The New Corporate Blended Rate for Fiscal Year Entities
By Shmuel Simons, Senior, Tax & Business Services
On December 22, 2017, President Donald Trump signed the Tax Cuts and Jobs Act into law, changing the entire U.S. tax landscape. A major component of the act affecting corporations is the reduced corporate flat tax rate of 21 percent.
The new law replaces the previous graduated corporate rate structure, which had a top rate of 35 percent, with a flat 21 percent rate, for taxable years beginning after December 31, 2017.
It is intuitive to apply the new rate to a calendar year-end corporation; as all income is contained within 2018, it is all taxed at 21 percent. But what about a corporation on a fiscal year calendar, which will file a tax return with income from months in both 2017 and 2018?
For fiscal year-end corporations, the act follows an old section in the Internal Revenue Code, Section 15, which states that in order for a fiscal-year taxpayer to obtain the benefit of the reduced corporate rate, the corporation must compute a tentative tax under both rates. This is done by prorating the tentative tax based on the number of days with, and without, the rate change, to arrive at a “blended” tax. The tax law does not allow the fiscal year-end entity to benefit from the newly introduced lower rate for the entire fiscal year. The portion of the year commencing prior to December 31, 2017 will remain subject to the rates in effect prior to the change. The new lower rate will only apply to the post change period.
So how does prorating work?
First calculate what percentage of the fiscal year occurred in 2017 and what percentage in 2018. Then multiply the 2017 percentage by 35 percent and the 2018 percentage by 21 percent. Now add these two rates, and that is your “blended” rate to be applied to your current fiscal – year income. This computation is reflected in the chart below:
|Fiscal year ended||Days in 2017||Days in 2018||% of days in 2017||% of days in 2018||Prorated rate for 2017||Prorated rate for 2018||Blended rate|
|January 31, 2018||334||31||92%||8%||32%||1.8%||33.8%|
|February 28, 2018||306||59||84%||16%||29.3%||3.4%||32.7%|
|March 31, 2018||275||90||75%||25%||26.4%||5.2%||31.5%|
|April 30, 2018||245||120||67%||33%||23.5%||6.9%||30.4%|
|May 31, 2018||214||151||59%||41%||20.5%||8.7%||29.2%|
|June 30, 2018||184||181||50%||50%||17.6%||10.4%||28.1%|
|July 31, 2018||153||212||42%||58%||14.7%||12.2%||26.9%|
|August 31, 2018||122||243||33%||67%||11.7%||14%||25.7%|
|September 30, 2018||92||273||25%||75%||8.8%||15.7%||24.5%|
|October 31, 2018||61||304||17%||83%||5.8%||17.5%||23.2%|
|November 30, 2018||31||334||8%||92%||3%||19.2%||22.2%|
|December 31, 2018||0||365||0%||100%||0%||21%||21%|
Let’s further illustrate this with a corporation which has a September 30, 2018, year-end, and pre-tax income of $100,000:
- The months of October, November, and December fall in 2017, totaling 92 days. 92 days divided by 365 days results in 25 percent.
- Multiply 25 percent by the 2017 rate of 35 percent, equating to 8.82%.
- The months of January through September fall in 2018, totaling 273 days. 273 days divided by 365 days results in 75 percent.
- Multiply 75 percent by the 2018 rate of 21 percent, equating to 15.71%.
- Now add these two rates together to get the appropriate blended rate of 24.53%.
- The blended rate of 24.5% is applied to the taxable income of $100,000.
What about temporary differences which originated in 2017, but are reversing in 2018?
Such a situation will similarly be taxed at the blended rate, with the rate being applied to differences reversing in and reversing out as applicable over the straddle periods.
How does this play out in financial statements when calculating income tax expense, to conform to ASC 740?
Corporations that maintained tax deferral accounting are required to reverse deferred tax assets (DTA) / deferred tax liabilities (DTL) at the rate to which year such asset or liability is expected to reverse. This will likely not be the blended rate, but the federal rate of 21 percent.
What will the effective tax rate disclosed with the financials look like?
Even though the corporation in the above example has a blended statutory tax rate of 24.53%, the effective tax rate (“ETR”) can be different due to temporary differences being tax-affected at different rates. The difference between the liability at the statutory tax rate and the liability at the effective tax rate is the effect of the rate change. This would only happen during a year when there was a rate change and will need to be disclosed within the financial statements.
For more information on the corporate tax law changes or on other components of the Tax Cuts and Jobs Act, please contact your Marcum advisor.