Breaking it down
Background
Under existing U.S. generally accepted accounting principles (GAAP), entities may elect to account for equity investments in LIHTC structures using the proportional amortization method if the eligibility criteria in ASC 323-740-25-1 are met. Many entities prefer applying the proportional amortization method over other methods (for example, equity method or cost method) because it results in the amortization of the investment being presented – net of the realized income tax credits and other income tax benefits – within the entity’s income tax expense (benefit) line item.
Comparison of accounting methods used for equity investments in tax credit structures
Equity investments in tax credit programs typically are accounted for using the equity method, the cost method, or the proportional amortization method. The following table highlights the subsequent measurement and presentation differences of the three methods.
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Method
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Subsequent measurement
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Presentation
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Proportional amortization method
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Investment’s cost basis amortized in proportion to the income tax credits and other income tax benefits received
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Cost basis amortization and income tax credit presented net in the income tax expense (benefit) line item
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Cost method
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Investment’s cost basis amortized in proportion to only the income tax credits received
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Cost basis amortization presented as other expense
Income tax credit presented in the income tax expense (benefit) line item
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Equity method
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Investment’s cost basis remeasured consistent with other equity method investments (that is, in proportion to allocable book gains and losses)
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Cost basis remeasurement presented as other income or expense
Income tax credit presented in the income tax expense (benefit) line item
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When the proportional amortization method initially was developed, the FASB limited the method's application to equity investments in LIHTC programs – even though the FASB acknowledged that other types of tax credit investments could meet the eligibility criteria. Since then, stakeholders have requested that the board broaden the scope of the proportional amortization method to include additional tax credit programs.
Crowe observation: In recent years, more entities have started to make equity investments in tax credit programs to meet environmental, social, and governance goals and priorities. Similarly, certain regulated entities continue to make such investments to meet goals under the Community Reinvestment Act.
Key provisions of ASU 2023-02
Broadened scope
In response to stakeholder feedback, ASU 2023-02 expands the scope of the proportional amortization method to equity investments in tax credits beyond those generated by LIHTC programs. Specifically, entities will be able to elect, on a tax-credit-program-by-tax-credit-program basis, to apply the proportional amortization method to all equity investments meeting the criteria in ASC 323-740-25-1.
Example of program-by-program policy election: Company A has equity investments in new markets tax credit (NMTC) programs, historic rehabilitation tax credit (HTC) programs, renewable energy tax credit (RETC) programs, and LIHTC programs. Company A elects to apply the proportional amortization method of accounting to qualifying NMTC and LIHTC equity investments, but not to HTC and RETC equity investments. As such, each NMTC and LIHTC investment is individually assessed for eligibility under the criteria in ASC 323-740-25-1. If the investment is eligible, the proportional amortization must be applied to the investment; otherwise, it cannot be applied. On the other hand, because Company A did not elect the proportional amortization method for HTC and RETC investments, none of those investments would be accounted for under that method.
Crowe observation: While the new ASU expands the scope of the proportional amortization method to equity investments in tax credit programs other than LIHTC, this does not necessarily mean all other tax credit programs will meet the eligibility criteria in ASC 323-740-25-1. For example, we understand that certain RETC programs might not meet the eligibility criteria because the income tax credits are priced in such a way that the projected yield from the income tax credits and other income tax benefits would not be positive.
New implementation guidance on eligibility criteria
The new ASU provides several clarifications on the eligibility criteria in ASC 323-740-25-1, which are summarized in the following table:
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Current wording of eligibility criteria
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Clarifications
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a. It is probable that the tax credits allocable to the investor will be available.
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Minor clarification that “tax credits” refers to income tax credits.
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aa. The investor does not have the ability to exercise significant influence over the operating and financial policies of the limited liability entity.
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Clarification that this criterion should be assessed in relation to the underlying project, not the limited liability entity. This clarification addresses practice issues that have arisen from investments in multitiered income tax credit structures in which the equity investor is not directly invested in the operating entity.
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aaa. Substantially all of the projected benefits are from tax credits and other tax benefits (for example, tax benefits generated from the operating losses of the investment).
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1) Clarification that the term “projected benefits” refers to total return and 2) requirement that the “substantially all” test be performed on a discounted basis. The discount rate used would be consistent with the investor’s cash flow assumptions.
Clarification that the presence of tax credits outside the scope of Topic 740 (e.g., refundable income tax credits) does not automatically disqualify an investor from applying the proportional amortization method. These tax credits would be included in the denominator, but not the numerator, when performing the “substantially all” test.
