Reporting Tax Credit Investments Using the Proportional Amortization Method

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:

1. It is probable that the income tax credits allocable to the tax equity investor will be available.
2. The tax equity investor does not have the ability to exercise significant influence over the operating and financial policies of the underlying project.
3. 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.
4. 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.
5. 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.

Delayed Equity Contributions

The ASU also requires entities using the proportional amortization method for qualifying investments to recognize committed unfunded contributions as delayed equity contributions. The amendment requires the entity to record a liability for any contributions that are unconditional and legally binding, or, if they are contingent upon a future event, when that contingent event becomes probable. The offset would be an increase in the carrying value of the tax credit investment. If the proportional amortization method is not applied to the investment, the entity cannot use the delayed equity contribution guidance, including LIHTC investments who have historically used the delayed equity contribution but did not elect the proportional amortization method.

Specific Disclosures

The ASU requires entities to disclose specific information to provide more insight about entities’ tax credit investments including:

1. The nature of the tax equity investment.
2. 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.

Modified Retrospective Transition

Under a modified retrospective transition, a reporting entity evaluates all investments for which it still expects to receive income tax credits or other income tax benefits as of the beginning of the period of adoption. The assessment of whether the investment qualifies for the proportional amortization method is performed as of the date the investment was entered into. A cumulative-effect adjustment reflecting the difference between the previous method used to account for the tax equity investment and the application of the proportional amortization method since the investment was entered into is recognized in the opening balance of retained earnings as of the beginning of the period of adoption.

Retrospective Transition

Under a retrospective transition, a reporting entity evaluates all investments for which it still expects to receive income tax credits or other income tax benefits as of the beginning of the earliest period presented. The assessment of whether the investment qualifies for the proportional amortization method is performed as of the date the investment was entered into. A cumulative-effect adjustment reflecting the difference between the previous method used to account for the tax equity investment and the application of the proportional amortization method since the investment was entered into is recognized in the opening balance of retained earnings as of the beginning of the earliest period presented.