Alert January 16, 2018

Disclosure of Accounting Impact of the Tax Cuts and Jobs Act in SEC Reports

Summary

On December 22, 2017, the Office of the Chief Accountant (the OCA) and the staff of the Division of Corporation Finance (the Staff) of the Securities and Exchange Commission published guidance relating to financial accounting and disclosure issues that result from the tax reform act generally referred to as the Tax Cut and Jobs Act (the Tax Act) that the president signed on the same date. Staff Accounting Bulletin No. 118 (SAB 118), published by the OCA and the Staff, provides a framework for companies to gather and analyze the information necessary to account for certain income tax effects of the Tax Act for the reporting period in which the Tax Act became law. Compliance and Disclosure Interpretation 110.02 (C&DI 110.02), published by the Staff, confirms that re-measurement of a deferred tax asset as a result of changes in tax rates or other provisions of the Tax Act will not trigger an impairment subject to mandatory reporting under Item 2.06 of Form 8-K. This alert also summarizes some of the other disclosure matters that companies should consider as they evaluate the impact of the Tax Act on their financial accounting and business disclosures.

SAB 118

The Tax Act changes numerous provisions of United States tax law that will affect a large number of companies. Because the Tax Act was signed into law on December 22, 2017, companies may not have completed their accounting for certain income tax effects when they issue their financial statements for the reporting period that includes December 22, 2017. SAB 118 provides SEC guidance on how companies should apply Accounting Standards Codification Topic 740, which provides accounting and disclosure guidance on accounting for income taxes under U.S. generally accepted accounting principles. SAB 118 deals only with the application of ASC Topic 740 in connection with the Tax Act, and states that its guidance should not be relied upon for purposes of applying ASC Topic 740 to any other changes in tax laws.

Because the Tax Act became law late in December 2017, it may be difficult for companies to assess and account for its impact on current and deferred taxes under ASC Topic 740 before they issue financial statements that include the reporting period in which the Tax Act was enacted.

SAB 118 provides the following guidance on accounting for the impact of the Tax Act on financial statements that include the reporting period in which the Tax Act became law:

  • Assessment is complete – companies that have completed their accounting for the income tax effects of the Tax Act must account for those effects in their financial statements for fiscal periods that include December 22, 2017.
  • Reasonable estimate – companies whose accounting for the income tax effects of the Tax Act is incomplete but for which the company has determined a reasonable estimate should report the reasonable estimate in their financial statements for fiscal periods that include December 22, 2017. The reasonable estimate would be reported as a provisional amount in the financial statements during the “measurement period” described below. SAB 118 states that any provisional amounts or adjustments to provisional amounts included in a company’s financial statements during the measurement period should be identified as such and “included in income from continuing operations as an adjustment to tax expense or benefit in the reporting period the amounts are determined.”
  • No reasonable estimate – in the case of any specific income tax effects of the Tax Act for which a company cannot determine a reasonable estimate, the company should not report provisional amounts. Instead, the company should continue to apply ASC Topic 740 based on the provisions of the tax laws that were in effect immediately prior to December 22, 2017. For those income tax effects for which companies are not able to determine a reasonable estimate (with the result that no related provisional amount was reported for the reporting period in which the Tax Act was enacted), companies would report provisional amounts in the first reporting period in which the company can make a reasonable estimate. The Staff does not believe that a company should adjust its current or deferred taxes for those tax effects of the Tax Act until the company can determine a reasonable estimate.

Measurement Period Timeframe. The measurement period for the guidance described above begins in the reporting period that includes the enactment of the Tax Act, or December 22, 2017. For companies with a calendar year end, this means that the relief provided by SAB 118 will begin with a company’s Form 10-K report for the year ended December 31, 2017. The measurement period ends when a company has obtained, prepared and analyzed the information necessary to complete the accounting requirements under ASC Topic 740. During the measurement period, the Staff expects that companies will act in good faith to complete their accounting for the impact of the Tax Act. SAB 118 states that the Staff believes that in no circumstances should the measurement period extend beyond one year from the date of enactment of the Tax Act. SAB 118 includes two examples that illustrate the application of the guidance to unremitted foreign earnings and deferred tax assets.

Changes in Subsequent Reporting Periods. During the measurement period, a company may need to adjust provisional amounts as it obtains, prepares and analyzes additional information about facts and circumstances that existed as of the enactment date that, if known, would have had an impact on the income tax effects that the company initially reported as provisional amounts. Companies may also need to report additional tax effects during the measurement period, based on additional facts and circumstances that existed as of the enactment date but were not initially reported as provisional amounts. SAB 118 states that companies should not report income tax effects of events that are not related to the Tax Act as measurement period adjustments.

