Tax Reform Impact on GAAP Accounting Entries

Transcription

1 January 2018 Tax Reform Impact on GAAP Accounting Entries On December 22, 2017, the Tax Cuts and Jobs Act of 2017 (the Act) was signed into law. Among other things, the Act reduced the corporate federal tax rate to a flat 21%. As a result, companies will need to re-measure deferred tax assets and liabilities at the new 21% tax rate. Current GAAP requires the effect of a change in tax laws or rates be included in income from continuing operations in the period that includes the enactment date. As such, calendar year-end entities will need to re-measure their deferred items within their December 31, 2017 financial statements and record the change in deferred tax resulting from the rate change in the Federal Income Tax line item. For entities that have elected to classify their investments as available-for-sale, the original deferred tax amount related to the unrealized gains and losses was recorded in accumulated other comprehensive income (AOCI) at the old rate and remains in AOCI as the change in tax rate is adjusted through continuing operations to reflect the new rate. This practice results in the related tax impact of items originally flowing through AOCI becoming stranded in AOCI. On January 18, 2018, the FASB proposed new guidance that, if approved and issued as an Accounting Standards Update (ASU), will allow entities some relief. The proposal requires companies to reclassify the tax impact stranded in AOCI to retained earnings. While the proposed effective date is for fiscal years beginning after December 15, 2018, it is anticipated that early adoption will be permitted. Once the proposed ASU is issued, companies will need to decide whether to early adopt the standard. Until the proposed ASU is issued, companies are prohibited from reclassifying the stranded tax to retained earnings. The following example illustrates the current tax accounting treatment required by GAAP and how to calculate the tax impact stranded in AOCI. 1

2 Reform Insurance Company Balance Sheets (after adjustment for tax reform) Assets As of December 31, Cash and cash equivalents $ 1,133,066 $ 5,580,616 Debt securities, at fair value 37,853,490 29,903,238 Equity securities, at fair value 3,921,654 3,934,712 Accrued investment income 343, ,578 Premiums receivable 6,206,000 6,446,000 Deferred policy acquisition costs 21,580 22,422 Prepaid reinsurance premium 360, ,968 Deferred federal income tax at 21% tax rate See calculations on pages , ,144 Other assets 18,794 18,854 Total Assets $ 50,471,980 $ 47,523,532 Liabilities and Shareholders Equity Liabilities Losses and loss adjustment expenses $ 17,604,994 $ 17,859,206 Unearned premiums 5,678,914 5,900,028 Losses payable 1,154, ,490 Federal income tax payable 1,277, ,880 Accounts payable and accrued expenses 102,902 89,360 Total Liabilities 25,818,532 25,402,964 Shareholders Equity Common stock, no par value, 200,000 shares authorized, 100,000 shares issued and outstanding 1,600,000 1,600,000 Accumulated other comprehensive loss, net of tax AOCI measured at old tax rate (66% or (100%-34%)) - see calculation on page 4* (186,518) (77,070) Retained earnings 23,239,966 20,597,638 Total Shareholders Equity 24,653,448 22,120,568 Total Liabilities and Shareholders Equity $ 50,471,980 $ 47,523,532 *Taxes flowing through AOCI continue to be measured at 34% because the impact of the tax rate change runs through net income not OCI. If the proposed ASU is issued and early adopted, the balance will be reflected at a 21% tax rate (79% or (100%-21%)) and an adjusting line item would be shown on the statement of changes in shareholders equity to reclassify the impact from AOCI to retained earnings. 2

3 Reform Insurance Company Statements of Comprehensive Income (after adjustment for tax reform) Revenues Year ended December 31, Premiums earned, net $ 6,015,940 $ 6,564,672 Net investment gains (losses) 303,832 (188,850) Total Revenues 6,319,772 6,375,822 Expenses Losses and loss adjustment expenses 1,268,316 2,765,814 Policy acquisition costs 24,424 26,426 General and administrative expenses 375, ,376 Total Expenses 1,668,616 3,155,616 Income Before Federal Income Taxes 4,651,156 3,220,206 Federal Income Tax Expense See calculations on pages 5-6 2,008,828* 1,160,580 Net Income 2,642,328 2,059,626 Other Comprehensive (Loss) Income, Net of Tax Net unrealized holding (losses) gains arising during the year, net of tax of ($57,148) and $107,740, respectively (34% tax rate)* (110,934) 209,142 Less: reclassification adjustment for net realized losses included in net investment gains (losses), net of tax of $766 and $2,454, respectively (34% tax rate)* 1,486 4,764 Other Comprehensive (Loss) Income, Net of Tax (109,448) 213,906 Comprehensive Income $ 2,532,880 $ 2,273,532 * Amounts flowing through other comprehensive income (OCI) continue to be measured using a 34% tax rate because the impact of the tax rate change ran through net income not OCI. If the proposed ASU is issued and early adopted, it will have no impact on these line items until

