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Deferred Tax Accounting

In addition to ASC Topic 718, requiring mandatory expensing of options based on the fair market value at grant, companies are required to submit an accounting statement in which they record the expected tax deduction benefits from the stock grant. This creates a deferred tax asset (DTA) because it is not yet deductible for income tax purposes at grant. This DTA is based on the company's current tax rate.

A DTA reduces the current tax expense reported in the company's P&L and creates a deferred tax liability on its balance sheet. When the company recognizes the compensation expense (e.g. exercise for options and vesting for restricted stock), it then makes adjustments based on the actual tax benefits. While companies have a reduction in tax rates to 21% under the Tax Cuts & Jobs Act, if they have been recording this asset using higher corporate tax rates than will now actually occur when the compensation is recognized, the shortfall will have to be reported as additional tax expense.

For more on this issue in relation to tax reform, see a commentary from Ernst & Young and a commentary from PwC on guidance in an SEC Staff Accounting Bulletin (SAB).

For more on this topic in general, see an article in Journal of Accountancy.

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