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On March 29, 2023, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2023-02, Investments – Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Tax Credit Structures Using the Proportional Amortization Method.
The main provision in this ASU permits reporting entities to elect to account for their tax equity investments – regardless of the tax credit program from which the income tax credits are received – using the proportional amortization method if certain conditions are met. Previously, the use of the proportional amortization method was allowed only for investments in low-income housing tax credit (LIHTC) structures.
Criteria
To qualify for the use of the proportional amortization method, all the following requirements must be met:
- It is probable that the income tax credits allocable to the tax equity investor will be available.
- The tax equity investor does not have the ability to exercise significant influence over the operating and financial policies of the underlying project.
- Substantially all the projected benefits are from income tax credits and other income tax benefits. Projected benefits include income tax credits, other income tax benefits, and other non-income tax-related benefits. The projected benefits are determined on a discounted basis, using a discount rate that is consistent with the cash flow assumptions used by the tax equity investor in making its decision to invest in the project.
- The tax equity investor’s projected yield, based solely on the cash flows from the income tax credits and other income tax benefits, is positive.
- The tax equity investor is a limited liability investor in the limited liability entity for both legal and tax purposes, and the tax equity investor’s liability is limited to its capital investment.
Accounting Implications
Application of Proportional Amortization Method
Under the proportional amortization method, an entity will amortize the initial cost of the investment in proportion to the income tax credits and any other income tax benefits received. Amortization and benefits are recorded into the income statement as a component of income tax expense (benefit). A reporting entity must apply the proportional amortization method on a tax credit program basis rather than applying the proportional amortization method at the reporting entity level or individual investments.
Tax Considerations
There will be a book-tax difference related to the amortization that is being recorded on the financial statements. For tax purposes this amortization is not allowed as a deduction on the tax return and will be reversed out as a tax adjustment. The tax return will reflect the income or loss, as well as any credits, flowing through the partnership K-1.
In addition to the amortization booked as an additional tax expense, federal and state tax benefits should be booked on that amount.
Any tax credit generated by the partnership will also be available for the corporation to utilize on the corporation’s tax return subject to any tax credit limitations calculated. Any tax credit carryforwards due to a tax credit limitation will create a deferred tax asset to be recorded on the corporation’s balance sheet.
Specific Disclosures
The ASU requires entities to disclose specific information to provide more insight about entities’ tax credit investments including:
- The nature of the tax equity investment.
- The effect of its tax equity investment on the entities’ balance sheet and income statement.
Transition Requirements
The amendments in this ASU must be applied on either a modified retrospective basis or a retrospective transition.
Scope & Effective Dates
ASU 2023-02 will apply to all reporting entities that hold the following:
- Tax equity investments that meet the conditions for and elect to account for them using the proportional amortization method, or
- Investments in a Low-Income Housing Tax Credit (LIHTC) structure through a limited liability entity that is not accounting for using the proportional amortization method.
The ASU will be effective for public business entities for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. The ASU will be effective for all other entities for fiscal years beginning after December 15, 2024, including interim periods within those fiscal years. Early adoption is permitted for all entities in any interim period, effective as of the beginning of the fiscal year that includes the interim period.
As you consider how you plan to approach this new guidance, consider reaching out to Wolf & Company. Our team of business tax experts will ensure you are filing and reporting properly and for the maximum return.
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