The 2017 Tax Cut and Jobs Act creates significant changes and new challenges in accounting for income taxes. One challenge relates to the interim computation of the annual effective tax rate, which may be impacted by changes in US tax law.
Hi I’m Eric Suplee, a Director in PwC's National Office.
Tax reform may have a significant impact on a company’s annual effective tax rate (or AETR). So, first, let’s talk about that rate. The AETR is the rate used by a company to estimate its tax provision in its quarterly financial reporting. You can see a summary of the basic interim tax accounting model on the screen.
The accounting guidance requires that companies estimate their annual effective tax rate for the year in the first quarter of each year. Companies would then update that estimate during each subsequent quarter.
This means that the AETR may change -
1) as there are changes in forecasted full year ordinary income or loss, or
2) as there are changes in items that comprise the estimated tax provision. For example, a change in a company’s estimated permanent differences from quarter to quarter.
Once forecasted-income for the year is calculated, absent any discrete items, the company multiplies year-to-date ordinary income or loss from continuing operations, by the AETR to determine the year-to-date tax provision. The current period tax provision equals the difference between the year-to-date computed amount and the tax provision previously recorded.
As you know, tax reform significantly changed the US Tax Code.
While the reduction of the corporate income tax rate to 21% has received a lot of attention, the other domestic provisions impact some of the rules around what or how much, is deductible. For example, tax reform expands the limitations on the deductibility of executive compensation and repeals the manufacturing deduction. While the rate reduction will clearly reduce the AETR, most of the other domestic provisions will likely cause the rate to increase.
The international provisions are likely more complex than the domestic provisions. Considering that they are new, there could be some uncertainty on how to interpret and apply the provisions. Additionally, to estimate their impact, companies will need forecasted data that they may not have gathered in the past. This may make it more difficult for companies to determine what impact, if any, these provisions will have on their estimated annual effective tax rate, especially since it needs to be estimated in the first quarter.
For example, determining whether a company may be subject to the base erosion anti-abuse tax (or BEAT) requires:
In addition, some aspects of the BEAT rules and their application may be uncertain, which further complicates this estimate.
Similar challenges also apply to:
These are just a few of the potential complexities.
The key is that tax reform has significantly changed the way US taxes will be applied and companies will need to take a holistic look at the impacts of it on their tax provision.
To make matters more challenging, from an accounting perspective, SEC Staff Accounting Bulletin No. 118 does not address accounting that arises after the period of enactment, unless it is an update of an item that was provisional or incomplete at the period of enactment. That is, SAB 118 does not apply to provisions of the tax law that go into effect after January 1, 2018. So, companies will need to make their best estimate of their AETR each quarter based on facts and circumstances each period.
The new tax law provisions, and the evolving interpretation of how they should be applied, could cause companies to have significant quarter to quarter changes in their AETR. Despite the uncertainties, there is no "pass" on making the best estimate each quarter, or on the controls that surround that process.
Thank you and good luck!