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On The Horizon: IRS issues guidance on executive compensation deductions

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Contents Current reporting issue

Impact of tax reform: IRS guidance on executive compensation deduction and proposed regulations related to one-time transition tax

FASB staff proposes taxonomy improvements for credit losses guidance SEC announces regulatory relief and assistance for hurricane victims GASB issues Q3 2018 newsletter CAQ

Highlights from July 2018 SEC Regulations Committee meeting released
Highlights from May 2018 IPTF meeting released
Results of survey on investor confidence published

IASB

IFRIC update published
IFRS Foundation proposes Taxonomy update



Current reporting issue Impact of tax reform: IRS guidance on executive compensation deduction and proposed regulations related to one-time transition tax The Tax Cuts and Jobs Act of 2017 (TCJA) made changes to the rules that limit a public entity’s ability to deduct compensation in excess of $1 million for covered employees, and added a rule that subjects unrepatriated foreign earnings to a mandatory one-time transition tax (see NDS 2018-03, “Accounting and financial reporting implications of the Tax Cuts and Jobs Act of 2017”). Entities now need to reconsider the accounting impact of these rule changes in light of recent IRS guidance, coupled with proposed regulations jointly issued by the IRS and Treasury, related to these two rules under the TCJA. In fact, public business entities that report on a calendar-year basis might need to account for these effects as early as the third quarter ending Sept. 30, 2018.

A summary of these rules of the TCJA, the related IRS guidance, and the proposed regulations, including the potential accounting implications, are discussed below.

Executive compensation deductions

The TCJA

  • Expanded the definition of a “covered employee” to include the CFO
  • Applied the $1 million deduction limit to a covered employee’s compensation in all future years, including those years after termination of employment or death
  • Eliminated the exemption for qualified performance-based compensation and commissions
  • Expanded the definition of a “public entity” subject to the limitation
  • Provided transition relief from the changes made to IRS Section 162(m) for compensation paid under a written binding contract that was in effect on Nov. 2, 2017, and was not subsequently materially modified

In Notice 2018-68, which was issued in August, the IRS published guidance affecting the TCJA’s rule that tightens the restrictions on public entity deductions for executive compensation under Internal Revenue Code (IRC) Section 162(m). This notice interprets the transition rules (referred to as the “grandfathering rules”) for written binding contracts in effect on Nov. 2, 2017, and answers taxpayers’ questions related to the amended definition of a covered employee.

Interpretations related to whether the grandfathering rules apply are subjective and complex, and continue to evolve. For example, entities might be required to determine whether a contract is binding under state contract law. Entities should consult with their tax specialists and other advisers to ensure that they have a full understanding of how the grandfathering rules will impact deductions for executive compensation under Section 162(m).

See the Aug. 23 Tax Flash for a summary of IRS Notice 2018-68.

Nondeductible compensation results in a permanent difference between book income and taxable income, impacting an entity’s effective income tax rate. Entities issuing share-based payment awards account for the cumulative compensation cost as a deductible temporary difference (resulting in the recognition of a deferred tax asset) if this cost will ultimately result in a future tax deduction under existing tax law.

Entities need to determine whether the guidance in the IRS notice impacts their previous judgments and estimates related to the amounts of executive compensation that will ultimately be deductible for 2018 and for future years. For example, an entity might change its previous estimate of the amount of deductible executive compensation for 2018 (and, therefore, change its estimate of taxable income for that year), or might change its assertion on whether cumulative compensation cost through 2017 for outstanding share-based payment awards will ultimately result in a future tax deduction under existing tax law.

Entities should consider the impact of any such changes when determining the estimated annual effective tax rate to apply to year-to-date income for the nine-month interim period ending Sept. 30, 2018, and when evaluating whether the existing deferred tax assets related to share-based payment arrangements can be realized. For example, deferred tax assets related to share-based payment arrangements as of Sept. 30, 2018, might include amounts recognized for cumulative compensation cost through Dec. 31, 2017, as well as additional amounts of deferred tax assets for compensation costs incurred and recognized in 2018.

Entities should also determine whether any income tax effects of these changes should be recognized and reported either as an adjustment to the estimated annual effective income tax rate or as a discrete item within the provision for income taxes during the three- and nine-month interim periods ending Sept. 30, 2018. Under the guidance in ASC 740-270-30-7, Income Taxes: Interim Reporting, entities are required to include in the effective tax rate the tax effect of a valuation allowance that is expected for a deferred tax asset at year-end for originating deductible temporary differences and carryforwards during the year. On the other hand, entities should recognize adjustments to an existing valuation allowance resulting from changes in judgment about whether a deferred tax asset can be realized as a discrete event in the interim period in which these changes occur.

