ASC 740 Tax Considerations for Year-End Audits

EPISODE 50: DHG's Phil Laminack discusses important tax topics that could affect year-end preparations for an audit, including deferred tax assets, year-end tax disclosures and considerations for companies with unrepatriated earnings overseas.



[00:00:09] JL: Welcome to today’s edition of DHG’s GrowthCast. I’m your host, John Locke. At DHG, our strength relies on our technical knowledge, our industry intelligence and our future focus. We understand business needs and are laser-focused on company goals. In this ever-changing world, DHG’s GrowthCast provides insights and thought-provoking conversations on topics and trends that address growth opportunities and challenges in the current and future marketplace.

Thanks for joining us as we discuss tomorrow's needs today.

[00:00:42] ANNOUNCER: The views and concepts expressed by today's panelists are their own and not those of Dixon Hughes Goodman LLP. Always consult the advice of your legal and financial professional before taking any action.


[00:00:58] JL: Today, we have with us Phil Laminack who is a director at DHG. We’re here to discuss today some important tax considerations as taxpayers start the new year in 2020. Phil, thanks for joining us today.

[00:01:11] PL: Thanks for having me, John. It’s a pleasure to be with you today.

[00:01:14] JL: I know there are few important few important items we want to walk through today with you and one of those being deferred tax assets. So Phil, can you share with us what companies should consider when evaluating the realizability of a deferred tax asset?

[00:01:29] PL: Sure, John. When it comes to the realizability of a deferred tax asset, we’re thinking about whether or not a valuation allowance is needed against that deferred tax asset. You can think about really on the balance sheet, any asset if a company is going to show an asset on the balance sheet, you need to be able to demonstrated that there is going to be an economic benefit received for that asset at some point in the future. When we’re looking at a deferred tax asset on the books, we want to make sure that we can prove that there is going to be some benefit for that down the road. So when we say prove that there will be some benefit, we’re using it more likely but not standard. Basically, 51% that you’re going to get some benefit for that.

The guidance under US GAAP indicates that we should look at all evidence, positive and negative and weigh that evidence to determine whether or not we feel that it’s more likely than not that there will be a benefit for that. Evidence that is objectively verifiable, something that is historic, factual is going to carry a lot more weight than something that is subjective. For example, something that might be objectively verifiable could be the results of prior periods, looking at cumulative result over period of years. Perhaps a new contract that has been executed, something that can be documented and substantiated. Something that might be subjective could be a forecast of future earnings, where you’re looking at in the future, taking your best guess as to what might happen and what you believe will happen. But it’s not something that you can prove and substantiate necessarily with documentation.

When we think about future taxable income, which is really what we need in order to say that we’re going to get a benefit from that deferred tax asset, we have to have income in the future in order to realize the benefit of that. The US GAAP provides four sources of future taxable income that we’re allowed to look at and evaluate. One of those is incoming carryback years. This is something that has come and gone over time. We used to have the ability before tax reform in 2017, if a company generated in net operating loss, they could carry that net operating loss back. With tax reform in 2017, the ability to carry those NOLs back went away.

But then with the CARES Act in 2020, for the next couple of years, we have the ability again to carry those back. Again, depending on your jurisdictions, that can be a source of taxable incomes, the ability that if I’m generating a loss or a deferred tax asset now, I can carryback to obtain a benefit.

Another source of taxable income is reversing deferred tax liabilities. So if a company has a deferred tax liability on the books, that can be a source of taxable income to offset a deferred tax asset. Another of the four sources is future forecasted income without respect to your temporary differences. This is basically your forecasted book income. One caveat with using forecasted book income as a source of taxable income is that if a company is in a three-year cumulative loss position, meaning that if you take the prior three-year period, an overall loss position, then the FASB would tell you that they don’t believe it’s appropriate for you to use that forecasted income as a source of future income.

The last of the four sources is tax planning strategies, which is an area they can get fairly subjective as to what you might be able to do to trigger your income in the future. But in general, we need to be able to point to one or more of those four sources and say, “Here’s where we’re going to have taxable income in the future in order to realize those deferred tax assets.” Then when we’re thinking about those sources, particularly the deferred tax liabilities, we want to look at the reversal pattern of those, to say, “Do we have deferred tax liabilities and deferred tax assets that are going to reverse in the right periods with the right character? Like ordinary income or capital gain income. Are they going to be in the same period in order to be able to offset each other?”

That’s an area that’s gotten a lot more interesting post 2017 tax reform, because you have items that may be indefinite lived. For example, you might have a piece of land that has a book tax basis difference. And because you’re not depreciating it, you’re not amortizing it. That can sit there for a very long time before it reverses. Similarly, with goodwill, companies that are holding your goodwill and doing impairment testing. If you have a book tax difference related to goodwill and it’s not being amortized or impaired, that can also sit there for a long time.

