When the new corporate tax rate kicks in: A primer

The lower corporate tax rate under the new tax law spurred some confusion for corporations whose taxable years don’t begin on January 1.

Tax professionals have been practically unanimous in their expectations for guidance from the Treasury Department on how to interpret and follow the new tax law. But on this issue — application of the new corporate rate to companies with a non-calendar taxable year — they shouldn’t have to wait at all, as the answer lies in Section 15 of the Internal Revenue Code.

According to the 2017 tax act, signed into law December 22, the new rate “shall apply without adjustment for taxable years beginning after December 31, 2017.” For companies that operated on a fiscal year schedule, in which their taxable year ends on the last day of some month other than December, accountants will have to do some simple math to determine a blended rate.

How is the blended rate calculated?

Those companies, most of which are retailers, must split their year-end taxable income into two portions: one before the Jan. 1, 2018, date, and the other after. The proportion of total income equal to the percentage of the taxable year that came before Jan. 1 is the amount subject to the old tax regime. Multiplying their total income by the percentage of the fiscal year that remains after Jan. 1 will yield the amount of income subject to the 21 percent tax. The total they owe in taxes will be the sum of the two calculations.

For fiscal-year companies of certain gross income levels whose fiscal years end June 30, for example, half their total taxable income will be subject to the 35 percent rate, and half will be subject to the 21 percent rate, essentially leaving them with a 28 percent rate, said Drew Lyon, a principal at Big Four firm PwC LLP.

If the fiscal year were to end on March 30, only a quarter of total income would be subject to the new regime, leaving the business with a blended rate of 31.5 percent. Companies don’t need to calculate the amount of income actually earned in each period before and after the effective date, but simply refer to the year-end total.

“Section 15 is something that none of us had to think about for years,” said Robert Kilinskis of Big Four firm Deloitte Tax LLP in Washington. “When you read it, it’s pretty straightforward, but there’s no direct reference to it in the statute.”

Companies that operate with a 52-53-week taxable year should similarly blend their rates, unless their years end within less than a week of the effective date. In that case, they’ll simply miss out on the new lower rate altogether, and subject their 2017 income to the old tax regime, said Adam Lehmann, tax risk and advisory partner at Grant Thornton LLP.

Even if the company in question has a longer year that runs past Jan. 1, he said, “You’d still get that exception, as long as you have that short period of six days or less” between the effective date and the end of the 52-53-week year, meaning, “You can ignore that Section 15.”

Could practitioners see more guidance?

Although it’s been more than two decades since the corporate rates changed, the Internal Revenue Service is unlikely to publish guidance on the effective-date question, said Michael Greenwald, a partner and corporate and business tax leader at accounting firm Friedman LLP.

“They’ve got so much on their plate at the moment, because of this new bill and regulatory projects that were already underway, that I don’t think the IRS sees this as a high-priority issue,” Greenwald said. “They’ll already be hard-pressed to deal with things as it is, with the budget cuts over the past few years.”

The IRS didn’t respond immediately to requests for comment.

The blending principle only applies to the corporate tax rate, and not to other deductions or credits that changed in the new tax law, Stefan Gottschalk, a senior director at RSM US LLP in Washington, told Bloomberg Tax. “Those either apply all year or nothing at all,” he said.

For example, the limitation on interest expense deductions for fiscal year taxpayers will kick in on their first taxable year that begins after Jan. 1, 2018. So for a company with a tax year that ends June 30, 2018, the interest limitation won’t apply until July 1.

What about deferred assets?

Fiscal year taxpayers could face challenges in determining the effect of a tax law change in the middle of their tax year, said Adam Lehmann, a tax partner at Grant Thornton in Hartford, Conn. The deferred tax assets and liabilities existing are supposed to be revalued as of the day the bill was signed into law — Dec. 22, 2017. For entities that prepare interim financial statements, estimating the effect of the law using the most recent quarter end, adjusted for known material transactions between the previous quarter end and date of enactment, usually is sufficient.

For other entities, calculating the effect of the law change may require additional work, Lehmann said. The effect of reversals of beginning deferred tax balances for the period through the enactment date has to be considered, as well as the deferred tax effects of temporary differences that originated prior to the enactment date.

This could be difficult for companies attempting to recalculate their blended rate, because it opens the door for some rate arbitrage for any significant transaction that occurred in the days between the law’s signing and the end of the month. Tax advisers should evaluate any material transactions in that time that would change the value of existing deferred tax assets or liabilities to know whether they need to base the calculation on Dec. 22 data, or whether the Dec. 31 data can be used as an approximation, Lehmann said.

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