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As corporations determine the impact of the one-time new tax reform-mandated ‘transition tax’ on overseas earnings, it’s important for investors to consider how the tax may impact a public company’s cash flow when valuing its stock.
A Tax Cuts and Jobs Act (TCJA) provision assesses a one-time ‘transition tax’ on accumulated 2017 untaxed earnings held overseas by considering those earnings repatriated. Generally, foreign earnings held as cash or cash equivalents are taxed at 15.5 percent. Remaining earnings are taxed at 8 percent.
Many American corporations have held their foreign-earned profits overseas for years to escape the world’s-highest 35% U.S. corporate tax rate. As the new tax reform package imposes this one-time tax, the U.S. will relinquish its right to tax foreign profits. The U.S. will then switch its corporation taxation method to a “territorial tax” system.
Under a territorial tax system businesses must pay income taxes only on the income earned within the subject country’s boundaries. The tax liability is determined by the subject country’s tax laws, and no other nation’s corporate tax may be charged. European nations have followed this tax method for decades, and it avoids double taxation. TCJA supporters say this tax change, coupled with the new flat 21% corporate tax rate, will return jobs and American investment dollars back home.
However, this TCJA tax payment may complicate traditional methods used to analyze a company’s financial statements and attractiveness as an investment. Corporations may pay the new one-time tax in eight annual installments under a back-loaded schedule, with a maximum 25% tax payment expected in the 8th year. While this TCJA provision offers corporate taxpayers a potential significant overall tax savings, The Wall Street Journal reports that huge household-name US corporations like Microsoft, McDonald’s and Johnson and Johnson may pay billions to repatriate these earnings they otherwise would not have. Financial analysts advise investors that this change may impact these companies’ cash flow as a percentage of their earnings – which is an important measure of a stock’s market value. Investors should consider the impact of the new lower US corporate tax rate on a subject business’s cash flow remembering that at the same time the subject company owes the final and largest one-time tax payment, which may also be partly offset by tax credits, deductions, deferred tax liabilities and more.
Tax reform and consumer confidence have lifted the stock market to record-breaking levels. Now investors and analysts following corporations with foreign profits must re-think how they value companies as they determine what to buy or sell.
If you have any questions or need more information, please contact one of our wealth accumulation experts at McRuer CPAs online, or call 816.741.7882.
