Introduction. Objectives. Avoid the Eight Common ASC 740 Pitfalls. Refresh on recent ASC 740 pronouncements. Tax Reform Update.

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1 Birmingham CPE Seminar ASC 740: Common Pitfalls & Regulatory August Introduction Objectives Avoid the Eight Common ASC 740 Pitfalls Refresh on recent ASC 740 pronouncements Tax Reform 2 DHG Birmingham CPE Seminar 1

2 Eight Common ASC 740 Pitfalls 1. Intraperiod Allocation 2. Hanging Credits 3. Jurisdictional Netting 4. Tax Attribute Disclosure 3 Eight Common ASC 740 Pitfalls 5. Alternative Minimum Tax 6. FIN 48 Disclosure 7. APB 23 Disclosure 8. Outside Basis Differences 4 DHG Birmingham CPE Seminar 2

3 Intraperiod Allocation Allocate tax expense to income and equity components such as: Continuing operations Discontinued operations Other comprehensive income Other items affecting shareholders equity General rule: the tax item should follow the book item of income, gain, expense, or loss 5 Intraperiod Allocation - Question True or False? The sum of the separate tax effects of each allocation always equals the amount of income tax that remains to be allocated out after allocating to continuing operations. 6 DHG Birmingham CPE Seminar 3

4 Intraperiod Allocation - Example Assume the following: No perm or temp book/tax differences $1,000 ordinary loss from continuing operations (ordinary income taxed at 40%) $1,500 capital gain from discontinued operations (capital gains taxed at 40%) Ordinary losses offset capital gains How much tax expense(benefit) allocated to discontinued operations? 7 Intraperiod Allocation - Example Incorrect Solution Capital Gain from Discontinued Operations $ 1,500 Capital Gains Tax Rate 40% Tax Expense to Discontinued Operations $ DHG Birmingham CPE Seminar 4

5 Intraperiod Allocation - Example Correct Solution Capital Gain from Discontinued Operations $ 1,500 Ordinary Loss from Continued Operations $ (1,000) Net Taxable Gain $ 500 Capital Gains Tax Rate 40% Total Tax Expense $ 200 Ordinary Loss from Continued Operations $ (1,000) Ordinary Income Tax Rate 40% Tax Benefit to Continuing Operations $ (400) Total Tax Expense $ 200 Tax Benefit to Continuing Operations $ (400) Tax Expense to Discontinued Operations $ Hanging Credits Indefinite-lived intangible assets are: Not amortizable for book purposes (held for impairment) May be amortizable for tax purposes Can result in hanging credit (a/k/a naked credit ) if there is a valuation allowance in play 10 DHG Birmingham CPE Seminar 5

6 Hanging Credits - Examples No Valuation Allowance DTA for Misc. Reserves and NOLs $ 10,000 DTL for Intangibles $ (6,000) Net DTA(DTL) $ 4, Hanging Credits - Examples Full Valuation Allowance DTA for Misc. Reserves and NOLs $ 10,000 DTL for Finite Lived Intangibles $ (6,000) Net DTA(DTL) $ 4,000 Valuation Allowance $ (4,000) Net DTA(DTL) $ 12 DHG Birmingham CPE Seminar 6

7 Hanging Credits - Examples Full Valuation Allowance DTA for Misc. Reserves and NOLs $ 10,000 Valuation Allowance $ (10,000) DTA after Valuation Allowance $ DTL for Indefinite Lived Intangibles $ (6,000) Net DTA(DTL) $ (6,000) 13 Jurisdictional Netting Separately state DTAs and DTLs if they: Are from different tax paying jurisdictions, or Arise form different tax paying entities (i.e. nonconsolidated filers in same jurisdiction) Most U.S. companies net by country, not state Complexities in VA situations Simplified by ASU Did you expand into a new jurisdiction? Did you add an additional tax paying entity in an existing jurisdiction? 14 DHG Birmingham CPE Seminar 7

8 Jurisdictional Netting - Example Country A Country B Worldwide Total DTAs $ 50,000 $ 20,000 $ 70,000 Total (DTL)s $ (30,000) $ (80,000) $ (110,000) Net DTA(DTL) $ 20,000 $ (60,000) $ (40,000) What DTA(DTL) should be reported on the consolidated balance sheet? 15 Jurisdictional Netting - Example Incorrect Total DTAs $ Total (DTL)s $ (40,000) 16 DHG Birmingham CPE Seminar 8

9 Jurisdictional Netting - Example Correct Total DTAs $ 20,000 Total (DTL)s $ (60,000) 17 Tax Attribute Disclosures Operating losses Tax credit carryforwards Expiration dates State-specific items may have different carryforward periods These are common sources of provision-to-return differences. Usually permanent in nature. Error vs. change in estimate? 18 DHG Birmingham CPE Seminar 9

