ICYMI | Analysis of the Initial Financial Statement Impact of the Tax Cuts and Jobs Act

SEC and FASB Guidance

U.S. GAAP accounting and disclosure requirements for income taxes are contained in Accounting Standards Codification (ASC) Topic 740, “Income Taxes.” GAAP addresses recognition of current taxes payable or refundable and requires deferred tax assets and deferred tax liabilities for future tax consequences of events recognized in companies’ financial statements or tax returns. Topic 740 also includes accounting requirements for changes in tax laws and rates; specifically, companies are required to record the effect of changes in tax law as a component of the tax provision in income from continuing operations in the period of enactment.

For large accelerated filers, Form 10-K is due 60 days after the end of the fiscal year (SEC Rule 33-8644). Calendar year-end companies had approximately two months to analyze the TCJA’s pervasive impact on their financial statements, facing challenges in reading and interpreting the new law, gathering data, assessing how it applied to their own facts and circumstances, and determining the impact in a very compressed timeframe. To address those concerns, the SEC issued Staff Accounting Bulletin (SAB) 118, which provides companies some latitude with timing in determining the TCJA’s financial statement impacts. Specifically, SAB 118 requires companies to determine whether the assessment and quantification of a particular income tax effect is complete by the due date of the financial statements and provides guidance for registrants in three scenarios:

• Measurement of certain income tax effects is complete. In this scenario, the income tax effect must be reported in the enactment period financial statements.
• Measurement of certain income tax effects can be reasonably estimated. Reasonable estimates are considered “provisional amounts,” and must be reported for the specific tax effects where the accounting is incomplete. Companies must record the provisional amount in the first period that it is determined, and subsequent adjustments to provisional amounts will be included as an adjustment to tax expense in the period that the adjustments are determined.
• Measurement of certain income tax effects cannot be reasonably estimated. If companies cannot determine a reasonable estimate for sections of the TCJA, provisional amounts are not recorded. Companies may continue to use previous law for all tax-related items in their current financial statements and must report the provisional effects of the TCJA in the first period in which a reasonable estimate can be made.

FASB issued Accounting Standards Update (ASU) 2018-05, Income Taxes (Topic 740): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118, to reflect the issuance of SAB 118 in the SEC paragraphs of the codification. In addition, FASB issued ASU 2018-02, Income Statement—Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, to address concerns about GAAP’s requirement to recognize the impact of changes in tax laws and tax rates through the income statement. This treatment is required even in situations where the related tax effects of items were originally recognized in other comprehensive income (OCI) instead of income from continuing operations. By adjusting temporary differences originally recorded (and still residing) in accumulated other comprehensive income (AOCI) through current period income, a potentially disproportionate effect could be left as a residual, known as a “stranded tax effect.” Specifically, the original deferred tax amount recorded would remain in AOCI even though the related deferred tax item will be reduced to reflect the new rate through current period income. ASU 2018-02 allows reclassification from AOCI to retained earnings of stranded tax effects resulting from the new federal corporate income tax rate, thereby eliminating the stranded tax effects created by the TCJA.

Highlights of Tax Law Changes

Most of the TCJA’s tax provisions are effective beginning January 1, 2018. Even though the law was not yet effective, U.S. GAAP requires companies with a December 31 fiscal year-end to consider the impact of the legislation’s provisions in their 2017 financial statements, to the extent that those effects can be reasonably estimated.

Methodology and Analysis

The authors chose 75 companies, representing a cross section of the Fortune 500, to analyze the impact of initially adopting the TCJA on their financial statements. Within the Fortune 500, all firm sizes are equally represented. All companies in the sample have a December 31 year-end and were audited by the Big Four (Exhibit 1). With the exception of the public administration category, the sample included companies in all Standard Industrial Classification (SIC) codes. Manufacturing companies made up the largest number of companies in the sample (27); the smallest number (4) was in the mining category.

