The 2017 Tax Cut and Jobs Act creates significant changes and new challenges in accounting for income taxes. One challenge relates to the valuation allowance assessment, which may be impacted by changes in US tax law.
Hi I’m Eric Suplee, a Director in PwC's National Office.
The 2017 Tax Cut and Jobs Act has numerous financial reporting impacts. One potentially significant impact is in connection with assessing the realizability of deferred tax assets. The accounting guidance for assessing the need for a valuation allowance has not changed. However, changes in the tax law may impact the application of that guidance.
Today, I would like to talk about certain aspects of tax reform that could impact a Company’s valuation allowance assessment.
Number one, the existence of cumulative income or loss over a three year period, is a consideration in the valuation allowance assessment. Many companies may have significant one-time taxable income from the deemed mandatory repatriation of foreign earnings triggered by the toll charge. This one-time item may have put the company into a cumulative income position. However, the valuation allowance assessment considers the weighing of all available evidence, not solely whether there is cumulative income or loss. It’s important to remember that the toll charge was a one-time item and should be weighted as such. Companies in a cumulative income position, only because of the deemed inclusion, may still need a valuation allowance on their deferred tax assets.
Next, the tax accounting guidance identifies four sources of taxable income to assess the realizability of deferred tax assets. Those four sources are: 1) taxable income in prior carryback years, 2) reversal of existing taxable temporary differences, 3) tax-planning strategies, and 4) projections of future taxable income. Tax reform could impact each of these four sources.
The 2017 Act prohibits the carryback of net operating losses, or NOLs, generated in tax years ending after December 31, 2017. This eliminates consideration of taxable income in prior carryback years as an income source for prospective NOLs.
Additionally, usage of tax-planning strategies may be limited going forward. The 2017 Act allows for an indefinite carryforward of NOLs generated after December 31, 2017. Tax planning strategies are defined as actions that a company might not ordinarily take, but would take to prevent an operating loss or tax credit carryforward from expiring unused. Since NOLs generated in tax years ending after December 31, 2017 will not expire, a tax-planning strategy, by definition, would not provide a source of future taxable income.
Additionally, the 2017 Act limits a taxpayer’s ability to utilize NOL carryforwards to 80% of taxable income. This may prevent a dollar for dollar source of future taxable income when considering the reversals of existing taxable temporary differences. On the other hand, the indefinite carryforward of NOLs may allow for deferred tax liabilities related to indefinite-lived intangibles, commonly referred to as “naked credits,” to be considered as a source of future taxable income.
Last, but certainly not least, a company’s projection of future taxable income will likely change. Future taxable income would consider tax law changes such as the repeal of the manufacturing deduction, changes to the deductibility of executive compensation, and the effects of new international tax provisions.
Importantly, the NOL utilization rules have not changed for NOLs that were generated prior to Tax Reform. This may require a separate assessment of realizability of deferred tax assets for NOLs with a finite-life versus those with an indefinite-life.
There are, of course, other areas where tax reform interacts with the valuation allowance assessment. Special consideration is needed when evaluating the possible valuation allowance assessment for tax provisions such as, GILTI, BEAT, and the expanded interest limitations, otherwise known as the "Section 163(j) interest limitations".
In summary, a company’s valuation allowance assessment should be based on all available evidence. This includes the four sources of taxable income described in the tax accounting guidance, giving more weight to those sources which are more objective. US tax reform may have a significant impact on a company’s evaluation of these sources and the realizability of its deferred tax assets.
Thank you and good luck!