If you’ve read the news in the last month, you are no doubt aware that a tax bill has been passed by Congress and signed by the President. Since the Tax Cuts and Jobs Act (“the Act”) passed late in 2017, most of the changes will not take effect until tax year 2018 or later. However, because the bill was signed, and therefore enacted before the end of 2017, many of its provisions will affect financial statements that include the activity of one or more C corporations for 2017.
Change in Tax Rate and Deferred Tax Assets and Liabilities
The Act changed the U.S. corporate income tax rate to a flat rate of 21% for tax years beginning after January 1, 2018. Under financial accounting standards, corporations are required to record not only taxes currently payable, but also the future tax benefit or expense related to the reversal of book to tax timing differences. Deferred tax assets and liabilities represent the amount of future taxable income or tax deductions resulting from these timing differences, multiplied by the tax rate expected to apply when these amounts are realized. Changing the tax rate applies to the company’s pre-tax deferred tax assets and liabilities will result in a tax expense or benefit on the 2017 profit and loss statement. Depending on whether the company has a net deferred tax asset or liability on December 31 and the magnitude, this could cause a significant change to net income after taxes. This applies to corporations for their first period ending after date the law was signed: December 22, 2017.
Deemed Repatriation of Foreign Earnings
Under old law, income from foreign subsidiaries was only included in U.S. taxable income when earnings were distributed or deemed distributed. For financial statement purposes, companies with foreign subsidiaries either recognized or did not recognize the undistributed income of such entities in their U.S. taxable income based on whether such earnings were assumed to be permanently reinvested in the foreign country or not. Under the new tax law, undistributed and previously untaxed post-1986 foreign earnings will be deemed distributed in 2017. The tax on the deemed repatriation will be 15.5% on liquid assets or 8% on illiquid asset and may be paid over an eight-year period with no interest. The Financial Accounting Standards Board (FASB), has ruled that the liability should not be discounted for financial statement purposes.
Alternative Minimum Tax Repeal
The Act repeals the Alternative Minimum Tax (AMT) for corporations, and allows existing AMT credit carryforwards to be used to reduce the company’s regular tax expense in 2018-2020. Any credits not used against regular tax are eligible for a 50% refund in 2018-2020 and a 100% refund in 2021. Companies with AMT credit carryforwards may need to recharacterize existing deferred tax assets to a current or long-term receivable as of December 31, 2017. Additionally, the portion of any valuation allowance attributable to AMT credit carryforwards, may be removed resulting in a deferred tax benefit.
Expensing of Fixed Assets
The Act provides for 100% bonus depreciation on qualified assets both acquired and placed in service after September 27, 2017 and before January 1, 2023. Taking bonus depreciation will not only affect the temporary difference and therefore the current tax expense and deferred tax asset or liability for fixed assets, but could also have an impact on the valuation allowance for existing deferred tax assets, including net operating losses created by expensing fixed assets.
Interest Expense Limitations
The Act repeals a limitation on interest paid to foreign related parties and replaces it with a much broader limitation. Under the new law, interest expense for taxpayers with average annual gross receipts in excess of $25 million will be limited to an interest deduction of 30% of “adjusted taxable income”. This applies regardless of whether the recipient of such interest is foreign or domestic. Amounts disallowed under the old law and carried forward represent a deferred tax asset. It is not currently known what will become of these deferred tax assets, but it is more than likely that there will be transition rules that will require an adjustment.
In addition to these, there are many other changes that will affect businesses’ current and deferred taxes going forward. These include:
- Repeal of the deduction for domestic production activities (DPAD)
- Repeal of 50% deduction of certain meals and entertainment expenses
- Expansion of the limitation on executive compensation under section 162(m)
- Reduction in the dividends received deduction
- Repeal of tax deferral for like-kind exchanges of property other than real estate
- Inclusion of certain income from foreign subsidiaries
- Alternative tax on certain payments made to foreign entities
To discuss how these and other changes will affect your business, please contact Tax Partner, Roger Wilkins.