Overall Impact

All 75 companies in the sample disclosed at least some component of the TCJA’s impact on their financial statements. As shown in Exhibit 1, the vast majority of companies analyzed had not concluded their determination of the new law’s impact, and, accordingly, their financial statements included provisional impacts. Of the 75 companies in the sample, 70 disclosed that their tax amounts were provisional, and one disclosed that their analysis was complete. The status of four companies was indeterminate; although they addressed uncertainties in their disclosure, they did not use the word “provisional,” so their classification was unclear.

Exhibit 2 provides an analysis of the TCJA’s impact for all companies in the sample. The mean total tax expense for this group is just over $1 billion; 18 of the 75 companies reported an overall tax benefit for the calendar year, while 57 companies reported an overall tax expense. Given this variance, the mean represents a wide range, from a $21.5 billion tax benefit to an almost $29 billion tax expense. As would be expected from such complex legislation, the TCJA had disparate ramifications for the companies in the sample; some companies benefited while others reported increased costs. Overall, the highest benefit reported by a company in the sample due to the new law is $28.2 billion, and the highest reported expense is $22.6 billion.

Remeasuring Deferred Tax Assets and Liabilities

Since reduced corporate tax rates are a key feature of the TCJA, the authors’ primary focus was to analyze the impact of remeasuring deferred tax accounts; 66 of 75 companies in the sample specifically reported the impact of that remeasurement. The mean remeasurement reduced the net deferred tax account by $322.5 million. The range of remeasurement was quite large; the largest reduction generated a $29.6 billion benefit, and the largest increase generated a $20.3 billion expense.

Foreign Provisions

After reviewing tax disclosures for all sample companies, it became clear that remeasuring deferred tax accounts was only one aspect of a complex new law. While all companies are affected by the reduction in corporate tax rates, companies with foreign operations incur additional tax consequences; 43 of the 75 companies reported a transition tax (mean of slightly less than $900 million), while 11 companies disclosed components that included related foreign and state impacts (mean of approximately $270 million). Such effects included changes in unremitted foreign earnings, as well as foreign withholding taxes or state taxes associated with anticipated remittances.

While the transition tax is a one-time tax, other foreign provisions will continue to affect companies in future periods. Provisions associated with GILTI, BEAT, and FDII first take effect for 2018 tax years and are expected to continue indefinitely. Details surrounding these new rules are complex, and the results of this analysis suggest that companies are still sorting through the impact of these changes. For example, 15 of 62 companies with foreign operations specifically indicated that the impact of GILTI, BEAT, or FDII had not yet been determined. Only one of these 15 companies indicated that the amounts, once determined, were not expected to be material.

In addition, seven companies disclosed other, less material consequences associated with the TCJA. Such items included changes associated with income tax contingencies, AMT, executive compensation, or any number of miscellaneous provisions. The mean impact of these other items for these seven companies was a tax benefit of $1.9 million.

Favorable and Unfavorable Impact

As shown in Exhibit 2, the TCJA created roughly an equal number of companies reporting a benefit in their initial financial statements as those reporting increased costs. Specifically, 35 companies reported a favorable impact associated with tax reform, and 40 reported an unfavorable impact. For favorable impact companies, the mean benefit of tax reform in 2017 is just over $2 billion. The smallest benefit reported from remeasurement of deferred tax balances is $45.8 million, and the largest is almost $30 billion.

Whether companies experienced a positive or negative impact is at least partially driven by whether they were in a net deferred tax asset or liability position. Five of the 35 favorable companies in the sample did not report the impact of remeasuring their deferred tax balances, so the degree to which remeasurement contributed to their benefit from the new legislation cannot be determined; the other 30 companies reported a mean benefit from remeasurement of approximately $1.7 billion. Since the mean total impact for this group was $2 billion, clearly remeasurement is a significant component (82.7%) of the TCJA’s benefit. All companies in the favorable sample recorded a tax benefit associated with the remeasurement process, so it appears that these companies were in a net deferred tax liability position, since a decrease in the deferred liability generates a favorable tax impact.

