Reporting for Income Taxes

Federal income taxes have been given a lot of attention this year, thanks to the Tax Cuts and Jobs Act (TCJA). Companies that issue financial statements under U.S. Generally Accepted Accounting Principles (GAAP) are required to follow Accounting Standards Codification (ASC) Topic 740, Income Taxes. The guidance is complicated and requires companies to report the effect of new laws in the quarter they’re enacted. Here’s an overview of the FASB’s work on its income tax projects in recent years.

Disclosures and backwards tracing

Income taxes were on the FASB’s agenda long before the new tax law was enacted. In recent years, several large accounting firms have asked the FASB to take an extensive look at the disclosure requirements for income tax accounting under GAAP and simplify them.

Another area of concern is GAAP’s prohibition against the practice of backwards tracing. Under this practice — which is permitted under international accounting standards — the effect of a change in the amount of a deferred tax credit or charge is recognized in the same line item used for the deferred taxes when they were first recorded.

“Ultimately the board will look at the costs of backwards tracing, which historically were high, and weigh the alternatives to see if the benefits outweigh the cost,” said FASB staffer Jason Bond during a March 20, 2018, meeting of the FASB’s Financial Accounting Standards Advisory Council (FASAC).

Effects of new tax law

The FASB’s work on income tax accounting has been intensified by the enactment of the new tax law. The Securities and Exchange Commission (SEC) issued relief in late December that will help public companies report the effects from the TCJA. A couple of weeks later, the FASB unanimously agreed to follow the SEC’s lead.

Accounting Standards Update (ASU) No. 2018-02, Income Statement — Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, retains the prohibition on backwards tracing despite the requests the FASB received from the banking industry to eliminate it. ASU No. 2018-02 gives businesses the option of reclassifying to retained earnings the so-called “stranded tax effects” left in accumulated other comprehensive income (AOCI) because of the TCJA’s reduction of the corporate income tax rate.

Back to the drawing board

The FASB plans to revisit the financial reporting effects from the new tax law in the third quarter of 2018. By then, the FASB will have enough data from year-end 2017 financial statements and first and second quarter 2018 SEC filings to help its members gauge the effect of the new law on accounting and financial reporting.

The FASB now has the time to consider questions it was unable to answer as it rushed to complete the amendments in ASU No. 2018-02. The extra time will let the FASB examine the costs and benefits of backwards tracing and debate elimination of the prohibition.

Many believe the prohibition was retained for pragmatic reasons: The FASB was concerned about the difficulty companies would face in getting the needed information in subsequent years and then whether the adjustments they would do would provide a clear benefit to the investors reading their financial statements.

Some FASB members believe that there may be some areas of accounting that could benefit from backwards tracing — and others where the costs remain prohibitive. The FASB will also consider whether additional disclosures about income taxes could help satisfy investor demands.

Other tax-related issues

In addition to the prohibition on backwards tracing, the FASB is concerned about financial reporting inconsistencies related to:  

Global intangible low-taxed income (GILTI). The new tax law imposes a tax on foreign income in excess of the deemed returns on tangible assets of foreign corporations. In general, the income will be effectively taxed at a 10.5% tax rate less foreign tax credits. The FASB must provide guidance on whether deferred tax assets and liabilities should be recognized for basis differences expected to reverse as GILTI in future years or if the tax on GILTI should be included in the period in which it is incurred.

Base erosion and anti-abuse tax (BEAT). This tax is similar to the now defunct corporate alternative minimum tax (AMT). It’s designed to be an incremental tax in which the business can never pay less than the statutory rate. Under the new law, companies must pay the BEAT if it is greater than their expected tax liability.

Stay tuned

There’s no simple resolution to the FASB concerns about income tax reporting and the financial reporting inconsistencies that may result from different interpretations of the new tax law. So, expect this issue to stay on the FASB’s agenda for months and, perhaps, years to come.

© 2018