On December 22, 2017, the president signed into law the Tax Cuts and Jobs Act (the “Act”). The Act includes a permanent reduction in the maximum corporate income tax rate from 35% to 21% effective for tax years beginning after December 31, 2017.
Although companies should benefit from the reduced corporate tax rate under the Act, the Act could have an immediate and substantial negative effect on the current earnings of any company that carries a deferred tax asset (“DTA”) on its balance sheet. The lower corporate income tax rate under the Act means the future benefit of a company’s existing DTA needs to be computed at the new (lower) tax rate. Accordingly, a company will need to reduce the value of its DTA and take a corresponding increase to its tax expense in the current reporting period, thereby reducing net earnings.
Under generally accepted accounting principles in the United States, many financial institutions use the asset and liability method of accounting for income taxes. Under this method, a company determines the value of its DTA based on the current enacted federal tax rate (i.e., generally, 35% prior to the passage of the Act). As a result of the reduction in the corporate income tax rate to 21% from 35% under the Act, a company will need to revalue its net DTA effective as of December 22, 2017.For most companies, the reduction in the corporate tax rate should result in a corresponding reduction in the value of the company’s DTA. Because this revaluation must be made for the period during which the Act was effective, i.e. during the year and quarter ended December 31, 2017, the write-down of DTA will result in an immediate increase in income tax expense, and thus reduced earnings, for any company with DTA on its books.
Public Disclosure Related to the Impact of the Act
Companies should review with their auditors and legal counsel the impact of the Act on their current and future financial statements. With the Act becoming law on December 22, 2017, some publicly registered companies have filed current reports with the Securities and Exchange Commission (the “SEC”) disclosing the expected impact on earnings due to the Act, and specifically, due to the revaluation of the company’s DTA. If a company determines that the passage of the Act will result in a material change to its DTA, which will materially impact earnings for the period ending December 31, 2017, we recommend that consideration be given to the filing of a Current Report on Form 8-K with the SEC. Depending on the timing of the determination as to the impact on the DTA, disclosure may be coordinated with the fourth quarter/year-end earnings press release. Companies that do not have filing obligations with the SEC should consider issuing a press release disclosing the estimated impact of the Act, if material.
The SEC Accounting Staff has provided initial guidance indicating that the re-measurement of the DTA to reflect a reduction in corporate tax rates is not an impairment under ASC Topic 740, Uncertainty of Income Taxes. Each company must make its own determination as to the methodology of revaluation and whether any such revaluation will have a material impact on its results of operations.
Luse Gorman is one of the leading firms nationally in advising financial institutions on capital-raising, mergers and acquisitions, corporate and securities, regulatory and executive compensation/employee benefits matters. Please contact Eric Luse, John Gorman, Lawrence Spaccasi and Kip Weissman, if you would like to discuss any information contained in this alert.