For unfavorable companies in the sample, remeasurement makes up less of the total TCJA impact than for the favorable group. The mean impact for the 36 of 40 companies reporting remeasurement is $789 million of the mean total TCJA impact of $1.8 billion (43.8%, compared to 82.7% for the favorable group). The analysis clearly indicates that the transition tax is also a significant factor for unfavorable companies; the mean transition tax for this group is $1.3 billion, as opposed to only $149 million for favorable companies. It is too early to determine whether the law’s unfavorable impact will be ongoing for unfavorable companies; although the transition tax is a one-time tax, the ongoing impact of additional foreign provisions (e.g., GILTI and BEAT) that take effect in 2018 will continue to affect expense in future periods.

The sample showed that 13 companies disclosed the total impact of the TCJA (7 favorable, 6 unfavorable), but did not provide complete and specific details of its effect on current period tax expense. In some cases the amounts are quite large; the largest undisclosed benefit is over $20 billion, and the largest undisclosed cost is $5.7 billion. Even though the number of favorable and unfavorable companies not disclosing details of the new tax law is virtually identical, there is quite a disparity in the amounts reported between the groups. Favorable companies have an undisclosed mean benefit of $3.2 billion, but the mean expense reported by unfavorable companies is significantly smaller—only $627 million. While no definitive conclusions can be drawn from this information, perhaps companies felt less pressure to disclose specific components of the new legislation when the overall impact was favorable.

Domestic and Foreign Operations Impact

As noted above, many provisions in the TCJA address taxation of foreign operations. To explore whether companies with foreign operations are affected differently by the new law, the authors separately analyzed companies that operate globally and those that operate only domestically. A company is classified as operating in foreign jurisdictions if its 10-K discussion includes references to foreign operations, foreign income taxes, or other similar references. As reported in Exhibit 3, a substantial majority (62 of 75 companies, or 82.7%) of sample companies operate in foreign jurisdictions, while a minority (13 of 75, or 17.3%) has no (or immaterial) foreign operations.

The subsample of global companies demonstrates a greater variance in total tax expense than does the domestic subsample, but mean amounts are comparable. Global companies reported a mean total tax provision of approximately $1 billion, with amounts ranging from an overall tax benefit of $21.5 billion to an overall tax expense of $28.9 billion. By comparison, domestic companies report a mean total tax provision of $939 million, with amounts ranging from a benefit of $2.3 billion to an overall tax expense of $11.2 billion. Although the sample of 75 companies is limited, the findings with respect to mean values are somewhat inconsistent with recurring regulatory and media reports that suggest multinational corporations use aggressive tax planning techniques not available to other companies to substantially lower their tax burden (e.g., David Kocieniewski, “G.E.’s Strategies Let It Avoid Taxes Altogether,” New York Times, Mar. 24, 2011, https://nyti.ms/2FPJmR9; Kate Linebaugh, Scott Thurm, and Jessica Lessin, “Apple Tax Bill Overstated to Investors,” Wall Street Journal, May 21, 2013, https://on.wsj.com/2G1uiPq; John McKinnon “Lawmakers, White House Explore Tax Revamp for U.S. Firms Overseas,” Wall Street Journal, July 21, 2015, https://on.wsj.com/2CG42Xy).

Global companies report a mean unfavorable impact of approximately $8 million associated with the TCJA, while domestic companies recognize a mean unfavorable impact of approximately $68 million. Because they are not affected by the new law’s foreign provisions, the overall impact for domestic companies is driven by remeasurement of the U.S. deferred balance. This remeasurement results in a mean expense of approximately $57 million for the 12 domestic companies reporting this information.

A majority of global companies disclosed specific details of the impact associated with remeasuring deferred balances and the transition tax (54 and 43 of 75 companies, respectively). Global companies reported a mean benefit of approximately $407 million associated with the remeasurement of U.S. deferred balances, which was largely offset by a mean expense of approximately $896 million associated with the one-time transition tax. Eleven companies also reported a mean tax expense of $270 million related to other foreign and state implications.