We have to look at those indefinite items, and a lot of times, those are pulled out of the equation and evaluated separately. Before tax reform, we really didn’t have many indefinite-life deferred tax assets. We mostly have indefinite-life deferred tax liabilities for those items were booked had more basis than tax, but was holding them indefinitely. Now, after tax reform, we have a couple of new categories of indefinite-life deferred tax assets, primarily net operating losses that used to be able to carry forward for 20 years but now can carry forward indefinitely. Then also, the interest limitations under new Section 163(j) that came out as part of tax reform, is also an indefinite-life to carryforward.

That comparison of the periods of reversal has certainly gotten a little bit more interesting and a little bit more complicated after-tax reform. A lot to think about there.

[00:07:14] JL: There’s a lot to consume there. Now, you even add in the CARES Act, right, on top of that.

[00:07:20] PL: Absolutely, yeah. Exactly. The CARES Act has raised the bar yet again and that the CARES Act reinstituted temporarily the carryback of NOLs. It also increased — before tax reform in 2017, you could use your NOL up to 100% of taxable income in the year you are going to utilize the NOL. Tax reform in 2017 decreased that from 100% to an 80% threshold. But then the CARES Act has now temporarily increased that back to 100% for 2019 and 2020. It also increased the threshold under 163(j) from 30% to 50%. Those are some taxpayer favorable items. But again, it’s only for 2019 and 2020, unless they potentially extend those again. We’ll see what happens as we move through 2021 if there’s additional stimulus, where it’s possible. You can see them extend those into 2021 or even 2022.

[00:08:19] JL: Yes. Stay tuned on that, because there’s a lot of variables that are impacting the economy right now, so we’ll have to wait and see what that holds, right?

[00:08:28] PL: Exactly.

[00:08:30] JL: When we look at companies as they prepare for year-end tax disclosures, what should they be thinking about as we had in here to 2021.

[00:08:42] PL: That’s a great question. I would say outside of the normal things that we think about every year, 2020 has really raised a lot of interesting issues for companies. Some companies have thrived and had the best years they’ve ever had in 2020. Some companies have really struggled and are really facing an uncertain future. As we think about how that impacts everything that that needs to be disclosed, really, we want to think through. What has happened in 2020 that could have a material impact on the tax situation of a company? Whether that’s the CARES Act, the provisions in the CARES Act that could be impacting a company. There’s been a lot of regulations issued by the IRS in 2020. So thinking through all of those law changes carefully and considering which ones could have a material impact.

Even thinking about the economic situation of COVID and everything that’s happening. There’s a lot of issues that companies may be thinking about this year that they haven’t had to think about in a long time. Things like going concern issues for companies that are really struggling, companies that received the payroll protection, the PPP loans, companies may be looking at doing goodwill impairments or inventory impairments. We’ve seen a lot of troubled debt modifications for companies that are looking to refinance their debt, improve their loan terms. We’ve seen companies terminating leases, buying out leases early, walking away from office space, or warehouse space or retail space, whatever else. Those are a lot of things that have happened in mass in 2020 that we generally haven’t seen a lot of.

Thinking through how those are impacting the company, what is the tax implications of all of those and is there anything that needs to be disclosed whether or not it hit in 2020 or whether companies expected to hit in 2021. But there may be a need to disclose those to the shareholders if it’s a subsequent event in the financial statements or things like that. For the tax preparers of the tax footnotes, the important thing is to make sure that you are talking with the financial accounting folks, with the operations folks, understanding what they’re considering from an overall business perspective and then thinking through to the potential tax implications of all of those items.

[00:11:07] JL: Yeah. Internal communication is going to be key moving forward in maximizing this tax liability, right?

[00:11:15] PL: It always is, but more so this year probably than ever.

[00:11:18] JL: Let’s shift a bit, Phil and look at things from an international perspective, particularly companies that have un-repatriated earnings overseas. So what should they be contemplating in terms of an outside basis differences?

[00:11:32] PL: That’s a great question, John. Outside basis differences tend to be one of the more complex areas of ASC 740. There were a lot of folks after tax reform passed in 2017 that thought maybe outside basis differences wouldn’t still be relevant. But that’s really a misnomer, this is still an area that is highly relevant, still highly complex even with the ability now to bring earnings back to the US from overseas tax-free, via the dividends received deduction. There can still be considerable shareholder tax on those foreign operations. For example, a dividend coming back may have local country withholding taxes. If you have a sale of stock in a foreign subsidiary, that can still be taxable with you as shareholder. If you have other liquidating events or other certain types of transactions, that can still impose tax on the US shareholder, the guilty, the subpart F regimes still provide tax to the US shareholder. Even though the dividends coming back are no longer taxable, we still need to think about all of the potential tax implications for the US shareholder with respect to that foreign subsidiary.

