United States

Insurance industry update: Addressing stranded tax credits

ARTICLE  | 

In February 2018, the Financial Accounting Standards Board (FASB) revised U.S. generally accepted accounting principles (GAAP) by issuing Accounting Standards Update (ASU) 2018-02, Income Statement – Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. This ASU was issued in response to enactment of the Tax Cuts and Jobs Act of 2017 (TCJA) on Dec. 22, 2017. The new ASU permits a company to reclassify the disproportionate income tax effects of the TCJA on items within accumulated other comprehensive income (AOCI) to retained earnings, and requires certain new disclosures.

In summary:

  • Changes in tax rates for items included in AOCI go through income tax expense from continuing operations.
  • This results in a disproportionate tax effect being recorded in AOCI (referred to as stranded tax effects).
  • Historically, this disproportionate impact would have been reversed based upon an accounting policy election.
  • The ASU allows for reclassification from AOCI to retained earnings for stranded tax effects resulting from the TCJA.
  • The ASU requires certain disclosures for both entities that elect to reclassify the income tax effects of the TCJA and those who do not make that election.
  • The guidance, which may be adopted for any period for which financial statements have not yet been issued, is effective for fiscal years beginning after Dec. 15, 2018, and may be applied retrospectively to the date of enactment or the beginning of a reporting period (annual or interim). Early adoption of the amendments is permitted, including adoption in any interim period for:
    • Public business entities: For reporting periods for which financial statements have not yet been issued (e.g., quarterly Form 10-Q filings).
    • All other entities: For reporting periods for which financial statements have not yet been made available for issuance (e.g., annual GAAP holding company financial statements).

You may be interested in hearing how some issuer insurance companies addressed these changes at Dec. 31, 2017 and in subsequent first- and second-quarter Form 10-Q filings.  

Our observations 

After reviewing more than a dozen Form 10-K annual and Form 10-Q quarterly filings for insurers, we noted varying methods of implementation of this standard. Common differences included:

Adoption date:

  • Approximately 50 percent of our sample population early adopted the standard.*
  • Approximately 50 percent of our sample population did not early adopt; however, they quantified the estimated impact* of adoption.

Computations varied based on using:

  • Statutory tax rates
  • Effective tax rates
  • Inclusions and exclusions of discrete items in AOCI
  • Specific-security identification of available-for-sale securities versus portfolio method
  • *Inclusion or exclusion of the effects of the simultaneous or anticipated adoption of ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities*

*Disclosure: Insurance entities with equity portfolios often adopted or planned for the adoption of ASU 2016-01 in conjunction with the prospective adoption election of ASU 2018-02 whereby the entire unrealized balance of deferred tax assets and liabilities on equity securities was (or will be) reclassified from AOCI into retained earnings prior to the adoption of ASU 2018-02. Under this scenario, stranded tax effects for equity securities were excluded from the computation required by ASU 2018-02. This, along with the other variables in computations noted above, resulted in notable disparity in disclosures and computed amounts (or anticipated amounts) of the effect of the standard tax effects across our sample.

Open to interpretation

The FASB indicated the objective of the guidance in ASU 2018-02 is to reclassify the stranded tax effects resulting from the TCJA. The FASB did not specify what constitutes a stranded tax effect resulting from the TCJA and did not mandate any specific methods for determining the amount of the reclassification beyond the amount specified in paragraph 220-10-45-12A(a) of the FASB ASC. That is, the FASB clarified that the reclassification should include the effect of the change in the federal corporate income tax rate related to items remaining in AOCI, which would likely be the most significant stranded tax effect of the TCJA. Because the FASB did not specify what constitutes a stranded tax effect, entities have flexibility in determining what other stranded tax effects resulted from the TCJA.

Our observations exemplify that the FASB’s conclusions have allowed varying interpretations for the implementation of this standard. Questions? Contact us for more information.

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