Any adjustments made in 2018 to deferred tax asset and liability balances existing on Dec. 31, 2017, should also be recognized as discrete events in the interim period in which these changes occur. On the other hand, adjustments made in 2018 to the additional deferred tax asset and liability balances recognized during 2018 should be recognized as an adjustment to the estimated annual effective income tax rate for the nine-month interim period ending Sept. 30, 2018.

One-time transition tax on unrepatriated foreign earnings

The TCJA subjects unrepatriated foreign earnings to a mandatory one-time transition tax on post-1986 earnings and profits (E&P). U.S. shareholders in specified foreign corporations are required to include their pro rata share of E&P in taxable income for 2017 if the E&P has not already been subject to U.S. tax.

In August, Treasury and the IRS released a package of proposed regulations, which provide comprehensive rules and examples covering several issues related to the one-time transition tax. These proposed regulations are the latest development in the government’s ongoing series of documents interpreting the TCJA’s provisions.

See the Aug. 8 Tax Flash for a summary of these proposed regulations.

Entities that report on a calendar-year basis determined and recognized their estimated obligation related to the one-time transition tax under the TCJA as of and during the year ended Dec. 31, 2017. Public business entities might have revised these estimates during one or both of the quarters ended March 31, 2018, and June 30, 2018. Generally, changes in estimates (if unrelated to errors) for the prior year’s tax provision are recognized during the interim period(s) of the current year in which these changes were identified as a discrete item within the income tax provision for the interim period(s).

Interaction with SAB 118

The guidance in Staff Accounting Bulletin (SAB) 118 does not apply to accounting effects that arise in periods following the period containing the TCJA’s enactment date (Dec. 22, 2017). As a result, SAB 118 does not apply to the determination of the estimated effective annual income tax rate for interim periods during the year ending Dec. 31, 2018. Further, SAB 118 requires entities to disclose certain quantitative and qualitative information about the income tax effects of the TCJA’s provisions if the accounting was incomplete during the measurement period.

When determining whether to apply the accounting and disclosure guidance in SAB 118 to adjustments (recognized either as discrete events or as part of the effective tax rate) during interim periods in 2018 resulting from changes in judgment based on the IRS guidance or on the proposed regulations discussed above, entities will need to determine whether (1) these adjustments directly relate to areas where the accounting for the income tax effects of the TCJA was incomplete as of the end of the previous reporting period, and (2) the related disclosures were made. Entities should not apply the accounting and disclosure guidance under SAB 118 to adjustments related to areas not previously accounted for under SAB 118. While additional implementation guidance on certain provisions of the TCJA is still anticipated, the estimated annual effective tax rate for interim periods during 2018 should represent the entity’s best estimate of the total tax provision in relation to the best estimate of worldwide pretax ordinary income.

Under SAB 118, entities might have recognized provisional amounts for deferred tax assets and liabilities as of Dec. 31, 2017, including deferred tax asset amounts related to the cumulative compensation cost under share-based payment arrangements. Now that the IRS and Treasury department have issued additional guidance, entities should consider the income tax effects and, if required, update the estimated annual effective tax rate for 2018 or revise the deferred tax balances to reflect the new information.

Under SAB 118, the measurement period begins as of the date the Act was enacted and ends when an entity has obtained, prepared, and analyzed the information required to complete the accounting requirements under ASC 740, regardless of which reporting period the enactment date falls within. The measurement period cannot extend beyond one year from the enactment date. SAB 118 also requires entities to provide financial statement disclosures during the measurement period about each material financial reporting impact of the TCJA if the accounting under ASC 740 remains incomplete.



FASB staff proposes taxonomy improvements for credit losses guidance The FASB staff issued proposed taxonomy improvements related to ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.

Comments on these proposed taxonomy improvements are due Nov. 2, 2018.



SEC announces regulatory relief and assistance for hurricane victimsOn Sept. 19, the SEC issued an Order to provide regulatory relief and assistance to a broad class of companies and others affected by Hurricane Florence. The Order conditionally exempts affected companies and others for periods of time following the hurricane from certain requirements of the federal securities laws, including Exchange Act filing requirements; proxy and information statement delivery requirements; Investment Company Act of 1940 delivery requirements for annual and semiannual reports of registered investment companies; transfer agent compliance with certain Exchange Act sections and rules; Exchange Act filing requirements for registered municipal advisors’ annual update to Form MA; and certain limited auditor independence requirements.

Those affected by the hurricane that require additional or different assistance in their efforts to comply with the requirements of the federal securities laws are encouraged to contact the Commission staff directly for individual relief or interpretive guidance.

