Update as of December 6, 2017: Congress and the President are nearing the finish line for significant tax reform with the likelihood of passing by the end of the year. Since it has the potential to significantly change the corporate tax rate, the below is even more relevant at this time. Read more about the impact of the lower corporate tax rate, if enacted.
Yogi Berra is often attributed with saying, “It’s difficult to make predictions, especially about the future.” This is especially true with predictions about revisions to the tax code. However, many observers now believe a reduction in the corporate tax rate is a realistic possibility as a result of the combination of a new Trump administration and a Republican-controlled Congress. According to www.donaldjtrump.com, “The Trump Plan will lower the business tax rate from 35 percent to 15 percent, and eliminate the corporate alternative minimum tax.” In light of these dynamics, a potential sleeper issue for many companies, especially those carrying sizeable deferred tax assets on the balance sheet, is a potential charge to earnings resulting from the remeasuring of deferred tax assets due to a change in the corporate income tax rate.
At a high level, deferred tax assets are reported as assets on the balance sheet and represent the decrease in taxes expected to be paid in the future because of net operating loss (NOL) and tax credit carryforwards and because of future reversals of temporary differences in the bases of assets and liabilities as measured by enacted tax laws and their bases as reported in the financial statements. NOL and tax credit carryforwards result in reductions to future tax liabilities, and many of these attributes can expire if not utilized within certain periods. If a company believes it is more likely than not that some portion or all of the deferred tax asset will not be realized, a valuation allowance must be recognized. By way of example of the charge that can result from a reduction in corporate income tax rates, the disclosure below is from the earnings release of a large financial institution when the U.K. enacted reduced corporate income tax rates in 2013:
“Income tax expense for the third quarter of 2013 was $2.3 billion on $4.8 billion of pretax income. This includes a charge of $1.1 billion for remeasuring certain deferred tax assets due to the U.K. corporate income tax rate reduction of 3 percent enacted in July 2013. In the year-ago quarter, the company reported income tax expense of $770 million on $1.1 billion of pretax income. This included a $0.8 billion charge for remeasuring certain deferred tax assets due to the enacted U.K. corporate income tax rate reduction of 2 percent.”
Therefore, companies with sizeable deferred tax assets should consider analyzing the potential impact that could result if corporate income tax rates are reduced, including discussing these potential impacts with tax and independent auditors. If the potential impacts are significant, management should consider bringing these issues to its audit committee so that they are fully informed of the possible financial statement impacts of any corporate income tax reduction, as well as revisit their SEC disclosures to ensure the risks are adequately disclosed.