Disclosures During the Measuring Period. If a company accounts for income tax effects of the Tax Act for which accounting under ASC Topic 740 is incomplete during the measurement period described above, SAB 118 indicates that the company should include financial statement disclosure concerning the material financial reporting impact for which accounting is incomplete, including:

  • qualitative disclosures of the income tax effects of the Tax Act for which the accounting is incomplete;
  • disclosures of items reported as provisional amounts;
  • disclosures of existing current or deferred tax amounts for which the income tax effects of the Tax Act have not been completed;
  • the reason why the initial accounting is incomplete;
  • the additional information that is needed to be obtained, prepared, or analyzed in order to complete the accounting requirements under ASC Topic 740;
  • the nature and amount of any measurement period adjustments recognized during the reporting period;
  • the effect of measurement period adjustments on the effective tax rate; and
  • when the accounting for the income tax effects of the Tax Act has been completed.

Form 8-K Impairment Reporting – C&DI 110.02

Item 2.06 of Form 8-K requires companies to report material charges for impairments of assets. Companies that have deferred tax assets will need to revalue those assets in light of the changes in tax rates under the Tax Act. C&DI 110.02 confirms that re-measurement of a deferred tax asset to reflect the impact of a change in tax rate or tax laws is not an impairment under ASC Topic 740 and will therefore not trigger a reporting requirement under Item 2.06.

C&DI 110.02 also notes that changes in tax rates or other elements of U.S. tax laws under the Tax Act could affect a company’s financial statements (including the likelihood that the company will realize a deferred tax asset). C&DI 110.02 states that if a company determines that an impairment has occurred as a result of the provisions of the Tax Act during the measurement period described in SAB 118, the company can defer disclosure of this impairment or provisional amounts related to the possible impairment until the company’s next periodic report, rather than reporting these amounts under Item 2.06 of Form 8-K. This is based on an instruction to Item 2.06 that provides that Item 2.06 does not require a company to report a material impairment if the company concludes that a material charge for an impairment is required in connection with the preparation, review, or audit of its financial statements that are required to be included in its next periodic report if the company files the report on time and discloses its conclusion in the periodic report.

Other Disclosure Considerations

Regulation FD. Companies should be prepared for questions from investors, analysts and the media about the impact of the Tax Act on their financial statements. Companies that expect to discuss these matters before publicly disclosing them in their earnings releases or periodic reports should consider whether this information is material non-public information that is subject to the disclosure requirements of Regulation FD. Companies may comply with Regulation FD in a variety of ways, including by filing an Item 7.01 Form 8-K report.

Form 8-K Item 2.02 – Information Regarding Completed Fiscal Periods. Item 2.02 of Form 8-K requires companies to file a Form 8-K report if they make any public announcement or disclosure material non-public information regarding the company’s results of operations or financial condition for a completed quarterly or annual fiscal period. Item 2.02 applies to both new information as well as to the release of additional or updated material non-public information.

Non-GAAP Financial Measures. Companies should review their financial disclosures for compliance with Regulation G and Item 10(e) of Regulation S-K, which apply to non-GAAP financial measures. This could include, for example, financial disclosures that include adjustments for the impact of the Tax Act. Although these disclosures may in many cases satisfy the requirements of Regulation G that the disclosure include presentation of the most directly comparable GAAP financial measure and a reconciliation of the two measures, companies should remember the additional requirements of Item 10(e) that apply to documents filed with the SEC and, in part, to earnings releases furnished under Item 2.02 of Form 8-K.

MD&A, Risk Factors and Forward-Looking Statement Disclaimers. Companies should consider additional disclosure about the potential future impact of the Tax Act in their SEC reports or registration statements and in their voluntary disclosures (such as earnings releases). For example, companies should review their disclosure of known uncertainties and trends in Management’s Discussion and Analysis of Financial Condition and Results of Operations. Companies should also consider including cautionary disclosure about any risks or uncertainties and the potential impact of those risks or uncertainties in the Risk Factors section or with the forward-looking statement disclaimers, or both, as appropriate.

Company Offerings and Insider Sales. Until a company has completed its accounting for the effects of the Tax Act and filed financial statements that reflect those effects, companies should consider the potential impact of interim accounting disclosures on sales of company securities by the company and its affiliates. The interpretive relief provided by SAB 118 does not create a safe harbor for interim accounting disclosures. In order to minimize potential disclosure issues, companies may wish to prioritize the completion of their accounting work. Until a company has completed its accounting and filed the related financial statements, it should consider the potential liability both for disclosures about the effects of the Tax Act and for disclosures about U.S. federal tax laws in registration statements. These considerations apply not only to specific public offerings but also to ongoing company offerings such as at-the-market offerings, dividend and direct stock purchase plans, and equity incentive plans as well as to sales by affiliates who may be in possession of material non-public information.