The Tax Cuts and Jobs Act of 2017, also known as TCJA, brings significant change to the business world in the areas of tax compliance and financial statement reporting.
Much of the media coverage regarding TCJA relates to the tax consequences of the act. However, for those businesses that require financial statements based on U.S. GAAP (generally accepted accounting principles), the impact is far more reaching.
For C corporations, the new flat tax rate of 21 percent is the most publicized change. In terms of the effect felt on financial statements, it varies.
As per GAAP (ASC 740-10-05-5), issuers of financial statements must estimate for taxes payable or refundable in the current year, as well as any deferred tax liabilities or assets. Deferred tax liabilities and/or assets occur when there are temporary differences between GAAP and tax treatments. The most common differences for small businesses originate from depreciation, especially when businesses use accelerated depreciation allowable by the IRS (such as under Section 179, bonus depreciation).
Along with the flat tax rate, TCJA allows for an expanded bonus depreciation that allows 100 percent deduction for both new and used qualified assets placed in service after Sept. 27, 2017. The expansion of bonus depreciation contributes to the GAAP and tax differences that will be seen on financial statements.
Although TCJA provides a flat tax rate of 21 percent that will reduce corporate income tax for many businesses, some small C corporations that have had taxable income under $50,000 will actually have a tax increase, since the 2017 rate is 15 percent on the first $50,000 of taxable income. However, those businesses classified as personal service corporations will have a tax decrease from 35 percent to the new flat tax of 21 percent, which will be apparent on their financial statements.
One of the drawbacks of TCJA is the limitation placed on net operating losses, also known as NOLs.
TCJA limits the use of NOLs to 80 percent of taxable income. In prior years, corporations were able to completely wipe out current-year taxable income with NOLs generated in prior years. Another restriction from TCJA is the removal of the ability to carryback NOLs, whereas corporations previously were able to carryback an NOL two years. With the removal of the carryback period, TCJA compensates for that loss by removing the 20-year limitation on NOL carry-forwards.
All of the changes to the treatment of NOLs will have a direct impact on financial statements, including footnotes to those issuers with NOLs.
In addition to the reduction of the corporate tax rate and NOL limitations, TCJA limits two expenses incurred by most corporations: interest expense and meals and entertainment.
The limitations on these expenses will increase the differences in income reported on financial statements and tax returns.
TCJA imposes a limitation on interest expense to not exceed 30 percent of taxable income. Fortunately, the portion of interest expense that is above the limitation, and thus disallowed, is permitted to be carried forward to future tax years. It is important to note that this limitation does not apply to small businesses with average gross receipts of $25 million or less for the past three years.
The deduction for meals and entertainment has been further reduced to eliminate all entertainment expenses, which include meals that are considered entertainment as well. Meals provided to employees by the employer for their convenience have been reduced from 100 percent deductibility to 50 percent.
Small businesses will see a substantial impact on their financial statements resulting from the provisions found in TCJA. Business owners should keep apprised of any guidance released by the IRS to better interpret how TCJA will influence both their tax and financial statement reporting.
Ashley N. Blessing is a supervisor in the small business department of Herbein Company Inc. in Reading. She is co-chair of the Pennsylvania Institute of Certified Public Accountants’ Reading Chapter Emerging CPAs Committee and is a member of the chapter’s community engagement committee.