Tax Reform: Impact on valuation allowance assessments - additional considerations

Start adding items to your reading lists:
or
Save this item to:
This item has been saved to your reading list.

Video , PwC US Dec 05, 2018

Valuation allowance assessments can be complex in light of tax reform. Watch our latest video for a quick summary on key considerations.

US tax reform may have a significant impact on a company’s valuation allowance assessment in many aspects. This video is a continuation of our tax reform series, where we cover more detail about specific items that companies should consider when preparing their valuation allowance assessment. Specifically this video discusses the following three (3) key items:

  • First, companies may now need to perform scheduling of the expected timing of the reversal of their deferred taxes because of the additional limitations on net operating loss, or NOL, and interest carryforwards.
  • Second, companies may need to make certain accounting policy elections related to NOLs or deferred tax assets that would reverse to generate NOLs.
  • Third, the realizability of foreign tax credits has become more challenging after tax reform, and it may be difficult to avoid valuation allowances on such credits.
loading-player

Playback of this video is not currently available

Duration: 5:55

Transcript

Hi I’m Megan Bowles, a senior manager in PwC’s national office. As you know, the 2017 Tax Cuts and Jobs Act has many financial reporting impacts. This video is a continuation in our series of videos on tax reform.

Today, I would like to hit on 3 key points to be considered in the valuation allowance assessment in light of tax reform. These include:

1) Scheduling of taxable income,

2) Important accounting policy elections, and

3) Realizability of foreign tax credits.

First, companies may now need to perform scheduling of the expected timing of the reversal of their deferred taxes because of the additional limitations on net operating loss, or NOL, and interest carryforwards. In particular, there is now an 80% limitation on the utilization of post-tax reform NOL carryforwards.

For example, consider a company with a $100 NOL and a $100 deferred tax liability. The $100 deferred tax liability would provide an income source to utilize only 80% or $80 of the NOL, to the extent the NOL arose post tax reform.

Scheduling when that taxable income, in combination with additional sources of taxable income, is expected to occur may be more relevant because the 80% limitation may shift loss utilization into later years when taxable income may not be available. This may be particularly true if a company has post-tax reform indefinite lived NOL carryforwards, which are subject to the 80% limitation in addition to pre-tax reform finite-lived NOL carryforwards.

The new rules further restrict the deductibility of net interest expense. Deductions on interest expense are now limited to 30% of adjusted taxable income. This may cause more companies to have much larger interest carryforward deferred tax assets that need to be assessed for realizability, although these carryforwards will continue to be indefinite-lived.

As an example, a company that incurs pre-tax losses could end up in a taxable income position due to the magnitude of the interest limitation.  In that case, the company may be able to conclude that its NOLs are realizable, however, the company may conclude that its interest carryforward is not realizable if, even without the interest add back, the company would be in losses.

A scheduling exercise may be necessary to consider the interplay of the 80% limitation on post-reform NOLs, and the 30% limitation on interest carryforwards. Importantly, to realize the benefit of a deferred tax asset, future taxable income is necessary, even in the case of an indefinite lived carryforward.

Second, there are certain accounting policy elections that may impact valuation allowance assessments. For example, the tax on Global Intangible Low-Taxed Income, or GILTI, may impact the realizability of deferred tax assets. A GILTI accounting policy election needs to be made by companies that have both NOLs, or existing deferred tax assets that are expected to reverse to generate NOLs in a future period, and they expect to have future GILTI inclusions.

We believe these companies can select from two acceptable accounting policies when performing the valuation allowance assessment – the incremental cash tax savings approach or the tax law ordering approach. Under the incremental cash tax savings approach, a company should look to whether the NOL reduces expected cash taxes payable to determine the amount of the valuation allowance. The with-and-without approach compares:

  1. What its incremental cash taxes would be with the NOL (the "with" calculation), and
  2. What its incremental cash taxes would be without the NOL (the "without" calculation). A valuation allowance would be recorded to the extent the NOL does not provide an incremental benefit.

Under the tax law ordering approach, NOL carryforwards are considered realizable if they will be utilized to reduce the expected tax liability, this is before considering any potential Section 250 deductions or foreign tax credits that are available based on the GILTI provisions. Keep in mind that the tax law ordering approach can result in a smaller (or no) valuation allowance compared to the incremental cash tax savings approach. It could also lead to a higher and potentially more volatile effective tax rate in future periods.

Finally, the realizability of foreign tax credit, or FTC carryforwards, has become even more challenging after tax reform. In many cases, it will be difficult to avoid a valuation allowance for FTC carryforwards post tax-reform due to the shift to a territorial system along with the lower corporate US tax rate of 21%.

In summary, US tax reform may have a significant impact on a company’s valuation allowance assessment in many aspects and each company should consider its individual facts in determining the extent of that impact. For additional information regarding the accounting impact of tax reform, please see our In depth publications available on CFOdirect.com, or speak with your PwC tax accounting specialist. Thank you for watching.

Contact us

Heather Horn

Heather Horn

US Strategic Thought Leader, National Professional Services Group, PwC US

David Schmid

David Schmid

International Accounting Leader, National Professional Services Group, PwC US

Follow us