Evolving regulations and other trends that emerged ahead of 2024 tax season could provide insights for ongoing focus areas into Q2 2024, as well as for future income tax provisions and filings.
Navigate potential tax law changes and their impact to help improve your tax planning strategies, particularly those trends impacted by Financial Accounting Standards Board Accounting Standards Codification®(ASC) Topic 740.
ASC 740 Trends for Q4 2023 Provisions
When reflecting on 2023 ASC 740 trends, the following key points should be considered:
- Valuation allowances
- Naked credits
- R&D expenses
Valuation Allowances
Valuation allowances loomed large due to changing economic conditions and the interaction of several Tax Cuts and Jobs Acts provisions. In its second year of limitation without adjustment for depreciation, disallowed interest expense under Internal Revenue Code Section 163(j) continued to create significant carryforwards.
Entities without sufficient taxable income to deduct interest expense often also generated net operating losses (NOLs). These deferred tax assets (DTAs) are analyzed independently and often require more in-depth scheduling to calculate valuation allowances and adjustments.
Naked Credits
Tax treatment of NOLs and limited business interest expense also caused an uptick in the need to schedule hanging deferred tax liabilities (DTLs) or naked credits. Naked credits result when an entity has indefinite-lived DTLs, which won’t be able to be offset by the reversal of DTAs, resulting in the need to record a valuation allowance in excess of its net DTAs.
The 30% limitation to adjusted taxable income and depreciation recapture rules under Section 163(j), and the 80% taxable income limitation on post-2017 NOLs, decrease the amount of indefinite-lived deferred tax liabilities (DTLs) that could be included in valuation allowance analyses. This also contributed to the increased need for deferred scheduling.
R&D Expenses
Section 174 treatment of specified research and experimental expenditures (SREs) was another common theme of the season. Beginning in tax periods after December 31, 2021, domestic SREs can no longer be expensed but instead must be amortized over five years. Passage of the Tax Relief for American Families and Workers Act of 2024 would retroactively restore the ability to expense through tax year 2025.
High hopes for this bill motivated passthrough entities to delay March 15 filings, and while for ASC 740 impacts aren’t recorded until legislation is enacted, financial statement auditors frequently requested support for estimations and analysis of potential impacts for disclosure.
Q2 2024 Developments and Reminders
The second quarter of 2024 saw several legislative developments both internationally and at the state level, further reviewed below.
International Tax Developments
Foreign Tax Legislation: Pillar Two Developments
Companies with consolidated annual revenue of 750 million euro or more may now be subject to Pillar Two tax legislation in various countries. The objective of Pillar Two is to enact a global minimum corporate tax rate of 15% on the income of large international businesses in each jurisdiction where they have operations.
Many countries have enacted legislation aimed at codifying the Pillar Two framework into their tax law, while other countries have committed to enacting such legislation. Countries that have passed Pillar Two legislation include Germany, Ireland, Japan, and the United Kingdom.
The analysis required for multinational entities that are subject to Pillar Two can be quite significant. Companies that are subject to Pillar Two rules must consider the potential effects of Pillar Two tax liabilities and reflect their best estimate of Pillar Two in their effective annual estimated tax rate (EAETR).
Proposed Section 987 Regulations
Section 987 provides guidance on the tax treatment of remittances from qualified business units (QBU) with a functional currency other than the US dollar. In November 2023, the IRS issued proposed regulations under Section 987. The proposed regulations deal with the timing, amount, character, and source of any gain or loss recognized under Section 987.
The proposed regulations are proposed to be effective for tax years beginning after December 31, 2024, but must be applied earlier regarding certain terminating QBUs. The proposed regulations also provide transition rules. Companies to which these proposed regulations apply must consider the potential effects for purposes of their EAETR.
State and Local Tax Developments
Colorado Unitary Definition Change
On May 14, 2024, Colorado Governor Jared Polis signed legislation that revises the corporate unitary combined reporting law, effective for tax years starting January 1, 2026. The legislation replaces the traditional three of six unitary test with a set of constitutional principles to determine the existence of a unitary business.
A unitary business is defined as a single economic enterprise comprising either separate parts of a single C corporation or an affiliated group of C corporations that are sufficiently interdependent, integrated, and interrelated.
The legislation provides apportionment rules for partnership income, intercompany transactions, and allocation of partnership tax items. The legislation also introduces revised rules for unitary combined reporting, requiring all members of an affiliated group of C corporations that are part of a unitary business to file a combined report as a combined group.
Under ASC 740, new tax laws should be considered in the interim period when they’re enacted. Under Colorado law, the legislation isn’t officially enacted until the day following the 90-day referendum period during which Colorado voters can petition to have the measure added to a ballot, in this case August 7, 2024.
If Colorado voters file a successful referendum challenge, the law wouldn’t be effective until the results of the general election in November 2024 are official.
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If you have questions on how new tax laws could impact ASC 740 and your financial planning, please contact your Moss Adams professional.
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