Tax Reform Poses Potential GAAP Concerns
With all of the attention on tax reform efforts and potential changes to the tax code, companies should pause to consider and evaluate the impact that these changes could have on their financial reporting under generally accepted accounting principles (GAAP). For years many companies have developed tax strategies, utilizing both short-term and long-term tax credit investments, to reduce their overall tax liability. While the alternative minimum tax (AMT) may have tempered some of these strategies, with tax reform and lower expected tax rates, companies may be wondering if they have overindulged in prior years. A post in this space last year explored several key areas of concern; the following discussion adds to those points.
Deferred Tax Assets
The most obvious effect of tax reform is expected to be lower corporate tax rates. Companies will likely enjoy the benefit of a much lower tax rate that will allow more resources to be reinvested into the company or serve as additional distributions to shareholders. Because of lower tax rates and expected lower tax liabilities in the future, companies will need to evaluate the realization of their existing deferred tax assets. Will companies be able to utilize the deferred tax assets before such benefits expire? Under current GAAP, companies are unable to record a valuation allowance or adjust the current carrying amount on deferred tax assets until the new tax rates are enacted. When the tax reform bill becomes law, companies will need to record the anticipated effect that this change will have on the utilization and realization of the deferred tax assets in their next financial reporting period.
Some tax strategies employed by companies were intended to provide long-term and future tax savings and were formulated through various investments. Investors will need to evaluate the impact that tax reform has on these investments. Tax-motivated investments will be significantly impacted by the change in tax rates. Different accounting methods or policies will have varying impacts. For example, low-income housing tax credit (LIHTC) investments accounted for by the cost and equity methods would be more susceptible to impairment than those accounted for under the proportional amortization method, especially in the later years of the tax credit period. Carrying values of new markets, historic and renewable energy tax credit investments are generally unlikely to be impacted by the changes in tax rates; however, you will want to discuss with your tax personnel or tax advisor as different structures and accounting approaches will have differing results.
Historic Tax Credit
It’s likely the historic rehabilitation tax credit (HTC) will be affected by tax reform. Currently, GAAP allows companies to recognize the benefits from investment tax credits upon receipt or over a period of time. With the proposed change that the HTC be recognized at 20 percent a year over five years, investors would no longer be able to recognize the entire tax credit benefit of their investment up front, but would likely recognize their benefit over five years or the life of their investment.
Base Erosion and Anti-Abuse Tax (BEAT)
Another significant change for corporations to consider is the introduction of the Base Erosion and Anti-Abuse Tax (BEAT). This tax is expected to cause a significant disruption within tax credit industries from multinational companies with more than $500 million in annual gross receipts. If a company can reduce its U.S. tax liability after foreign payments to its affiliates below ten percent of taxable income, then it is subject to the BEAT. Multinational companies that invest in various tax credit programs may be dissuaded from future investment. Some tax credit industry professionals have analogized this new tax to a reformed alternative minimum tax. The BEAT could have a further detriment to how corporations evaluate the carrying amounts of their deferred tax assets.
While we await the final outcome of tax reform, it is never too early to evaluate the above considerations and their potential impact on financial reporting. Management will want to be proactive as it refines its strategy of tax credit investing to incorporate these potential changes. By doing so, the tax credit industries may quickly be aligned to fulfill the demand that investors will have in the future. Novogradac & Company’s professional services teams are available now to assist you in assessing the possible effects of tax reform.