What GAAP does provide is a way to bypass that calculation, where the US shareholder asserts that they are permanently reinvested with respect to the subsidiary as referred to in GAAP language as the APB 23 Assertion. That’s something that companies very commonly do, as they’re permanently reinvested in their foreign subsidiary, which then permits them to bypass having to do the outside basis difference calculation. Really when we think about 2020 year-end, the change for a lot of companies is going to be the cash position. In order to say that you’re permanently reinvested in those offshore earnings, you really have to be able to demonstrate that you don’t need that cash back in the US, that you have plenty of cash available in US to fund your US operations, and that the cash you’re accumulating overseas is going to be plowed back into your foreign operations to grow and expand your foreign operations.

Companies that have experienced a downturn in 2020 related to COVID, they may need that cash and then maybe a hard assertion to make that that pile of cash that I have sitting overseas, I’m not going to bring that back to fund my US operations or keep my business afloat in the current environment. There are a lot of companies, a lot of auditors that are really taking a hard look at that permanent reinvestment assertion right now and saying, “Do you really still have the ability to leave that cash untouched?” or “Is there an increased likelihood that you’re going to need that cash to come back and fund your overall operations?”

[00:14:08] JL: These are great point, Phil and I really appreciate your perspective and sharing this with their audience. But I’d be remiss if I didn’t ask you one last question about the Consolidated Appropriations Act. Would you just give us some background and tell us how that could impact certain taxpayers this year?

[00:14:27] PL: Absolutely. That was a very robust piece of legislation that included a lot of different items. I’ll focus mainly on the ones that would apply to businesses, particularly thinking about the financial statement implications of those. I would say probably the most welcomed piece within the legislation was the clarification that expenses associated with the PPP loans would be deductible. Prior to that act, the IRS had put forth their view that current law said that the expenses or a company paid payroll or rent or whatever else with the PPP loans, they qualify them for loan forgiveness. That those expenses would not be deductible, so you would not be taxed on the loan forgiveness. But then the expenses that you paid would not be deductible to the company, so you would have a favorable item related to not being taxed on the loan forgiveness. But then you’ll have an unfavorable item related to not being able to deduct the expenses.

Congress came out pretty quickly after the IRS put out that guidance back in 2020 and said, “That was not our intent. We intended a double benefit, if you will, where you’re allowed to still deduct your expenses, but you’re not taxed on the forgiveness of debt.” Congress clarified in the December legislation that those expenses would in fact be deductible. For companies that took out those PPP loans, that was very welcome news. Because now, not only are you not going to be taxed on the forgiveness, but you still are entitled to the deduction for those expenses when you pay them out. That provides a significant benefit to those companies.

Another area within the Act that was very welcome was the expansion and continuance of the employee retention credit. That was a credit program designed to incentivize companies to keep employees on the payroll. Keep employees covered with health insurance and other benefits while they were experiencing a downturn. That program was expanded, originally it ended at the end of 2020. Now, with the new legislation, it will continue into 2021.

One other interesting distinction is that in the CARES Act, you had the PPP loans and then you had the employee retention credit, but the act said you couldn’t do both, so you have to pick one or the other. You had to look which one is more favorable and you couldn’t participate in both programs. But the new Act now allows companies to participate in both programs. If you have a company that took out the employer retention credit and therefore was not eligible for PPP loan, well now, they can go and apply for a PPP loan in addition to taking the employee retention credit or vice versa. Companies that took out a PPP loan last year, which made them ineligible for the employee retention credit now have the opportunity to calculate and claim the employee retention credit. So there is an opportunity now to participate in both programs, which will be welcome news for companies that are struggling as a result of COVID.

[00:17:32] JL: Yes. We all need a lot good news right now.

[00:17:36] PL: Absolutely.

[00:17:37] JL: Well, Phil. Thank you so much for sharing this information on the Consolidated Appropriations Act, as well as these other timely updates. So appreciate your time today. Thanks for being with us.

[00:17:50] PL: Thanks, John. It was great to be with you, man.

End of Interview

[00:17:54] JL: Thank you for joining us today on this episode of DHG GrowthCast. We hope today’s discussion with DHG’s Phil Laminack, ASC 740 group leader will help you confidently prepare for your 2020 tax filing. I’m your host, John Locke, and I look forward to connecting with you again soon on a future episode of DHG GrowthCast.

About DHG's GrowthCast

At DHG, our strength lies in our technical knowledge, our industry intelligence and our future focus. We understand business needs and are laser focused on company goals. In this ever-changing world, DHG’s Growthcast, provides insights and thought -provoking conversations on topics and trends that address growth opportunities and challenges in the current and future marketplace. Join us in discussing tomorrow’s needs today.

Disclaimer: The views and concepts expressed by today’s guests are their own and not those of Dixon Hughes Goodman LLP. Always consult with your legal and financial professional before taking any action.



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