FASB Update Allows Proportional Amortization Method for All Tax Credit Structures
The Financial Accounting Standards Board (FASB) March 29 published Accounting Standards Update 2023-02, which makes investing in new markets tax credits (NMTCs), historic tax credits (HTCs), renewable energy tax credits (RETCS) and any new tax credits created in the future more attractive to investors.
This is primarily done by FASB expanding the proportional amortization method to be available to all tax credit investments, not just the low-income housing tax credit (LIHTC), which was the case before this update.
The proportional amortization method results in the cost of an investor’s tax credit investment being amortized in proportion to the income tax credits and other income tax benefits received with the investment gains and losses and tax credits being presented net in the income statement as a component of income tax expense (benefit), often referred to as presented “below the line.” On the other hand, investments in other similar tax credit structures are typically accounted for using variations of the equity or cost methods. The difference with the equity or cost method is it often results in investment gains and losses and tax credits being presented gross on the income statement in their respective line items, often referred to as presented “above the line,” creating an uneven playing field when compared to LIHTC investments that are accounted for using the proportional amortization method. This is because the proportional amortization method provides a better understanding of the returns from such investments than the equity or cost method and is often simpler to implement. Read more about this in a previous Notes from Novogradac blog.
This update from FASB will allow entities to elect proportional amortization on a tax-credit-by-tax-credit- basis rather than an all or nothing approach. This election provides investors with greater flexibility to decide whether or not to adopt the proportional amortization method based upon what makes sense for their tax credit investments portfolio. Again, this would apply for the LIHTC, NMTC, HTC, RETCs, as well as for any new tax credit programs created by Congress in the future.
For public business entities, the new amendments are effective for fiscal years beginning after Dec. 15, 2023. For all other entities, the amendments are effective for fiscal years beginning after Dec. 15, 2024. Early adoption is permitted for all entities in any interim period. For calendar-year-end entities, this would include the first quarter ending March 31, 2023. Any entity that early adopts for an interim period is required to adopt the proportional amortization for the entire year for which that interim period pertains.
FASB Provisions that Remained Unchanged
While the above changes make various tax credit incentives more beneficial to investors, there are also some provisions that the Novogradac Generally Accepted Accounting Principles (GAAP) Working Group advocated for that did not change.
The first is that none of the five eligibility criteria changed. Again, read more in this Notes from Novogradac blog. The GAAP Working Group suggested that it would be to the benefit of tax credit investors to make changes to some of the criteria, most notably the positive yield and substantially all requirements.
By not changing the positive yield and substantially all requirements, it may make it difficult for many renewable energy investments to qualify for the proportional amortization method as they are currently structured. Learn more about how the proportional amortization method affects renewable energy investors in the April 4 edition of the Novogradac Tax Credit Tuesday podcast.
That being said, discussions are already starting about ways investment structures could be modified in order to meet the criteria as they currently stand.
Furthermore, an issue that came up during the exposure draft was a statement that said that if an entity consolidated their equity investment, then that entity would not be able to use the proportional amortization method. While this generally doesn’t present an issue for most tax credit investments, it does present an issue for NMTCs, of which most investments are consolidated.
Similar to the issues with the existing five criteria noted above, investors have already started discussing ways to change aspects of their investment structures to avoid consolidation.
These topics will be featured in the April 11 edition of the Novogradac Tax Credit Tuesday podcast.
Join the Conversation
The GAAP Working Group will continue to discuss the update as well as additional improvements that will allow more investments to qualify. Join the GAAP Working Group today to stay up to date on future developments and be part of the conversation on how FASB can make further improvements.