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How Tax Reform May Affect Financial Reporting

7/11/17 – Curt Wenzler & Jami Vallandingham

As Congress and the Trump administration push for major changes to the U.S. tax code, large companies are encouraging the Financial Accounting Standards Board (FASB) to monitor how the changes may affect U.S. Generally Accepted Accounting Principles (GAAP).

Blueprint for change

Republican lawmakers are weighing proposals to overhaul the existing tax code. The effect on financial reporting could be significant, and companies may not have enough time to digest all the changes.

“If we haven’t thought about the impacts or consequences of fundamental change, will we be behind the eight ball when the change comes?” asks Erik Bradbury, professional accounting fellow at Financial Executives International, a trade group that represents some of the largest U.S. companies. Bradbury goes on to say, “If we haven’t gathered experts and if some of the changes go through, we might be putting people in a very difficult position.… We’re not talking about a small change that is a change in the corporate rate. We’re talking about a much larger potential change in the tax system.”

One example of possible tax reform comes from House Ways and Means Committee Chairman Kevin Brady (R-Texas). He has released a tax reform blueprint that calls for a consumption tax that’s a hybrid of an income tax and the value-added tax (VAT). The latter is particularly common among European Union members. The blueprint:

• Allows immediate expensing rather than deprecation for acquired assets,
• Bars deductions for net interest expense, and
• Includes a border adjustment tax.

The border adjustment tax would essentially exempt goods and services that are exported from being taxed. However, imports would still be taxed.

Financial reporting for taxes

Under GAAP, income taxes typically are accounted for under Topic 740, Income Taxes. However, gross receipts taxes and equity taxes have been excluded from that guidance. Consumption taxes, such as a VAT, also are usually accounted for as operating taxes outside the scope of the income tax guidance.

Given the possibility of tax reform that would be a hybrid between an income tax and a VAT and the increasing prevalence of such taxes outside the United States, Financial Executives International has asked the FASB to assess the effect of tax reform on financial reporting. The trade group would like the FASB to consider changing the existing reporting requirements to instead classify these alternative taxes as an operating expense or an income tax.

The challenge with trying to assess the effect of tax reform on GAAP is that where the reforms will end up is unknown. If the proposed blueprint doesn’t become law, questions about how to account for a tax that is a mix between an income tax and a VAT may be moot.

Some practitioners predict that tax reforms will consist of lowering corporate tax rates and a one-time tax on multinational corporations’ undistributed foreign earnings. These changes would have different financial reporting implications.

Stay tuned

In response to comments from Financial Executives International, a FASB spokesperson said the FASB is paying attention to the issue. “The FASB continually monitors legislation that could affect generally accepted accounting principles, including stakeholder perspectives on its potential impact, before determining whether it’s appropriate to take action.”

Contact Curt Wenzler or Jami Vallandingham for the latest on tax reform — and how the changes might impact financial reporting under GAAP.