The Tax Cuts and Jobs Act (the Act), enacted on December 22, 2017, creates some interesting consequences when applying US GAAP principles for income tax accounting related to deferred taxes. FASB guidance requires that deferred income tax assets and liabilities be remeasured as a result of changes in tax laws or tax rates. As commonly known by now, the Act reduced the maximum tax rate for corporations to 21% from 35%.
Adjustments from revaluing deferred tax assets and liabilities at the lower tax rate creates an income tax accounting effect that is required to be reported through income tax expense from continuing operations. This classification results in the deferred tax amounts for temporary differences recorded in Accumulated Other Comprehensive Income (AOCI) in equity remaining at the original rate, even though the related deferred tax asset or liability balance has been restated to conform to provisions in the Act. Hence, the term “stranded tax effects”.
A couple of the more common examples of items recorded through AOCI that typically have associated deferred income taxes are unrealized gains or losses from foreign currency translation and on holding investments classified as “available-for-sale”. These amounts are presented in AOCI at their gross amounts net of their deferred income tax effects.
To address this mismatch of deferred income taxes effects of the Act, the FASB issued ASU 2018-02 on February 14, 2018, which permits, though does not require, companies to move the disproportionate income tax effects from AOCI to retained earnings. Companies that elect this reclassification must do so for all items in AOCI affected. Additionally, companies must disclose whether or not they elected this accounting treatment, and certain other disclosures are required. The ASU is effective for calendar year 2019 financial statements but may be adopted earlier.
Please contact us to discuss your specific situation if you wish more clarity on this topic.