Deferred Tax Assets and Liabilities By Guest Blogger William R. Stromsem, JD, CPA

The Tax Cuts and Jobs Act of 2017 lowered the corporate income tax rate to a flat 21 percent and provided a one-time deemed repatriation tax on controlled foreign corporations’ current earnings and prior untaxed earnings back to 1986. The repatriation rate is 15.5 percent on liquid assets and 8 percent on illiquid assets instead of the prior 35 percent rate. Many large corporations are reporting radical changes to their bottom line from adjustments to their deferred tax assets and liabilities.

It is difficult to estimate the book income effect of the repatriation tax because we do not know how management may have initially accounted the deferred tax, with many companies assuming that earnings would be perpetually reinvested overseas and not booking deferred tax liabilities. Also, there is uncertainty as to when repatriation will be recognized with the new tax law allowing the tax to be paid over up to eight years. Some companies will pick up the tax expense immediately, with Apple announcing that it will pay $38 billion to repatriate its foreign earnings of $252.3 billion that have not been previously taxed in the U.S. It is estimated that more than $2.6 trillion in corporate profits are sitting in foreign bank accounts.

For tax rate changes, recent reports in the press show major companies taking hits: Amgen, $6-6.5 billion; Bank of America, $3 billion; and Credit Suisse, $2.32 billion. Fannie Mae and Freddie Mac had net operating losses from the financial meltdown and will have to adjust the value of their deferred assets downward by a combined total of $10-$20 billion. However, about two-thirds of the companies in the Dow Jones Industrial Average will have a boost in income as a result of reducing deferred tax liabilities. These include Verizon, $18.4 billion; Exxon, $12 billion; Pfizer, $17.5 billion; and Apple, $11 billion.

These valuation changes flow through the income statement, but most savvy analysts view this as not important and a distraction from real operating results. On the first page of his annual letter to shareholders, Warren Buffet commented on the $24 billion increase in Berkshire Hathaway income from adjusting its deferred taxes, saying that it distracted from operating results and, “For analytical purposes, Berkshire’s ‘bottom-line’ will be useless.”

Smaller corporations have less dramatic dollar amounts, but they still must make required valuation adjustments to their deferred taxes and be prepared to explain unexpected results to owners and lenders.

Accounting for taxes is a generally shared responsibility for financial accounting and tax experts, but often they each look at the other as having the primary responsibility. Financial accountants sometimes see tax accounting as tax, and tax experts see tax accounting as having FINs (financial interpretations). The important thing is for everyone to know what is required at this point. Accounting Standards Codification (ASC) 740, Income Taxes, requires adjustments to the beginning of the year balance of a valuation allowance if there is a change in circumstances that causes a change in management’s judgment about the realizability of the recognized deferred tax assets. A valuation allowance is required if it is more likely than not that some or all of the deferred tax asset will not be realized in the future. ASC 740 also requires analysis and disclosure of changes to deferred tax assets, which will help in seeing how corporations are managing their deferred tax assets and liabilities.

William R. Stromsem, JD, CPA, is a technical writer for TSCPA’s Federal Tax Policy Committee and an assistant professor at George Washington University School of Business.

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