US Corporate Tax Cuts: Investors Should Request Companies Include Income Tax Footnote with 2017 Earnings Release

Investors need to request that the companies they invest in include the income tax footnote along with their 2017 earnings release. Why? Because if firms wait until the financial statements are released — possibly weeks after earnings disclosures — investors will likely lack potentially valuable information for their investment analysis and decision making.

Over the last several weeks, many companies — Citigroup, Goldman Sachs, and BP Amoco, among them — have issued statements about the negative consequences of requiring them to incorporate the provisions of the newly enacted Tax Cut and Jobs Act into their 2017 financials. Other firms have been identified as particular beneficiaries of certain aspects of the bill.

The tax bill requires companies to establish liabilities associated with deemed repatriated earnings and reassess the valuation of certain deferred tax assets or liabilities in their 2017 financials. They must also consider many other provisions that could affect 2017 financial statements, whether because they impact transactions in 2017 — such as cost recovery of qualified property purchased after 27 September 2017, the elimination of the corporate alternative minimum tax (AMT) credit carryforwards, etc. — or they affect existing assets and liabilities because the law impacts estimates of future taxable income — like the 30% limitation on the deductibility of interest expense, the lower tax rate, etc.

The volume and complexity of the changes combined with their interconnected intricacies have left companies scrambling to understand and incorporate the new rules into their 2017 financial statements since President Donald Trump signed the bill into law on 22 December 2017.

On the same day, the US Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin 118 (SAB 118) in response to public requests from companies for relief since the bill became law so late in the year. SAB 118 is not a filing date extension for financial statements, however. Rather it gives companies one year to complete the tax estimates included within the financial statements resulting from the new law. It also requires new financial statement disclosures as to the completeness of the accruals at year-end 2017 and throughout 2018 as firms adjust, or “true-up,” these accruals. More specifically, SAB 118 provides guidance for registrants depending on their measurement of certain income tax effects:

• When the tax effects are complete, companies should note that in their disclosures and include the estimates in their financial statements.
• When the tax effects of specific estimates are incomplete but can be reasonably estimated, firms should provide provisional amounts — or subsequent adjustments to provisional amounts — in the measurement period during which they are determined.
• If the tax effects cannot be reasonably estimated, registrants are not required to include them in their financial statements until they can make a reasonable estimate. Pending that estimate, they should apply existing tax accounting provisions.

Under SAB 118, companies can recognize or disclose estimates that have varying degrees of reliability provided they categorize them according to the criteria above and provide the following information when the accounting is incomplete:

• Qualitative disclosures of the income tax effects of the law when the accounting is incomplete.
• Disclosure of items reported as provisional amounts.
• Disclosure of existing current or deferred tax amounts for which the income tax effects of the tax bill have not been completed.
• The reason why the initial accounting is incomplete.
• The additional information that must be obtained, prepared, or analyzed to complete the accounting requirements under existing tax accounting rules.
• The nature and amount of any measurement period adjustments recognized during the reporting period.
• The effect of measuring period adjustments on the effective tax rate.
• When the accounting for the income tax effects of the law has been completed.

SAB 118 permits firms to assess the completeness of their estimates at a date of their choosing, from year-end up to when the earnings or financial statements are released.

While firms are allowed these “true-up” periods for certain business combination estimates, the use of this provision has been limited over the last decade due to a change in accounting rules. The SEC’s application of similar guidance to tax estimates is unprecedented, though it is understandable given that the tax bill was passed so late in the calendar year.

For investors, the 2017 tax legislation and the SEC guidance pose unique challenges. While companies have warned about the potential negative consequences, the details are limited and other impacts of the legislation on investee firms have yet to be commented on.

Furthermore, while the SEC has provided firms some much-needed relief, that relief could leave investors without information on the precision of the estimates since companies don’t have to disclose how they’ve applied SAB 118 with their earnings releases but rather some time after, with their financial statements.

Because of this delay, investors should request the companies in which they are shareholders provide the income tax footnote at the time of the earnings release so they can better understand the effects of the new legislation.

The Financial Accounting Standards Board’s measures to improve tax disclosures were trumped — pun intended — by the passage of the 2017 Tax Act. The footnote disclosures won’t include necessary information for investors, such as a rollforward of the current and deferred income tax or an indication of the location of the deemed repatriated tax liabilities generated by the new bill, or provide the cash to pay it. That said, investors will still need the tax footnote to understand the nature of the change in existing accruals, the establishment of new accruals, and the degree of precision associated with such estimates.

Only with the footnote will investors be able to make a meaningful judgment on the quality of these earnings-related adjustments. For that reason, investors should seek the additional disclosures. And the sooner the better.

Investors will also need to consider the importance of liquidity disclosures at year-end. But that is a story for another post.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Images credit: ©Getty Images/ Wil Etheredge