Wealth through Investing

US Corporate Tax Cuts: Two Boogeymen to Keep in Mind


The yet-to-be-completed US tax bill reducing the corporate tax rate from 35% to 20% and encouraging the repatriation of earnings is generally seen by investors as a positive development.

But investors should be mindful of several resulting tax consequences that may decrease valuations and corporate earnings once the bill is enacted.

Since the US Senate voted on legislation last week, firms and regulators have contemplated the potential ramifications. Representatives from the US Securities and Exchange Commission (SEC) told participants at the 2017 AICPA Conference on Current SEC and PCAOB Developments this week that they would keep an eye on the legislation and how it should affect the recognition and disclosures in companies’ year-end filings — assuming the final bill is signed before the financial statements are issued.

On Wednesday, Citigroup announced it would incur a $20-billion charge under the proposed Senate bill’s provisions. Citigroup’s statement illuminated two key impacts of the legislation that investors should keep in mind.

Net Deferred Tax Assets

First, companies with net deferred tax assets — those with significant net operating loss carryforwards (NOLs) or those with substantial deductions taken for tax before book (e.g., litigation expenses, loan loss accruals, etc.) — will see the value of those net deferred tax assets decline. Very simply, a $1,000 NOL is worth $350 under the current tax law’s 35% corporate rate, but would only be worth $200 should the rate fall to 20%.

Citigroup said that such a change would cost it $16–$17 billion. As a consequence, some corporations are exploring how they might accelerate earnings to more quickly apply those NOLs under the current higher tax regime, while they are worth more. Using these NOLs would lower a company’s taxable income and, by reducing current tax due, increase its cash.

Firms with a net deferred tax liability, in contrast, stand to benefit from the new lower rate.

Undistributed Earnings of Subsidiaries

The second and perhaps lesser-known effect of the tax bill would require companies to recognize tax liabilities on the undistributed earnings of subsidiaries if these companies change their previously articulated plans to not repatriate such earnings. US GAAP does not require firms to recognize tax liabilities on the earnings of subsidiaries when there is an explicit plan not to repatriate those earnings. The FASB issued a proposal last year to enhance the disclosure of such potential liabilities upon repatriation should repatriation plans change, but it has yet to be finalized.

Citigroup said this change could cost it between $3 and $4 billion.

Investors need to be aware of these potential valuation and income-statement effects. Until President Donald Trump signs the bill into law, US GAAP prohibits recognizing the effects in the financial statements. Regardless of the timing of the recognition in the financial statements, investors should consider these impacts as they calculate valuations in the upcoming months and discuss any potential effects with management.

If you liked this post, don’t forget to subscribe to the Enterprising Investor.

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.

Image credit: ©Getty Images/Tanarch


Source link

Leave a Reply

Your email address will not be published. Required fields are marked *