Bridget Stomberg, IU: Late-year
change in income tax rate leads to billions in unexpected profits and
February 7, 2018
politicians tout the merits of U.S. tax reform on personal returns and
corporate investment, many companies are scrambling to deal with the
law's immediate impact on the value of their deferred tax assets and
liabilities and their bottom lines in the fourth quarter.
Under the Tax Cuts and Jobs Act, signed into law by President Donald
Trump on Dec. 22, companies filing calendar-year financial statements
using generally accepted accounting principles, known as GAAP, are
required to re-evaluate their deferred tax assets and liabilities in the
fourth quarter as a result of the late-year change in the corporate
income tax rate from 35 to 21 percent
In a paper being published Feb. 5 in Tax Notes, professors from Indiana
University's Kelley School of Business and the University of Virginia's
McIntire School of Commerce report that this could result in a median
drop in earnings of $100 million for 211 companies in the Standard &
Poor's 500 needing to re-value their net deferred tax assets.
For the median company, that figure is equal to about 10 percent of
prior net income. The total negative financial effect overall on these
companies could total $108 billion.
"This tax act is going to have financial reporting considerations that
have been largely overlooked so far in the discussion," said Bridget
Stomberg, assistant professor of accounting at Kelley. "It's changing
future cash flows. One company might be picking up a lot of income this
quarter as a result, while their competitor might be recognizing a big
Among the companies they found with potentially large decreases in net
earnings are Citigroup Inc. ($18.67 billion or 125 percent of prior-year
net income), General Motors Co. ($13.84 billion or 147 percent of
prior-year income), American International Group ($8.28 billion, or 975
percent, after a small loss the previous year), Bank of America ($7.6
billion, 43 percent) and Ford Motor Co. ($3.6 billion, 78 percent).
On the other hand, the tax law will have unexpected benefits for 317
publicly traded companies in the sample, who could report a median
increase in accounting earnings of $341 million or about $400 billion
Some of the biggest beneficiaries of the tax law change could include
Berkshire Hathaway, which could report the largest increase in net
earnings, $30.78 billion or 128 percent of prior-year net income,
followed by AT&T Inc. ($23.49 billion, 181 percent), Verizon
Communications Inc. ($18.36 billion, 140 percent), Comcast Corp. ($13.92
billion, 160 percent), Pfizer Inc. ($12 billion, 167 percent), Exxon
Mobil Corp. ($11.96 billion, 153 percent) and Apple Inc. ($11 billion,
By law, companies report differences between financial statement income
and taxable income each year, leading to deferred taxes. For one-third
of companies in the study's sample, future tax liabilities will go up
because companies were recording an expected future benefit of 35 cents
on the dollar, which the Tax Cuts and Jobs Act reduced to only 21 cents
on the dollar.
Stomberg and her co-author, Jeri Seidman, an assistant professor at the
McIntire School of Commerce, used disclosures of total deferred tax
assets and liabilities from the income tax footnotes in the most recent
annual reports of 528 companies that were listed in the Standard &
Poor's 500 anytime in 2016 or 2017.
They calculated the magnitude of net deferred tax assets and liabilities
and estimated the expected change at each company given the 14
percentage-point reduction in the corporate tax rate. They also
estimated the effect of these adjustments on profits, leverage and
effective tax rates.
The authors hope the findings in their paper, "The Financial Reporting
Consequences of Tax Reform: How the Corporate Tax Rate Will Affect
Profits," will help those reading financial statements anticipate and
better understand the nature of these one-time adjustments. They
acknowledge that many investors, as well as some company CEOs and CFOs,
will struggle to understand the real impact of the law on fourth-quarter
"Our anticipation is that companies are going to call it out as a
transitory item," Stomberg said of the one-time adjustment to deferred
tax assets and liabilities. "This quarter there should be more of a
focus on non-GAAP earnings, or pro-forma earnings, where companies
compute book income with this number in it, but then take it out and say
to everybody, 'Try to focus on this other number instead.'
"Obviously, if you're a company that's getting hurt by it, you have a
big incentive to do that," she added. "Because it's so big and because
it's affecting everybody, it's going to be hard for companies to not
call it out, even it is a benefit to them."
said this is going to be a difficult financial reporting season for
public companies because the legislation was passed so late in the year.
Nearly all public companies are required to file their 10-K annual
report within the first 60 days of the year, but many firms are unsure
whether they'll be able to make the calculations in time.
"There's going to be a lot of work that companies have to do in a very
short period of time to figure this out, to calculate the effects and
communicate them to analysts and shareholders," she said. "The SEC is
allowing companies some flexibility in reporting these numbers in their
annual reports because the act was passed so quickly and so close to the
end of the year. The companies really need more time to digest the
financial statement information."
Although the large one-time adjustments do not affect taxes paid in the
fourth quarter of 2017, these changes will affect the magnitude of
future tax benefits and obligations.