Factoring tax reform into public company disclosures
The Tax Cuts and Jobs Act made far-reaching changes to the tax code when it was signed into law last December and resulted in significant tax accounting modifications. On the same date, staff at the Securities and Exchange Commission issued Staff Accounting Bulletin No. 118 and Exchange Act Form 8-K Compliance and Disclosure Interpretation (C&DI) 110.02 to clarify the effect of these sweeping changes on the reporting and disclosure obligations of public companies, generally effective for tax years beginning after Dec. 31, 2017.
The SAB acknowledges that some registrants might not have had the information necessary to evaluate the income tax effects of the TCJA at the time of issuance of financial statements for the period including Dec. 22, 2017 and provides some relief in that regard. The related C&DI confirms that the remeasurement of a deferred tax asset (DTA) to incorporate the effects of newly enacted tax rates or other provisions of the TCJA does not constitute an impairment, and therefore does not trigger an obligation to report under Form 8-K, Item 2.06. Both, however, are intended to shed light on the application of U.S. GAAP to the accounting modifications resulting from the new tax reform legislation.
In addition to this guidance, let’s look at further considerations that public company reporting entities should be aware of as they assess the business impact of the TCJA.
1. Form 10-K disclosures
Registrants should include the impact of the TCJA in their disclosures of risks and uncertainties that could cause a discrepancy between actual results and the expectations upon which their forward-looking statements are based.
Registrants should also include cautionary disclosures concerning risks and uncertainties surrounding the passage of the TCJA, as well as the potential impact of such risks and uncertainties, in the section on risk factors.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Registrants must disclose the material effects of the tax changes made under the TCJA when preparing the MD&A, including a discussion of results of operations, liquidity and capital resources (e.g., remeasuring DTAs and deferred tax liabilities due to the lower corporate income tax rates and reevaluating the realizability of DTAs).
Note that, per Code Section 15, non-calendar-year companies are to use a blended tax rate by dividing their year-end taxable income into two portions: one that precedes Jan. 1, 2018, and another that follows that date. Multiplying total income by the percentage of the year preceding Jan. 1, 2018 will yield the amount that is subject to the rate of 35 percent, while multiplying total income by the percentage of the year following Jan. 1, 2018 will yield the amount that is subject to the rate of 21 percent. The aggregate amount owed in taxes will be the sum of these two calculations. By way of example, if a company has a year-end of March 31, it will use a blended tax rate of 31.5 percent, consisting of nine months at 35 percent and three months at 21 percent.
When considering the financial reporting impacts of the TCJA, registrants should be mindful of the accounting for such elements as (1) the remeasurement of DTAs and deferred tax liabilities due to the new lower tax rates for businesses, (2) the carryover and carryback rules for net operating losses, (3) the one-time tax on undistributed earnings of foreign subsidiaries that were not previously subject to U.S. income taxes (i.e., the mandatory repatriation tax), (4) the elimination of the alternative minimum tax (AMT), (5) a new base erosion anti-abuse tax (BEAT), and (6) a new global-intangible-low-taxed-income (GILTI) measure. Note the use of the blended tax rate, discussed above, for non-calendar-year companies.
Registrants should also be mindful of the U.S. GAAP/non-GAAP reconciliation requirements of Regulation G and Regulation S-K Item 10(e), per the C&DI on non-GAAP financial measures, most recently updated on April 2, 2018. For example, if a registrant estimates the impact of a provision of the TCJA and indicates what its results would have been excluding the impact of the TCJA, then the registrant is presenting a non-GAAP financial measure, which triggers the reconciliation requirements.
2. Proxy statement disclosures
Compensation Discussion and Analysis (CD&A)
The TCJA impacts the deductibility of executive compensation under Code Section 162(m) in such a way that could influence companies’ design and management of their executive compensation programs for tax years beginning after Dec. 31, 2017.
For example, prior to the TCJA, Section 162(m) imposed an annual limit of $1 million on the deductibility by a “publicly held corporation” of compensation paid to each “covered employee,” and excepted from the deduction limit “qualified performance-based compensation.” The TCJA eliminates this exemption, making all compensation paid to a covered employee of more than $1 million nondeductible, except for compensation, subject to the transition rule, that is provided pursuant to a written binding contract in effect on Nov. 2, 2017 and is not materially modified on or after that date.
Additionally, the TCJA expands upon the definition of a covered employee to include (1) the chief executive officer, the chief financial officer and the three most highly-paid officers for the taxable year, other than the CEO and the CFO (i.e., the definition previously excluded CFOs); and (2) any individual who was a covered employee for any taxable year beginning after Dec. 31, 2016, even following termination of employment and death (i.e., previously, the covered-employee designation did not carry forward to future years).
Finally, whereas prior to the TCJA, Section 162(m) only applied to companies with publicly-traded equity, the TCJA expands its applicability to also include, among other entities, companies with publicly-traded debt.
3. Form 8-K disclosures
As mentioned above, registrants should include the impact of the TCJA in their disclosures of risks and uncertainties that could cause a discrepancy between actual results and the expectations upon which their forward-looking statements are based.
Results of operations and financial condition
Although SAB No. 118 seems to cover financial reporting as it relates to financial statements in periodic reports, as opposed to those included in companies’ earnings releases, registrants should still be mindful of the disclosures in SAB No. 118 when preparing earnings releases and consider including them to the extent appropriate.
Note that Form 8-K, Item 2.02, is not limited to companies’ earnings releases, but rather is triggered by any public disclosure of material non-public information regarding a company’s results of operations or financial condition for a completed quarterly or annual fiscal period. Accordingly, a registrant could be required to report under this item if it makes material disclosures regarding the financial reporting impact of the TCJA that relate to the fiscal period including Dec. 22, 2017 but are made after the end of such period.
Regulation Fair Disclosure
Registrants should expect to receive inquiries from analysts and investors concerning the business impact of the TCJA. If a registrant plans to discuss such matters before issuing its financial results, then it should consider its Regulation FD obligations under Item 7.01, because such disclosures may be material, given that investors may not be able to evaluate the impact of the TCJA based on earlier disclosures.
Even if a registrant concludes that a Form 8-K is not required, it may still choose to report under Item 8.01 updates to prior disclosures.
Where to go for further guidance
Guidance from the IRS is expected to evolve over the next several months, perhaps even years. In the meantime, public companies can continue to gain an understanding of the impact of the TCJA on their financial reporting and disclosure obligations by looking to the guidance in SAB No. 118, the related C&DI and other public companies’ TCJA disclosures to help balance compliance challenges with the need to provide quality information for investors.
To see how your peers and other reporting entities across industries are handling TCJA-related disclosures, download the Thomson Reuters special report, Effects of the Tax Cuts and Jobs Act on Public Company Disclosures, and view excerpts from recent SEC filings.