Six global companies reported various other miscellaneous impacts of the TCJA that yielded a mean tax benefit of approximately $7 million, while 12 global companies either disclosed no specific details or incomplete details on components making up the impact of tax reform. By comparison, one domestic company disclosed expense associated with other miscellaneous provisions ($27 million), and one domestic company did not disclose specifics regarding a $172 million expense associated with tax reform.

A review of ranges across all categories for the sample again demonstrates the disparity of the TCJA’s impact across companies. The subsamples of global and domestic companies each include companies that experience favorable and unfavorable consequences overall and within most disclosure categories; however, the range of impact is substantially wider for foreign companies than for domestic companies, as evidenced by the minimum and maximum values in all categories of disclosure. Interestingly, the transition tax actually yielded a tax benefit for one global company within the sample. A closer review of this particular company’s disclosure reveals that the tax benefit is generated by the reduced federal rate being applied to earnings that were previously deferred for U.S. tax purposes. This unexpected result exemplifies the complexity of the TCJA’s changes and underscores the unique impact from company to company.

While the overall mean initial financial statement impact of tax reform is unfavorable for both global and domestic companies, the impact is more detrimental for domestic companies, at $68 million, versus $8 million for global companies. This result appears to be driven, at least in part, by the remeasurement of U.S. deferred balances that generate a mean favorable impact for global companies ($407 million benefit) and a mean unfavorable impact for domestic companies ($57 million expense). This suggests that wholly domestic companies were originally in a net deferred tax asset position, while global companies with foreign operations were originally in a net deferred tax liability position. Because companies operating in foreign jurisdictions will experience the ongoing impact of anti-abuse measures imposed through BEAT and GILTI, these companies may experience a cumulative unfavorable impact over time. Despite these new taxes, a finding that the initial impact of the TCJA did not generate more adverse consequences for global companies operating in foreign jurisdictions may surprise lawmakers and the general public.

Industry Impact

The minimum and maximum amounts presented in Exhibit 2 indicate a disparate impact across companies in the sample. A more detailed analysis of industry-specific ranges, as presented in Exhibit 4, indicates that this variance is driven largely by companies in the SIC 6 category (finance, insurance, and real estate). Companies in this category represent both the largest benefit and the largest expense for total tax, total TCJA impact, and remeasurement associated with deferred balances. Firms in the services industry [Standard Industrial Classification (SIC) code 7], however, generated both the largest benefit and largest expense associated with the one-time transition tax. With respect to undisclosed specifics around tax reform, a company within the SIC 4 category (transportation and public utilities) was responsible for the largest undisclosed benefit, while SIC 3 (manufacturing) was responsible for the largest undisclosed expense.

Interestingly, these same industries and companies represent the most significant impact (favorable or unfavorable) with respect to the subsample of companies with foreign operations, as shown in Exhibit 5. Industry representation across minimum and maximum values for domestic companies, as presented in Exhibit 6, is more varied; however, companies in SIC 6 are again represented with respect to maximum tax expense, maximum impact of the TCJA, and maximum expense associated with remeasuring U.S. deferred balances. Companies in SIC 4 make up the list of those with the greatest benefit associated with total tax impact, impact of the new act, and remeasurement associated with U.S. deferred balances. This combined analysis suggests that the unfavorable burden of tax reform is not borne by one or two specific industries. Most industries experience a combination of favorable and unfavorable effects across represented companies, with those effects driven largely by the directional impact of the remeasurement of deferred balances.

More to Come

This study highlights the multifaceted ramifications companies face as they report on the potential impact of the TCJA. The law’s complexity is evidenced by the wide variety of disclosures in the sample companies. While reductions in deferred tax accounts are a clear result of the new law, its numerous other provisions may have affected financial statements in a way that users did not anticipate. Reduced tax rates affect all companies, but those with foreign operations incur additional tax consequences. The impact is felt across sectors; most industries experience a combination of favorable and unfavorable effects, although some exhibit greater variation than others. In addition, most of the amounts reported by companies were provisional in nature, which indicates that adjustments throughout 2018 should be expected and that uncertainty still exists regarding the ongoing impact of the new law.