10 Alternative Minimum Tax AMT NOL can differ from regular tax NOL Can only offset AMT liability with 90% of AMT NOL Effectively pay 2% tax AMT tax credit Generated when AMT is paid Utilized against regular tax in a future year Watch out for valuation allowance considerations 19 Alternative Minimum Tax NOL - example Regular NOL Regular NOL Created in PYs AMT NOL 1,000,000 AMT NOL Created in PYs 1,000,000 Current Year Income 800,000 Current Year Income that can be offset 720,000 = 800,000 x 90% Current Year Tax 0 Current Year AMT 16,000 = 80,000 x 20% Remaining NOL 200,000 Remaining NOL 280,000 AMT Tax Credit to offset future tax 16,000 AMT Tax Credit created 16, DHG Birmingham CPE Seminar 10

11 FIN 48 (ASC740-10) Disclosure More likely than not test Determines when to recognize a tax position Met if there s a >50% chance the position will be sustained upon examination De-recognize tax position when: Effectively settled Statute expired No longer meets >50% test 21 FIN 48 (ASC740-10) Disclosure Common Federal Issues: Tax Credits Transfer Pricing Domestic Production Activities Deduction Accounting Methods Common State Issues: Nexus (i.e. choosing not to file in state) Apportionment Methods Intercompany Expenses 22 DHG Birmingham CPE Seminar 11

12 FIN 48 (ASC740-10) Disclosure Key Questions What new positions might have been created this year? What new authoritative guidance might impact a previously assessed position? 23 APB 23 Disclosure General Rule for Foreign Subsidiaries: Record a DTL for the excess of book basis over tax basis in subsidiary DTL not required if investment is permanent in nature Permanently invested in initial investment Earnings permanently reinvested DTA for excess of tax basis over book basis typically not recorded unless expected to be realized within the foreseeable future ABP 23 is an assertion, not an election 24 DHG Birmingham CPE Seminar 12

13 APB 23 Disclosure Area of increasing PCAOB focus Documentation Needed: U.S. capital needs Local capital needs Reinvestment plans Dividend history 25 Outside Basis Differences Record DTA(DTL) for difference between tax and book basis of an investment in a foreign sub or domestic partnership Calculation based on Domestic or foreign entity Form of the entity Calculation considerations: Cumulative translation adjustments Transactions with non-controlling shareholders Other comprehensive income items 26 DHG Birmingham CPE Seminar 13

14 Outside Basis Differences Foreign Subs DTL for residual U.S. tax on unremitted foreign earnings DTL for local country withholding taxes on future repatriation DTA(DTL) for currency movement on initial and subsequent capital contributions DTA for unborn foreign tax credits Withholding tax ( 901) Deemed paid tax ( 902) 27 Outside Basis Differences Domestic Subs APB 23 (ASC ) indefinite reversal criteria is not applicable to domestic subsidiaries or partnership interests For domestic partnership, DTA(DTL) should be based on outside basis difference, not the inside basis differences within the partnership Divergent methods in practice Consistent and reasonable application is key 28 DHG Birmingham CPE Seminar 14

15 ASC 740 ASU : Intercompany Transactions ASU : Share-based payment 29 ASU : Share-based payment Old Excess benefits went to APIC, Short falls went to APIC (if company has an APIC pool) if not it went through the effective tax rate If taxpayer was in an NOL position, the excess benefits were not recorded. New Excess benefits and Short falls both go through the effective tax rate If taxpayer is in an NOL position an opening journal entry will need to be made to retained earnings and the deferred tax asset for the excess benefits that were not recorded described above. 30 DHG Birmingham CPE Seminar 15

16 ASU : Effective Dates Public companies: mandatory for periods beginning after 12/15/2016 (i.e. calendar year 2017) Private companies: mandatory for periods beginning after 12/15/2017 (i.e. calendar year 2018) 31 ASU : Intercompany Transactions Old tax effects of intra-entity asset transfers (intercompany sales) are deferred until the asset is sold to a third party or recovered through use New no exception of recognition for intra-entity assets (other than inventory); would recognize the tax expense, even though the pre-tax effect are eliminated at consolidation Inventory is still deferred until sold to a third party 32 DHG Birmingham CPE Seminar 16

17 ASU : Effective Dates Public companies: mandatory for periods beginning after 12/15/2017 (i.e. calendar year 2018) Private companies: mandatory for periods beginning after 12/15/2018 (i.e. calendar year 2019) 33 Tax Reform Commonalities among the current proposals: Simplify tax code Lower tax rates for individuals, small and large businesses Unprecedented capital expensing Incentivize U.S. based companies to bring jobs and profits back to the U.S. 34 DHG Birmingham CPE Seminar 17

18 Heather Wallace Phil Laminack DHG Birmingham CPE Seminar 18