At the end of 2017, I was on the edge of my seat waiting to see if a new tax law would be passed. I read every article I could find, and even watched The U.S. Senate livestream one night… yep, I did. But I knew that if a new law was passed, there would be huge implications to accountants everywhere! Well, as we all know, the Tax Cuts and Jobs Act of 2017 was passed on December 22nd. The provisions of this act impacted individual, business, and international taxes. The biggest headline was the reduction in corporate tax rates from a maximum 35 percent to 21 percent. For companies, this created significant accounting implications! This blog post takes a look back at the impact the Tax Cuts and Jobs Act has had on the accounting world. This is relevant right now for readers of the financial statements! Companies with a December 31 year-end have filed their Form 10-Ks, so we can now see the impact from the change in the tax law.
The same month the new tax law was passed, the SEC issued Staff Accounting Bulletin No. 118 (SAB 118). SAB 118 provided relief to companies when accounting for the effects of the Tax Cuts and Jobs Act (TCJA). It provided guidance to public business entities that were not able to complete the requirements of ASC 740 in the period of enactment. Normally, the effects of tax law changes on deferred tax balances are recognized in the period the new legislation is enacted. Not only was this new tax law complex, but the December 22 enactment date was very close to December 31. So, the SEC issued SAB 118 which allowed companies a period of up to 12 months to finalize their accounting for the tax effects of the TCJA. Note that this guidance only applies to the TCJA and should not be used when applying ASC 740 to other changes in tax laws. This period of time was referred to as the “measurement period,” which began on December 22, 2017, and ended no later than December 22, 2018 for all entities. By that date, entities must have completed their analysis and recorded the final impact of the TCJA.
On February 14, 2018, the FASB issued ASU 2018-02, Income Statement – Reporting Comprehensive Income (Topic 220) Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. This guidance allowed entities to reclass the tax effects related to accumulated other comprehensive income as a result of the TCJA to retained earnings.
Normally, the total effect of tax law changes on deferred tax balances are recorded in the income tax expense (or benefit) from continuing operations in the financial reporting period. This can create suspended debits or credits in other comprehensive income when there is a change in tax rates, and the effect is not backwards traced. Take for example a deferred tax liability of $3,500 based on a 35% tax rate that was recorded through other comprehensive income (OCI) as a result of a change in fair value on an available for sale debt security. If the tax rate drops from 35% to 21%, an adjustment of $1,400 ($3,500 - $2,100) would be recognized in continuing operations, not OCI (i.e. no “backwards tracing” is allowed). With such a large cut in tax rates, recognizing the entire effect of the change in tax law in income tax expense (or benefit) would also result in a disproportionate tax balance remaining in accumulated OCI (AOCI).
ASU 2018-02 gave financial statement preparers the option to reclassify the suspended tax effects related to items in AOCI to retained earnings instead of through continuing operations. If elected, this reclassification was applicable to every period where the new corporate rate in the TCJA was recognized. Companies first would take a look at the amount in OCI as of the enactment date. They would then compute the amount to be reclassified as the change in the gross deferred tax amount (and related valuation allowances if applicable) based on the decrease in tax rate. Note that the reclassification was only limited to income tax effects arising from the TCJA. Other tax effects remained in AOCI.
As expected, disclosure was very important! A description of the accounting policy for reclassifying the income tax effects for AOCI was required. A disclosure stating if they reclassified the effects from TCJA that were hanging was also required, as well as information on other reclassified tax effects. Companies that chose not the elect to reclassify the income tax effects should disclose in the period of adoption a statement of their decision. So as you are flipping through the Form 10Ks, you’ll recognize and understand what these disclosures and adjustments are all about!
Accounting for income taxes is not an easy topic. Luckily, there are courses that we provide on The Revolution that you can take at your own pace! The collection of our ASC 740 courses is available for purchase, and they have all received outstanding reviews. As always, contact us with any questions you have!
This post is published to spread the love of GAAP and provided for informational purposes only. Although we are CPAs and have made every effort to ensure the factual accuracy of the post as of the date it was published, we are not responsible for your ultimate compliance with accounting or auditing standards and you agree not to hold us responsible for such. In addition, we take no responsibility for updating old posts, but may do so from time to time.