The $2.2 trillion economic stimulus package, the Coronavirus Aid, Relief, and Economic Security (CARES) Act includes many tax and non-tax provisions to assist individuals, businesses, and the unemployed. Tax changes in the CARES Act and other tax law changes that have come about to offset the economic impact of the COVID-19 pandemic create many potential issues to consider with accounting, from going concern evaluations to financial statement disclosures. For public companies with quarterly financial filings to prepare, there will be a number of income tax accounting implications that will need to be addressed now.
Accounting for Tax Law Changes in Interim Periods
Under ASC Topic 740, companies are required to account for changes in tax law in the period in which the new legislation is enacted. The CARES Act is considered enacted on March 27, 2020, when President Trump signed it into law. As such, for calendar year SEC registrants, the time to account for the law change is the first quarter of 2020.
If the tax effects of tax law changes affect income tax receivable of the current year, an organization would recognize the tax effects in the estimated annual effective tax rate starting in the interim period that includes the enactment date. ASC Topic 740-270 also requires companies to use their annual estimated tax rate to calculate the income tax expense in the interim period. That rate is then applied to the pre-tax income or loss earned year to date in order to compute the estimated year-to-date income tax expense.
The calculation for annual estimated effective tax rates may be a little difficult in the current environment because companies will need to consider how current market conditions may affect their companies’ annual estimated effective tax rate. This approach requires a forecast of “ordinary income,” which is generally defined as income from continuing operations before taxes, excluding significant unusual or infrequently occurring items. While it may be challenging to determine whether significant events should be classified as infrequently occurring or unusual, it may be necessary. Companies will need to carefully consider both future expectations as well examine the specific facts and circumstances surrounding the event. In addition, ASC 740 includes a provision that if a reliable estimate of the annual taxable income cannot be made, the actual effective tax rate for the year to date may be utilized as the best estimate of the annual effective tax rate. The ability to forecast for other purposes, such as impairment computations and going concern analysis, may call into question a conclusion that the company is unable to reasonable estimate the annual effective tax rate.
It’s also important to consider how tax law changes affect prior tax returns. The tax effects of income tax receivable for a prior year would be recognized as a discrete income tax expense from continuing operations as of the enactment date.
Deferred tax assets and liabilities may need to be remeasured to reflect the impact of tax law changes in the interim period in which the law went into effect. This remeasurement is allocated to the income tax expense from continuing operations.
Tax Law Changes in the CARES Act
The CARES Act includes tax-related provisions that may affect income taxes, including:
- Temporarily removes the taxable income limitation of 80% to allow net operating losses (NOLs) to fully offset income
- NOLs generated in 2018, 2019, or 2020 can be carried back five years, with no taxable income limitation
- The CARES Act increases the interest expense limitation from 30% to 50% of Adjusted Taxable Income to all taxpayers for tax years beginning in 2019 and 2020
- The CARES Act accelerates the refund of prior AMT credits, which under the tax reform law commonly known as the Tax Cuts and Jobs Act (TCJA) were to be refunded incrementally through 2021
- A fix for the “retail glitch” that permits qualified improvement property to be eligible for 100% bonus depreciation if it was placed in service after Dec. 31, 2017
- Increase in the cash charitable contribution deduction for corporations from 10% to 25% of taxable income
Accounting for Net Operating Losses
Companies with deferred tax assets (DTAs) associated with NOL carryforwards originating in 2018 and 2019 that anticipate carrying back the related losses to earlier years, will need to consider the impact of tax rates in the carryback year to which the losses are applied and adjust the carrying amount of the related deferred tax assets accordingly as a discrete adjustment in the company’s Q1 2020 tax expense.
For example, an NOL from 2018 that was measured at 21%, under the CARES Act may be carried back to offset taxable income from 2013 that would have been taxed at a 35% federal income tax rate. This requires revaluing the carrying value of these DTAs at the high tax rate. If the refund is expected, the DTA should be reclassified on the balance sheet to a current tax receivable (or a reduction in taxes payable).
In addition to NOL balances as of the beginning of the year, if a company is forecasting a taxable loss for 2020 and expects to carry it back to a pre-2018 tax year, it may result in a benefit in the estimated annual effective tax rate at the 35% rate.
Valuation Allowance Considerations
Companies continuously need to evaluate their deferred tax assets to determine whether the weight of all available evidence supports their recognition, or if a valuation allowance is necessary. If an entity anticipates unexpected losses in the current year due to the COVID-19 pandemic, it will need to include this negative evidence in its valuation allowance assessment.
Conversely, the ability to carry back NOLs combined with the temporary removal of the 80% annual limitation on the use of NOL carryforwards may result in changes to a company’s conclusions regarding the realizability of its deferred tax assets. The changes to the NOL carryback and carryforward rules may also require the need to reassess the scheduling of reversals of existing taxable temporary differences, which may result in a change in the amount of valuation allowance required.
Note that under ASC Topic 740, the impact of a change in judgment regarding the realizability of your organization’s beginning-of-year deferred tax balances should be recognized as a component of income tax expense or benefit from continuing operations and recorded as a discrete adjustment in the current quarter, rather than an inclusion in the annual effective tax rate calculation.
Asserting Indefinite Reinvestment
The worldwide impact of the COVID-19 pandemic may require companies to revisit their ability to continue to assert the indefinite reinvestment of foreign earnings. If a company changes its indefinite reinvestment assertion, the impact of the change should be reported as a discrete item to income tax expense in continuing operations in the period in which the change in assertion occurs.
Companies with Year-to-Date Ordinary Losses in an Interim Period
Companies may have unexpected ordinary losses and will need to determine if they are able to benefit those losses when computing their estimated annual effective tax rate. It will be important for companies to keep in mind that when an entity has a year-to-date ordinary loss that exceeds the anticipated ordinary loss for the full year, ASC Topic 740 limits the income tax benefit recognized for the year-to-date interim period to the amount of ordinary loss anticipated to be recognized for the full year.
This limitation does not apply to companies that have early adopted ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes, which eliminates this exception in ASC Topic 740. Under the changes in ASU 2019-12, a company would no longer limit the tax benefit recognized in an interim period if it expects to realize a tax benefit.
Stay Tuned for More Guidance
Companies affected by the COVID-19 pandemic that are subject to Exchange Act reporting may be eligible for a 45-day grace periods for interim filing requirements. The situation around the COVID-19 pandemic continues to evolve. Our team will continue to provide updates as information becomes available through our COVID-19 Resource Center. For more information, please contact us.
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