How Closing a Tax Loophole Helps Resolve an Accounting Loophole

Zhan Furner, PhD, CPA, and Denise Dickins, PhD, CPA, CIA

The Tax Cuts and Jobs Act of 2017 (TCJA) was enacted on December 22, 2017. Among other things, the TCJA amended Internal Revenue Code (IRC) section 965 to impose a one-time transition tax on previously unrepatriated foreign earnings of 15.5% if held as cash and cash equivalents, and of 8% if held as illiquid assets. The purpose of this provision was to stimulate domestic economic investment and growth by encouraging multinational corporations (MNC) to repatriate some of the estimated $1 trillion in cash held offshore (Michael Smolyansky, Gustavo Suarez, and Alexandra Tabova, “U.S. Corporations' Repatriation of Offshore Profits,” Fed Notes, Sept. 4, 2018, http://bit.ly/2kpzoN8). During the first half of 2018, MNCs repatriated cash of approximately $465 billion (Jeffry Bartash, “Repatriated Profits Total $465 Billion After Trump Tax Cuts—Leaving $2.5 Trillion Overseas,” MarketWatch, Sept. 19, 2018, https://on.mktw.net/2kljkvM). In comparison, the effect of the 2004 tax holiday on offshore assets was repatriation of approximately $312 billion of an estimated $750 billion. The TCJA also closed a tax loophole by switching from a worldwide tax system, under which foreign-source income was taxed only when repatriated, to a quasi-territorial tax system, under which foreign-source income is substantially exempt from U.S. taxation, except for the additional tax imposed on certain foreign earnings [known as the Global Intangible Low-Taxed Income (GILTI) provision]. This article demonstrates how, in doing so, the TCJA also helps close an accounting loophole used by some MNCs to overstate financial reporting earnings.