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Small Business Panel Urges Caution With Backwards Tracing

After the Tax Cuts and Jobs Act reduced the corporate income tax rate from 35 percent to 21 percent, the FASB is reconsidering the prohibition in U.S. GAAP’s income tax guidance against “backwards tracing.” But small companies want the board to proceed slowly. In their view allowing the practice on an optional basis might be an improvement, but making it a mandatory requirement could complicate their financial reporting.

As Congress debated a steep cut to the corporate income tax rate last fall, banks and insurance companies petitioned the FASB to consider erasing a prohibition in U.S. GAAP’s income tax guidance against the practice called “backwards tracing.”

The term refers to the recognition of the changes in deferred tax amounts in the current year in the same line item in which the deferred tax amounts were originally recognized. The prohibition from ASC 740, Income Taxes, is meant to avoid forcing businesses to make complex calculations to trace back to prior years the effects of incremental changes in the tax rate or other minor differences.

In the case of the Tax Cuts and Jobs Act (TCJA), the reduction in the corporate income tax rate was major — to 21 percent from 35 percent. Banks and insurance companies, which record significant amounts of available-for-sale securities in other comprehensive income, wanted to record the effect of the reduction in value of their deferred tax credits for the items in other comprehensive income. Instead ASC 740 requires deferred tax assets and liabilities to be adjusted for the effect of a change in tax laws or rates with the effect included in income from continuing operations. The guidance applies even in situations in which deferred tax liabilities and assets are related to items presented in other comprehensive income, such as pension adjustments, gains or losses on cash flow hedges, and foreign currency translation adjustments.

President Donald Trump signed the new tax law on December 22, 2017, and early in 2018, the FASB decided that the complexity of the backwards tracing question required more time than was available for the short-term amendments the board was planning in response to the TCJA. The FASB amended U.S. GAAP to address banks’ and insurers’ main concerns via Accounting Standards Update (ASU) No. 2018-02, Income Statement — Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, offering businesses the option to reclassify to retained earnings the so-called “stranded tax effects” left in accumulated other comprehensive income because of the lower corporate tax rate.

The board, however, kept backwards tracing on its research agenda and is studying how to proceed. The board is considering whether changes should be made to the prohibition on backwards tracing or whether to propose alternatives to backwards tracing.

Members of the FASB’s Small Business Advisory Committee (SBAC) told the board during a May 10, 2018, meeting that it should proceed with caution.

Marshall Minoux, underwriting director at Travelers Cos., said if the board allows backwards tracing, it should not make it mandatory. Most tax changes, he reasoned, will not be as significant as those from the Tax Cuts and Jobs Act, he said.

“I can’t see the benefit coming close to touching the cost and effort to make those changes,” Minoux said.

Investors also could have trouble sorting out the effects of backwards tracing, said David Gonzales, an accounting analyst Moody’s Investors Service Inc.

“Sometimes it’s going to be very easy to deal with, and other times it’s going to be completely a quagmire trying to sort out backwards tracing,” Gonzales said.

For the most part, tax rate changes are typically small from year to year, and the accounting is not too difficult to handle, said Doug Reynolds, partner in the accounting principles consulting group at Grant Thornton LLP.

“But this big tax change we had, the numbers are huge or could be,” Reynolds said, who floated the idea of the FASB only requiring backwards tracing for significant changes.

Board members took in the feedback, but made no commitments. The board said it is still at an early stage of researching the topic.

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