On December 22, 2017, the Securities and Exchange Commission’s Office of the Chief Accountant and Division of Corporation Finance (“Staff”) issued important guidance that provides significant relief and helpful answers on some of the accounting and disclosure issues raised by the comprehensive tax act, commonly called the Tax Cut and Jobs Act, that was signed into law on that same date (the “Tax Act”). The Staff’s guidance is contained in two pronouncements: (1) Staff Accounting Bulletin No. 118 (“SAB 118”), which essentially allows companies to take a reasonable period of time to assess, measure and record the effects of the Tax Act, and (2) Compliance and Disclosure Interpretation 110.02 (“CDI 110.02”) under Exchange Act Form 8-K, which confirms that the accounting implications of the Tax Act will generally not trigger impairment reporting under Form 8-K.
A statement jointly issued by Chairman Jay Clayton, Commissioner Kara Stein, and Commissioner Michael Piwowar, available here, indicates the guidance “reflects the approach taken in similar situations where legislative changes could significantly affect financial reporting.” In a press release available here, Chief Accountant Wes Bricker stated that “[a]llowing entities to take a reasonable period to measure and recognize the effects of the [Tax] Act, while requiring robust disclosures to investors during that period, is a responsible step that promotes the provision of relevant, timely, and decision-useful information to investors.
Staff Accounting Bulletin No. 118
SAB 118, available here, expresses the Staff’s views on how the standard on accounting for income taxes (Financial Accounting Standards Codification Topic 740, Income Taxes (“ASC 740”)) should be applied in the context of the Tax Act. Specifically, given the magnitude of the changes in the Tax Act and the fact that it was signed into law shortly before many companies’ fiscal year or fiscal quarter end, SAB 118 addresses situations where a company is not able to complete its assessment of some or all of the income tax effects of the Tax Act by the time the company issues its financial statements for the fiscal period that includes December 22, 2017, the date on which the Tax Act was signed into law. Thus, if December 22, 2017 occurs during a company’s fourth quarter, SAB 118 will be available to provide reporting relief beginning with that company’s Form 10-K.
SAB 118 presents the following approach to accounting for the Tax Act’s impact on a company’s financial statements:
- To the extent that the company has completed its assessment under ASC 740 of the income tax effect of a provision of the Tax Act on its financial statements, the company must reflect the income tax effect in its financial statements for the fiscal period that includes December 22, 2017.
- To the extent that a company has not completed its assessment under ASC 740 of the income tax effect of a provision of the Tax Act on its financial statements, but can determine a “reasonable estimate” of the effect on its financial statements, the company should reflect the reasonable estimate in its financial statements as a “provisional amount,” and identify it as such.
- To the extent that a company cannot determine a “reasonable estimate” of specific income tax effect of the Tax Act on its financial statements, the company should continue to apply the provisions of the tax laws that were in effect immediately prior to enactment of the Tax Act. In other words, in this scenario, the company does not need to take into account the impact of the Tax Act.
In SAB 118, the Staff utilizes the concept of a “measurement period,” which begins in the fiscal quarter that includes December 22, 2017 and ends when the company has all of the information it needs to complete its assessment of all aspects of the Tax Act on its financial statements. The Staff expects companies to act in good faith in working toward completing the accounting required under ASC 740 and believes that in no circumstance should the measurement period extend beyond December 22, 2018. For each fiscal period during the measurement period, a company should perform the three-part analysis set forth above to account for the impact of the Tax Act. As a result of that process, a company may need to: (1) adjust or finalize a previously reported provisional amount; and/or (2) report additional tax effects that were not initially reported as provisional amounts.
SAB 118 also sets forth disclosures that the Staff expects companies to provide during the “measurement period” to provide information about material financial reporting impacts of the Tax Act. SAB 118 states that such disclosures include:
- Qualitative disclosures of the income tax effects of the Tax Act for which the accounting is incomplete;
- Disclosures of items reported as provisional amounts;
- Disclosures of existing current or deferred tax amounts for which the income tax effects of the Tax Act have not been completed;
- The reason why the initial accounting is incomplete;
- The additional information that is needed to be obtained, prepared, or analyzed in order to complete the accounting requirements under ASC 740;
- The nature and amount of any measurement period adjustments recognized during the reporting period; and
- The effect of measurement period adjustments on the effective tax rate.
SAB 118 states that companies also should disclose when their accounting for the income tax effects of the Tax Act has been completed.
Form 8-K Compliance and Disclosure Interpretation 110.02
CDI 110.02, available here, addresses important aspects of the interaction of the Tax Act’s provisions with public companies’ reporting requirements under Exchange Act Form 8-K. First, reflecting the fact that companies with a deferred tax asset will have to revalue that asset based upon the 21% nominal tax rate applicable under the Tax Act instead of the higher tax rates that previously applied, CDI 110.02 states that the re-measurement of a deferred tax asset in this situation is not an impairment, and thus will not trigger the obligations for impairment reporting under Item 2.06 of Form 8-K.
In addition, recognizing that the effects of new tax rates or other provisions under the Tax Act could impact other valuations on a company’s financial statements, CDI 110.02 states that during the “measurement period” provided for under SAB 118, a company is able to address those effects in its next periodic report instead of filing a Form 8-K. Specifically, because of the “measurement period” provided for under SAB 118, any assessment of the impact of the Tax Act will be exempt from the Form 8-K impairment reporting requirements under the “note” to Form 8‑K Item 2.06 stating that an 8-K is not required for impairments determinations “made in connection with the preparation [or] review … of financial statements required to be included in the next periodic report due to be filed under the Exchange Act.”