Exchange Act filing deadlinesFor registrants affected by the hurricane that are subject to the reporting requirements of Exchange Act Section 13(a) or 15(d), deadlines for materials filed or furnished under certain sections and rules of the Exchange Act have been extended for the period from and including Sept. 14, 2018, to Oct. 26, 2018; all reports, schedules, or forms must be filed on or before Oct. 29, 2018. Each report, schedule, or form must be filed on or before the specified date; must include disclosure of reliance on the Order; and must specify the reasons why, in good faith, the filing is delayed.

Auditor independenceIn addition, the SEC provides a limited exemption from the auditor independence requirements of Exchange Act Section 10A(g)(1) and Regulation S-X, Rule 2-01(c)(4)(i), in connection with bookkeeping or other services relating to the accounting records of an audit client. The Order allows an auditor to assist its audit clients in the reconstruction of previously existing accounting records that were lost or destroyed as a result of the hurricane, provided that such services are pre-approved by the audit committee and cease as soon as the following three conditions are met:

  • The lost or destroyed records are reconstructed;
  • The financial systems are fully operational; and
  • The client effects an orderly and efficient transition to management or other service provider.

Other reporting requirements In connection with the relief discussed above, the Commission announced positions that its staff will take under the Exchange Act, the Securities Act, and the Investment Advisers Act for purposes of determining whether a reporting company has satisfied certain reporting requirements, including the following positions:

  • For purposes of eligibility to use Forms S-3 and S-8, well-known seasoned issuer status, and eligibility requirements of Rule 144(c), a company relying on the Order will be considered current and timely in its Exchange Act reports during the applicable relief period if it was current and timely as of the first day of the applicable relief period. After the applicable relief period, a company will continue to be considered current and timely if it files any required report for which it relies on the Order on or before Oct. 29, 2018.
  • Companies that receive an extension pursuant to the Order on filing quarterly or annual Exchange Act reports will be considered to have due dates consistent with Oct. 29, 2018, and companies are permitted to rely on Exchange Act Rule 12b-25 when they are unable to file the required reports on or before the applicable due date.

In addition, the Commission staff will take the following positions when certain conditions and timelines are met:

  • A registered open-end investment company and a registered unit investment trust will have satisfied its prospectus delivery requirements.
  • A registered investment adviser will have satisfied Form ADV filing requirements.
  • A registered investment adviser will have satisfied the requirement to deliver written disclosure statements to its advisory client.

Regulation Crowdfunding and Regulation A reliefThe SEC has also adopted Interim Final Temporary Rule, Regulation Crowdfunding and Regulation A Relief and Assistance for Victims of Hurricane Florence. The Rule specifies the time period for relief for specified reports and forms due pursuant to Regulation Crowdfunding and Regulation A for companies affected by the hurricane. For reports and forms due during the period from and including Sept. 14, 2018, to and including Oct. 26, 2018, the report or form must be filed on or before Oct. 29, 2018; must include disclosure that the company is relying on the Interim Final Temporary Rule; and must include the reasons why, in good faith, the filing is delayed.



GASB issues Q3 2018 newsletter The GASB issued the Q3 2018 edition of its GASB Outlook e-newsletter, which includes summaries of the Board’s projects and key activities.



CAQ Highlights from July 2018 SEC Regulations Committee meeting released The Center for Audit Quality (CAQ) SEC Regulations Committee meets periodically with the SEC staff to discuss emerging financial reporting issues relating to SEC rules and regulations. The highlights summarize matters discussed at the meetings and do not represent official positions of the AICPA or the CAQ, nor are they authoritative positions or interpretations issued by the SEC or its staff

The CAQ recently issued highlights of the July 12 joint meeting between its SEC Regulations Committee and the SEC staff, which includes the following topics:

  • Indication from the staff that they will continue to issue comments regarding the new ASC 606 disclosures to the extent that there appear to be material items that conflict with the standard or material disclosures missing. The staff also encouraged audit committees to discuss with management and external auditors the company’s implementation of the standard relative to the standard’s requirements and investor and regulatory feedback. Suggested discussion topics include use of significant judgments in the application of the revenue standard (such as the identification of performance obligations and principal-versus-agent determinations) and disclosures for the disaggregation of revenue streams.
  • Clarification from the staff that significant deficiency letters will be made public on EDGAR within 10 days of issuance only for publicly filed registration statements or offering documents. Any significant deficiency letters issued on draft registration statements on a nonpublic basis will not be posted on an accelerated basis and will be released with the entire SEC correspondence after completion of the review process.
  • Transition discussion related to the implementation of the Final Rule, Amendments to Smaller Reporting Company (SRC) Definition, including clarification that:

      — The amendments cannot be applied to any filing made before the effective date, Sept. 10, 2018.
      — A company whose revenues fall below the threshold will have to wait until the determination date to evaluate whether it qualifies as an SRC based upon its public float (or lack thereof) at that time. The staff also clarified that the guidance that states “the determination date for SRC status is the last business day of the second fiscal quarter” in Compliance and Disclosure Interpretation, Exchange Act Rule 130.04, is still applicable.