4 Investments The cost or amortized cost, gross unrealized gains and losses, and estimated fair values of investments at December 31, 2017 and 2016 are as follows: December 31, 2017 Debt Securities: Cost or Amortized Cost Gains Losses Estimated Fair Value Obligations of U.S. Government agencies $ 4,101,590 $ 3,350 $ (22,352) $ 4,082,588 Corporate debt securities 16,278, (94,828) 16,184,360 Municipal bonds 17,677,624 1,940 (93,022) 17,586,542 Total debt securities $ 38,057,748 $ 5,944 $ (210,202) $ 37,853,490 Equity Securities: Fixed-income mutual fund $ 4,000,000 $ - $ (78,346) $ 3,921,654 Net Loss 12/31/2017 December 31, 2016 Debt Securities: Cost or Amortized Cost Gains Losses Estimated Fair Value Obligations of U.S. Government agencies $ 4,075,380 $ 7,366 $ (20,714) $ 4,062,032 Corporate debt securities 100,454 - (48) 100,406 Municipal bonds 25,778,886 5,156 (43,242) 25,740,800 Total debt securities $ 29,954,720 $ 12,522 $ (64,004) $ 29,903,238 Equity Securities: Fixed-income mutual fund $ 4,000,000 $ - $ (65,288) $ 3,934,712 Net Loss 12/31/2016 Measurement of At 34% At 21% Net unrealized loss (UNL) $ 282,604 $ 282,604 Tax effect A 96,086 B 59,348 Net of tax $ 186,518 66% of UNL A - Amount of tax recorded in AOCI on balance sheet B - Amount of tax recorded in deferred tax asset on pages 5-6 C = A-B - $36,738 Tax stranded in AOCI $ 223,256 79% of UNL If the proposed ASU is issued and early adopted, companies may reclassify the stranded tax effect by debiting AOCI and crediting retained earnings. 4

5 Federal Income Taxes The components of the provision for federal income taxes for the years ended December 31, 2017 and 2016 are as follows: Current expense X $ 1,572,430 $ 1,007,630 Deferred tax expense legislative rate change Y 379,556 - Deferred expense Z 56, ,950 Federal income tax expense $ 2,008,828 $ 1,160,580 Deferred federal income taxes arise from temporary differences between the valuation of assets and liabilities as determined for financial reporting purposes and federal income tax purposes and are measured at enacted tax rates. As of December 31, 2016, the Company measured its deferred tax items at an effective tax rate of 34%. On December 22, 2017, the Tax Cuts and Jobs Act of 2017 (the Act) was signed into law. Among other things, the Act reduced the Company s corporate federal tax rate to a flat 21%. As a result, the Company s deferred tax items are measured at an effective tax rate of 21% as of December 31, Although realization is not assured, management believes it is more likely than not that the entire deferred federal income tax asset will be realized. The amount of the deferred federal income tax considered realizable could be reduced in the near term if estimates of future taxable income are reduced. X - No change - current expense continues to be calculated at 34% for 2017 Y - Impact of change in tax rate - Total DTA in column 3 on page 6 $992,686 less total DTA in column 1 on page 6 $613,130 = $379,556 Z - Change in DTA at 34% DTA at 34% $ 992,686 $ 993,144 Less DTA for URL (96,086) (39,702) Adjusted DTA $ 896,600 $ 953,442 Change $56,842 expense related to normal balance fluctuation excluding impact of rate change Note: Proposed ASU has no impact on the income statement. The full impact of the change in rate continues to be recorded in net income. 5

6 The components of the net deferred federal income tax asset at December 31, 2017 and 2016 are as follows: Column 2017 Column 2016 Deferred federal income tax asset: Discount on unearned premiums $ 223,352 $ 376,928 Discount on losses and loss adjustment expenses 319, ,940 Accounts payable and accrued expenses - 8,988 Realized capital loss carryover 15,726 27,210 Net unrealized loss on investments 59,348* 39,702 Total deferred federal income tax asset 617,662 1,000,768 Deferred federal income tax liability: Deferred policy acquisition costs (4,532) (7,624) Net deferred federal income tax asset $ 613,130 $ 993,144 Column 3** 2017 $ 361, ,858 25,462 96,086* 1,000,024 (7,338) $ 992,686 * Agrees to DTA on Page 2 ** Column 3 - Net deferred tax asset is shown here for the purpose of calculating the legislative rate changes. Recalculated based upon column 1 divided by 21% times 34%. Check Figure Current tax $ 1,572,430 End of year DTA (613,130) Beginning of year DTA 993,144 Total equity impact $ 1,952,444 Total tax in provision $ 2,008,828 Adjust for amounts recorded in OCI: Ending UNR 34% (96,086) Beginning UNR DTA 39,702 Total equity impact recorded $ 1,952,444 6

7 If the proposed ASU is issued and early adopted, the tax stranded in AOCI would be reclassified as follows. Additionally, the AOCI on the balance sheet would be reflected net of the new tax rate of 21%. Common Stock Accumulated Comprehensive Loss, Net of Tax Retained Earnings Total Shareholders Equity Balance at January 1, 2016 $ 1,600,000 $ (290,976) $ 18,538,012 $ 19,847,036 Other comprehensive income, net of tax - 213, ,906 Net income - - 2,059,626 2,059,626 Balance at December 31, ,600,000 (77,070) 20,597,638 22,120,568 Other comprehensive loss, net of tax - (109,448) - (109,448) Reclassification adjustment - - (36,738) 36,738 - Legislative rate change Item C calculated on page 4 Net income - - 2,642,328 2,642,328 Balance at December 31, 2017 $ 1,600,000 $ (223,256) $ 23,276,704 $ 24,653,448 7