Practical Considerations in Light of the Staff’s Guidance
As companies undertake the challenge of developing, preparing, and analyzing the information (including running the computations) necessary to complete the accounting process under ASC 740, they should consider the following points:
- Voluntary Disclosures. SAB 118 addresses financial reporting in the context of issuing a company’s financial statements in periodic reports filed with the Commission. Although not addressed in SAB 118, we assume that the same reporting standards are available and apply to financial statements included in a company’s earnings release. Although earnings release financial statements typically do not include the notes that accompany financial statements included in periodic reports, companies should remain mindful of the disclosures called for in SAB 118 and consider the extent to which it is appropriate to include such disclosures in their earnings release. Among other things, companies may want to specifically identify amounts that are provisional and include a paragraph explaining the extent to which the impact of the Tax Act is or is not reflected in their earnings release financial statements. In addition, companies should address both positive and negative tax accounting effects of the Tax Act to the extent that they have completed their ASC 740 assessment of such effects or are providing a provisional assessment of those effects. Companies should also consider discussing when provisions of the Tax Act will start to impact their financial statements, since some provisions of the Tax Act do not become effective until future years. We expect many companies will include cautionary language that they are continuing to assess the tax accounting effects of the Tax Act or that the effects of Tax Act provisions are still being identified and evaluated.
- Regulation FD. The Tax Act’s impact on public companies’ financial reporting will be of great interest to the marketplace and yet often will be difficult to determine. While some companies may maintain a “quiet period” policy and determine not to address the impact of the Tax Act in advance of their next required periodic report, others may determine to address various aspects of the financial reporting effects of the Tax Act in advance of their earnings release. Companies that intend to discuss these issues before issuing their financial results should consider their Regulation FD obligations, as such disclosures may be material since investors may not be able to assess the impact of the Tax Act based on past disclosures.
- Item 2.02 of Form 8-K. Item 2.02 of Form 8-K applies to more than just a company’s earnings release, and instead is triggered by any public disclosure of material non-public information regarding a company’s results of operations or financial condition for a completed quarterly or annual fiscal period. Thus, any disclosures regarding material tax accounting effects of the Tax Act that relate to, but are made after the end of, the fiscal period that includes December 22, 2017 could trigger a required Item 2.02 Form 8-K. For example, if an executive of a calendar year company publicly comments on material tax accounting effects of the Tax Act during the first week of January 2018, the company may need to furnish such disclosures on a Form 8-K.
- Non-GAAP Financial Measures. To the extent that a company has not reflected the impact of the Tax Act in its financial statements (either on a provisional basis or as a result of having completed its assessment of such effect), and instead reports its financial results based on the tax laws as in effect immediately before enactment of the Tax Act, such disclosures continue to qualify as GAAP as a result of SAB 118. However, to the extent that a company has completed or provisionally provided for its assessment of the tax accounting effects of an aspect of the Tax Act and reflected those effects in its financial statements, but then backs out that impact to address period-over-period comparability, the company should be mindful of the non-GAAP rules. For example, if a company has accounted for the impact of a provision of the Tax Act in its year-end financial results, but then states what its results would have been “excluding the impact of the Tax Act,” the company is presenting a non-GAAP financial measure that triggers the GAAP/non-GAAP presentation and reconciliation requirements of Regulation G and Regulation S-K Item 10(e).
As noted above, the Tax Act will have far-reaching and on-going impacts on the tax accounting and financial statement disclosures of public companies. The Staff’s guidance reflects a practical and welcome approach to the accounting and disclosure implications of the Tax Act. As described by Director of the Division of Corporation Finance Bill Hinman, SAB 118 will result in “high-quality information” being presented in companies’ financial statements and financial statement footnotes. Particularly significant, by eschewing deadlines other than the one-year measurement period, the Staff guidance accommodates the fact that the Tax Act will have significantly different implications for different companies and may require extensive information gathering.
Many Tax Act accounting and disclosure issues remain to be addressed over the coming months during companies’ measurement periods, some of which may require guidance or consultations with regulators such as the Commission and the Treasury/Internal Revenue Service. For example, the Staff’s guidance does not expressly address the implications of filing a new Securities Act registration statement or conducting an offering off of an already effective registration statement during a company’s measurement period. The Commission’s press release notes that the Staff encourages publicly traded companies, auditors, and others to consult with the Staff for interpretative assistance. In addition, Gibson, Dunn & Crutcher’s lawyers are available to assist in addressing any questions you may have about these developments. To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work, or any of the lawyers in the firm’s Securities Regulation and Corporate Governance practice group.
 The official title of the Tax Act is “An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018.” Prior to an amendment, the Tax Act was originally titled the “Tax Cuts and Jobs Act.”
 Ironically, the statement was not a statement by the Commission because separately, on December 22, 2017, the Senate confirmed Hester Peirce and Robert Jackson as commissioners, marking the first time that the SEC has had 5 commissioners since 2015.
 As noted in SAB 118, ASC 740 addresses the recognition of taxes payable or refundable for the current year and the recognition of deferred tax liabilities and deferred tax assets for the future tax consequences of events that have been recognized in an entity’s financial statements or tax returns. As particularly relevant with respect to the Tax Act, ASC 740 also addresses adjusting (or re-measuring) deferred tax liabilities and deferred tax assets, as well as evaluating whether a valuation allowance is needed for deferred tax assets, and other income tax accounting effects of a change in tax laws or tax rates.
 Provisional amounts or adjustments included in an entity’s financial statements during the measurement period should be included in income from continuing operations as either an adjustment to tax expense or benefit in the reporting period the amounts are determined.
 That is, for any fiscal period in which the company’s assessment under ASC 740 of the income tax effect of the Tax Act on its financial statements is not complete.