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b. The investor's projected yield based solely on the cash flows from the tax credits and other tax benefits is positive.
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Minor clarification that “tax credits and other tax benefits” refers to income tax credits and other income tax benefits.
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c. The investor is a limited liability investor in the limited liability entity for both legal and tax purposes, and the investor's liability is limited to its capital investment.
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No change.
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Disclosure modifications
ASU 2023-02 will require reporting entities to disclose each reporting period specific information about equity investments in tax credit programs for which it has elected to apply the proportional amortization method, including to investments in those programs that do not individually meet the eligibility criteria. Whereas current GAAP does not prescribe which information must be disclosed, ASC 323-740-50-1A requires reporting entities to disclose all of the following each reporting period:
- “The amount of income tax credits and other income tax benefits recognized during the period, including the line item in the statement of operations and statement of cash flows in which it has been recognized
- “The amount of investments and the line item in which the investments are recognized in the statement of financial position
- “For investments accounted for using the proportional amortization method, the amount of investment amortization recognized as a component of income tax expense (benefit)
- “For investments accounted for using the proportional amortization method, the amount of non-income-tax-related activity and other returns received that is recognized outside of income tax expense (benefit) and the line item in the statement of operations and statement of cash flows in which it has been recognized
- “For investments accounted for using the proportional amortization method, significant modifications or events that resulted in a change in the nature of the investment or a change in the relationship with the underlying project”
Like current GAAP, ASC 323-740-50-2 also notes a reporting entity may choose to disclose the following information:
- “For investments accounted for using the equity method, the amount of investment income or loss included in pretax income
- “Any commitments or contingent commitments (for example, guarantees or commitments to provide additional capital contributions), including the amount of delayed equity contributions and the year or years in which contingent commitments are expected to be paid
- “The amount and nature of impairment losses during the year resulting from the forfeiture or ineligibility of income tax credits or other circumstances. For example, in a qualified affordable housing project investment, those impairment losses may be based on actual property-level foreclosures, loss of qualification due to occupancy levels, compliance issues with tax code provisions, or other issues”
Other changes
Based on feedback received on the FASB's originally proposed ASU, the final ASU makes the following additional changes to existing guidance:
- Removal of the ASC 323-740 cost method approach for LIHTC investments. Under current guidance, investments in LIHTC programs that are not accounted for under either the proportional amortization method or the equity method of accounting are accounted for under the cost method as outlined in ASC 323-740. ASU 2023-02 removes the cost method guidance from ASC 323-740 such that all tax equity investments, including those in LIHTC programs, not accounted for under either the proportional amortization method or the equity method of accounting would be subject to the guidance in Topic 321, “Investments – Equity Securities.”
- Removal of the equity method of accounting example in ASC 323-740-55. Under current guidance, equity investors in LIHTC programs that apply the equity method of accounting to their investments sometimes use the impairment assessment and measurement method outlined in ASC 323-740-55 rather than the general impairment guidance for equity method investments outlined in Topic 323. ASU 2023-02 removes the example in ASC 323-740 so that tax equity investments accounted for under the equity method of accounting all consistently apply the equity method guidance in Topic 323.
- Reduced scope of the delayed equity contribution guidance in ASC 323-740. Under current guidance, an equity investor in an LIHTC program recognizes a liability for delayed equity contributions that are unconditional and legally binding or that are contingent upon a future event that is probable of occurring. This guidance applies regardless of which accounting method is applied to the investment. ASU 2023-02 amends the “delayed equity contribution” guidance to limit its application to tax equity investments accounted for under the proportional amortization method.
Because these three other changes potentially could affect entities’ current accounting for LIHTC investments, ASU 2023-02 provides reporting entities the option to adopt the changes using the same transition method elected for general adoption of the ASU or using a prospective transition approach. Reporting entities can make a separate transition election for each of the three changes.
Effective date and transition
ASU 2023-02 is effective for reporting periods beginning after Dec. 15, 2023, for public business entities. All other entities will have an extra year to adopt. Early adoption is permitted. If a reporting entity adopts in an interim period, it must adopt as of the beginning of the fiscal year that includes that interim period.
Entities may adopt the ASU on either a modified retrospective or retrospective basis, except as otherwise noted in the previous “Other changes” section. Reporting entities should provide transition disclosures consistent with those required by Topic 250.
