changes may impact your companies’ financial statements, CFO Connections can help. You may contact us at [email protected].