    Subsequent to the meeting, the staff issued a Small Entity Compliance Guide to summarize key provisions of the Final Rule. Refer to the Aug. 16 On the Horizon for further information.
  • Indication from the staff that Regulation S-X, Rule 3-13 waivers are granted for Rule 3-10 requests in limited circumstances. Subsequent to the meeting, the staff issued a Proposed Rule, Financial Disclosures About Guarantors and Issuers of Guaranteed Securities and Affiliates Whose Securities Collateralize a Registrant’s Securities, that would amend the financial disclosures in Regulation S-X, Rules 3-10 and 3-16. Refer to the Aug. 2 On the Horizon for further information.
  • Discussion of emerging growth company (EGC) transition issues, including the loss of EGC status in the year public companies are required to adopt new accounting standards when they have elected to use private company adoption dates. In this scenario, the staff recently objected to a request for relief from adopting a new accounting standard in the year the company lost EGC status because it became a large accelerated filer. Registrants are encouraged to discuss their specific facts and circumstances with the staff.
  • Observation from the staff that they continue to issue comments on non-GAAP measures related to adjustments for individually tailored accounting principles

Highlights from May 2018 IPTF meeting released The highlights of joint meetings between the Center for Audit Quality’s SEC Regulations Committee’s International Practices Task Force and the SEC staff summarize issues discussed. The highlights do not represent official positions of the AICPA, the FASB, or the IASB, and are neither authoritative positions nor interpretations issued by the SEC or its staff.

The CAQ recently issued the highlights of the joint meeting between its International Practices Task Force (IPTF) and the SEC staff held on May 16, 2018. Discussions at the meeting included the following topics:

  • Regulation S-X, Rule 3-13 waivers and the previously announced nonpublic review process for foreign private issuers (FPIs)
  • Reporting considerations by auditors and issuers for financial statement presentations that may not comply with presentation requirements under IFRS Standards, such as for comparability reasons, including the use of a qualified audit opinion in certain limited circumstances
  • The need to retrospectively recast annual financial statements when FPIs file a new or amended registration statement on Forms F-1, F-3, or F4 that includes current-period financial statements reflecting a change in reporting currency
  • Whether the change in the auditor disclosure requirement in Item 16F is triggered by the approval from those charged with governance when shareholder approval is also required

Results of survey on investor confidence published
The Center for Audit Quality (CAQ) issued the results of its annual survey on investor confidence, “Main Street Investor Survey,” for 2018. The survey, which measures retail investor confidence in the U.S. and global capital markets, public companies, and audited financial information, found that

  • 74 percent of investors express confidence in the U.S. capital markets
  • 78 percent of investors have confidence in investing in U.S. publicly traded companies
  • 75 percent of investors are confident in the audited financial information of publicly held companies
  • 56 percent of investors express confidence in markets outside the United States
  • Investors have a high degree of confidence in the ability of external auditors (81 percent) and audit committees (80 percent) to fulfill their investor protection roles.



IASBIFRIC update published
The IASB’s IFRS Interpretations Committee (IFRIC) has issued the September 2018 Update summarizing the decisions reached by the Committee during its September public meetings.

Decisions on an IFRIC Interpretation become final only after the Committee has formally voted on the Interpretation, which is then sent to the IASB for ratification.

IFRS Foundation proposes Taxonomy update
The IFRS Foundation published for public comment “IFRS Taxonomy 2018 – Proposed Update 1, Common Practice (IFRS 13 Fair Value Measurement),” to reflect common reporting practice relating to disclosure requirements under IFRS 13.

The common practice elements in the IFRS Taxonomy reflect disclosures that entities applying IFRS Standards often include in their financial statements, but that are not explicitly required by IFRS Standards. The IFRS Taxonomy includes common practice content that enables more consistent tagging of financial statements prepared by applying IFRS Standards, which reduces the need for companies and regulators to create their own taxonomy elements.

Comments on the proposal are due Nov. 19, 2018.



© 2018 Grant Thornton LLP, U.S. member firm of Grant Thornton International Ltd. All rights reserved. This Grant Thornton LLP On the Horizon provides information and comments on current accounting and SEC reporting issues and developments. It is not a comprehensive analysis of the subject matter covered and is not intended to provide accounting or other advice or guidance with respect to the matters addressed in this publication. All relevant facts and circumstances, including the pertinent authoritative literature, need to be considered to arrive at conclusions that comply with matters addressed in this publication. For additional information on topics covered in this publication, contact a Grant Thornton client-service partner