In addition to preserving lower income tax rates for most individual taxpayers, the American Taxpayer Relief Act of 2012 extended a number of business tax breaks, in some cases retroactively to the beginning of 2012. That’s good news, right? However, the act’s timing complicates something very important for businesses: financial reporting.
According to Accounting Standards Codification (ASC) Topic 740-10-45-15, “the effect of a change in tax laws or rates shall be included in income from continuing operations for the period that includes the date of enactment.” So, for periods ended before the new law’s enactment date—January 2, 2013—you should account for income taxes as if the law hadn’t been enacted. Had the bill been signed into law two days earlier—on December 31, 2012—the financial statement impact would have been very different for the many businesses that operate on a calendar year.
Before we delve into how the act affects your financial statements, let’s review some of the key business-related provisions in the legislation. (You can read more about the act and its key provisions in a previous MA Alert.)
The legislation retroactively extended dozens of business tax incentives, including:
The research and development tax credit. This credit (commonly referred to as the R&D credit) had expired at the end of 2011. The act retroactively extended it through the end of 2013.
Section 179 expensing. The dollar limit for small-business expensing had dropped to $139,000 in 2012, with a $560,000 investment limit, and was scheduled to shrink to only $25,000 (with a $200,000 investment limit) in 2013. The act raised the limits to $500,000 and $2 million, respectively, for 2012 and 2013.
Controlled foreign corporation (CFC) provisions. For companies that conduct business internationally, the act extended two provisions that allow deferral of income associated with CFCs. One is the exception for “active financing income,” used primarily by financial institutions. The other is the Subpart F “look-through” provision, which allows deferred treatment of certain payments between related CFCs. Both provisions, which had expired at the end of 2011, were extended retroactively through the end of 2013.
Energy tax credits. The act retroactively extended several energy-related tax credits, some of which had expired at the end of 2011, through the end of 2013.
Other incentives. The act retroactively extended a variety of other business tax breaks, including the Work Opportunity and New Markets tax credits; 15-year cost recovery for qualified leasehold improvement, restaurant, and retail improvement property; and Empowerment Zone tax incentives.
For many businesses, these changes will generate tax benefits they can claim on their 2012 returns. And fiscal-year businesses may have an opportunity to file amended returns to claim benefits for the 2012 portion of their fiscal years beginning in 2011. But how should you recognize these changes in your financial statements?
2012 Financial Statements
If your company has a calendar year-end, you should prepare your 2012 financial statements without recognizing the tax effects of the act’s retroactive provisions. Instead, recognize them in the first interim reporting period that includes the enactment date—in this case, the first quarter of 2013 or January 2013. In addition, in preparing your 2012 financial statements, consider the impact of expired provisions on deferred tax assets and the need for valuation allowances without regard to the act’s extension of those provisions.
Even though you’re required to disregard the act for purposes of pre-enactment financial statement reporting, consider adding disclosures to your 2012 financial statements if the legislation will have a significant impact on your company’s income tax position.
2013 Financial Statements
As previously discussed, any 2012 tax effects attributable to the act’s retroactive provisions should be recognized in 2013, during the first reporting period that includes the enactment date. This may be the first annual period ending after the date of enactment or the first quarter of 2013.
2013 Interim Reporting
Accounting for income taxes is complex, but in simple terms, at the end of each interim reporting period, a company looks forward to the end of its tax year and—based on its expected income, expenses, and other tax attributes—estimates its annual effective tax rate for the year, taking into account the projected effect of deferred tax assets and liabilities. It then uses its annual effective tax rate to estimate its income tax expense on a current, year-to-date basis.
Under ASC 740, the implications of the legislative changes should be recorded as discrete items and shouldn’t be included in the 2013 annual effective tax rate calculation. Similarly, any effects the changes have on deferred tax assets and liabilities should be recorded in the period that includes the enactment date and shouldn’t be reflected in the annual effective tax rate. To the extent the act affects 2013 taxes, on the other hand, any changes in current or deferred taxes should be reflected in a company’s 2013 annual effective tax rate.
We're Here to Help
If you believe the legislation’s retroactive provisions will have significant effects on your company’s 2012 tax bill, contact your Moss Adams LLP professional to discuss how this will affect your company’s financial statements. We can help you determine whether it’s necessary to add tax-related disclosures to your year-end 2012 financial statements and help you account for income taxes in your 2013 financial statements.
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