The Emerging Issues Task Force (EITF) adopted a final consensus in December 2022, allowing the use of the proportional amortization method with respect to equity investments in tax credit programs beyond the low-income housing tax credit (LIHTC).
The final consensus may allow entities to elect the proportional amortization method with respect to all equity investments that meet the criteria of Accounting Standards Codification® (ASC) 323-740-25-1, more specifically:
Final Consensus Impact
The ability to apply proportional amortization removes a layer of complexity from the accounting for tax credit transactions, as the impact of both the tax credit and the associated cost of the investment can now be shown as a component of income tax expense (benefit).
The proportional amortization method of accounting is already an option for LIHTC investments. The impact of allowing this method for LIHTC investments simplified the process and welcomed more investors to the market, increasing demand for those credits.
The lowered barriers to entry from the final consensus, as well as the robust focus on Environmental, Social, and Governance (ESG) investing, should similarly drive more demand for other tax credit investments from financial institutions and corporate entities.
Effect on Tax Credit Pricing
This increased demand will put upward pressure on tax credit pricing. While increased pricing has an inverse impact on investor yields, it should help more projects reach completion by helping to fill project-level financing gaps in the current rising interest rate environment.
An entity’s application of proportional amortization is likely to have the most immediate impact on NMTC transactions because NMTC transactions inherently tend to meet the eligibility criteria outlined below.
Moreover, because of the requirement that NMTCs benefit low-income populations, they also produce a Community Reinvestment Act (CRA) benefit, making them even more attractive to financial institutions.
Even with these added transactional benefits, NMTC investments tend to produce a higher yield as compared to LIHTC investments, but the impact of additional demand, and thus pricing, may put pressure on those yields.
The Proportional Amortization Method
The proportional amortization method of accounting allows an investor to amortize the cost of the investment in proportion to the income tax credits and other income tax benefits received.
The amortization amount is calculated by multiplying the initial investment by the percentage of tax credits and benefits allocated in the current year to the total anticipated tax credits and benefits over the life of the investment.
The resulting amortization is presented as a component of income tax expense (benefit), as opposed to being presented on a gross basis on an entity’s income statement. This results in the amortization and tax benefit being reported net within income tax expense (benefit).
Eligibility and Election
A tax credit must meet the criteria set forth in ASC 323-740-25-1 to be eligible. Eligibility is determined, and the election can be made, on a tax credit program-by-program basis.
Specifically, ASC 323-740-25-1 requires all the following conditions to be met for an investor to be eligible to elect the proportional amortization method of accounting with respect to qualified investments:
- It’s probable the income tax credits allocable to the investor will be available
- The investor can’t exercise significant influence over the operating and financial policies of the limited liability entity
- Substantially all the projected benefits are from tax credits and other tax benefits—for example, tax benefits generated from the operating losses of the investment
- The investor’s projected yield—based solely on the cash flows from the income tax credits and other income tax benefits—is positive
- The investor is a limited liability investor in the limited liability entity for both legal and tax purposes, and the investor’s liability is limited to its capital investment
Currently, Generally Accepted Accounting Principles (GAAP) don’t dictate what must be disclosed for eligibility. However, the final consensus is expected to require reporting entities to disclose specific information regarding equity investments in tax credit programs for which it has elected to apply the proportional amortization method, including information relating to the investment balance and amounts recognized into the statements of operations and cash flows.
Upon issuance of a final update, expected in January 2023, the EITF’s final consensus will be effective for reporting periods beginning after December 15, 2023, for public business entities. All other business entities have until December 15, 2024, to adopt the changes, though early adoption is permitted.
The impact of proportional amortization on HTC and RETC transactions remains less certain.
RETC transactions, for example, are commonly structured to provide for other benefits in addition to the tax benefits—and may also allow the investor to exercise significant influence—so meeting substantially all eligibility requirements outlined above may not be possible. As a result, it’s possible additional guidance may be needed to clarify the eligibility requirements before wider adoption. However, many investors feel proportional amortization is a favorable accounting method to use, and plan to implement as soon as they’re allowed.
We’re Here to Help
To learn how the expansion of proportional amortization across all tax credit programs could affect the accounting for your investments, please contact your Moss Adams professional. You can also visit our Transferable Tax Credits and our New Markets Tax Credit pages for additional resources.