The voices of Tax Policy Center's researchers and staff
In a Harvard Business Review article last December, I described how the complex and poorly vetted provisions of the Tax Cuts and Jobs Act (TCJA) would be a boon for tax practitioners. But the panelists at a joint conference last week of the Tax Policy Center and the University of North Carolina Kenan-Flagler School of Business gave me second thoughts. At least for some in the accounting profession, the new tax law is more a nightmare than a bonanza.
That’s because the TCJA changed the amount of current and deferred tax liability public companies had to report to their shareholders for tax year 2017 (when the law changed). And firms had to make those disclosures in the first quarter of this year (when they reported results for 2017). But there is no way they—or their accountants—could figure out what the law required in time to prepare these reports accurately.
As a naïve economist, I thought otherwise. After all, the tax bill’s provisions generally aren’t effective until tax year 2018. Thus, companies don’t need to report how much tax they owe until they file their tax year 2018 returns next spring. By then, the IRS would have clarified some of the more difficult issues and tax advisors would have gained some insight into how to respond to others. Companies would still have to alter their quarterly estimated tax payments and many would wish to change behavior to gain the most benefit from the new law. But they would have ample time to figure out how much tax they owed when they filed a return.
The world of financial accountants is different. They must record a company’s tax liability or tax benefit when it is accrued, not when the liability is paid or the benefit received. For example, when a company buys a depreciable asset, the accountant records a tax deduction in the same year as she writes down the value of the asset on the company’s books. The deduction on the books, however, does not necessarily equal the deduction the tax law allows the company to claim on its tax return. This means that a company often shows deferred tax liabilities (DTLs) or deferred tax assets (DTAs) on its financial statement that reflect differences between tax liability accrued and taxes paid. These DTLs and DTAs affect the after-tax profit that companies report to their shareholders.
Because President Trump signed the TCJA on December 22, 2017, the law affects 2017 tax liability that is reported on a company’s financial books even though it has little or no effect on its 2017 tax payments. For example, suppose a bank is carrying unused tax losses from the financial crisis of 2008-09. Each dollar of these DTAs was worth 35 cents under prior tax law. But once the TCJA reduced the corporate rate to 21 percent, the value of these DTAs immediately fell to 21 cents per dollar. This change would be reflected in the net 2017 profits the bank would report to its shareholders.
This may seem paradoxical since the banking sector benefits from the corporate tax rate cut. But the bank must report its adjusted profits in the year of the tax change because it was credited with a DTA in the year the loss was incurred using the tax rate that was in place at that time. As an economist, I am troubled that financial accounting conventions don’t reflect a business’s true economic profitability. But the rules are the rules.
The write-down of unused losses due to the corporate rate cut is relatively straightforward. It is much more challenging for other provisions of the TCJA such as the tax on Global Intangible Low Taxed Income (GILTI) and the Base Erosion Alternative Tax (BEAT) that apply to firms that do business overseas.
Even something as apparently straightforward as the transition tax on pre-TCJA profits of controlled foreign companies (CFCs) raises complications. For companies that claimed their foreign profits were permanently invested overseas prior to the TCJA, the transition tax represents a new liability. Even though firms have up to eight years to pay the tax, the new liability must be recorded on their books in 2017.
But these firms may not even know the correct rate to compute their tax liability. While the TCJA imposed an 15.5 percent transition tax on cash assets and a 8 percent rate on other assets, the definition of “cash” is murky at best. For example, my TPC colleague Howard Gleckman raises the question of whether chickens are cash-equivalent (because they are marketable inventory). What tax liability should an accountant report on the chicken owner’s 2017 financial statement?
You may wonder why 2017 accrued liability even matters since it doesn’t reflect actual tax payments. But reported profits often drive executive compensation, stock market valuations, and real investment decisions. Reporting errors may have real-world consequences for business leaders, financial markets, and corporate behavior. Accountants want to accurately reflect the results from the new legislation, but without guidance from Treasury and IRS that won’t be forthcoming for months, it is hard to see how they can do so.
President Trump could have given accountants a bit of breathing room had he signed the tax bill after December 31, so that there would have been no effects on deferred tax assets or liabilities for tax year 2017. But he didn’t. And the result is that while accountants may have more lucrative work to undertake, they also have many more headaches.
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