EITF 21-A: Accounting for Tax Credit Investments

The U.S. Financial Accounting Standards Board’s (FASB) Emerging Issues Task Force (EITF) is a body that addresses timely and specific accounting issues. The EITF recently finalized Issue No. 21-A, titled “Accounting for Investments in Tax Credit Structures Using the Proportional Amortization Method.” This guidance was developed to standardize the accounting for a variety of tax credit investments.

Historically, a specialized accounting method known as proportional amortization was available primarily for investments in Low-Income Housing Tax Credits (LIHTC). Recognizing that companies invest in many other types of projects that generate tax credits, the EITF expanded the use of this method. This update provides a new, optional framework for certain investments that derive most of their value from the tax benefits they generate.

Scope and Eligibility for the Proportional Amortization Method

The updated guidance broadens the types of tax credit investments that can qualify for the proportional amortization method. Previously applied almost exclusively to LIHTC, the method is now available for investments in programs like new markets tax credits, historic rehabilitation tax credits, and various renewable energy tax credits, such as those for solar and wind projects. This change allows for a more uniform accounting treatment across different tax credit programs, reflecting the similar economic substance of these investments. The election to use this method is made on a program-by-program basis.

For an investment to be eligible for this accounting treatment, it must satisfy five specific conditions outlined in Accounting Standards Codification 323-740. The five conditions are that it is probable the tax credits will be received, the investor lacks significant influence over the project, substantially all benefits come from tax credits, the yield from tax credits is positive, and the investor is a limited liability partner.

A foundational requirement is that the entity must determine it is probable the allocable tax credits will be available. This involves assessing if the underlying project will comply with all technical requirements of the tax credit program, such as meeting placed-in-service deadlines. This probability assessment must be reconsidered if circumstances change.

The investor must not have the ability to exercise significant influence over the project’s operating and financial policies. An investor’s influence is generally considered significant if they hold 20% or more of the voting stock, but this is not an absolute rule. The evaluation focuses on participation in policy-making decisions, material intra-entity transactions, and other factors that would give the investor sway over the project’s management.

Another condition is that substantially all of the projected benefits are expected to be derived from tax credits and other tax benefits. This means any expected cash returns or other non-tax-related gains from the project are insignificant compared to the value of the tax credits.

The entity’s projected yield, based solely on the cash flows from the tax credits and other tax benefits, must be positive. It requires a discounted cash flow analysis where the value of the future tax credits exceeds the initial investment cost, confirming the investment’s rationale is centered on tax advantages.

Finally, the entity must be a limited liability investor in the project. This means the investor’s risk is capped at their capital investment and they are not liable for the project’s debts or other obligations beyond that amount. This is a common feature of tax equity investments where investors participate as limited partners.

Applying the Proportional Amortization Method

The proportional amortization method aligns the recognition of an investment’s cost with the receipt of its primary benefits: the tax credits. Under this approach, the investment is amortized over the period the tax credits are received. The amortization expense for a given period is calculated by multiplying the total investment cost by the proportion of tax credits received in that period relative to the total expected tax credits. This net amount is then reported as a component of income tax expense on the income statement.

For example, a company makes a $1 million investment in a solar energy project and expects to receive $1.2 million in tax credits evenly over 10 years, or $120,000 per year. The initial investment would be recorded on the balance sheet as an asset. This establishes the investment that will be amortized over time.

Each year, the annual tax credit of $120,000 reduces the company’s income tax liability. The investment’s amortization for the year would be $100,000, calculated as the $1 million investment multiplied by the ratio of the current year’s credits to the total expected credits. The net benefit for the period is the $20,000 difference, which is reflected as a reduction to income tax expense.

Cash distributions from the investment, if any, are treated as a return of capital. When cash is received, it directly reduces the carrying value of the investment on the balance sheet rather than being recognized as income.

Entities must also regularly assess their tax credit investments for impairment. An impairment loss must be recognized if it is no longer probable that the entity will receive the expected tax credits. This could happen if the underlying project runs into regulatory trouble or fails to meet operating targets. If an impairment is identified, the carrying value of the investment must be written down, and the loss is recognized in the income statement as part of the income tax expense line item.

Required Financial Statement Disclosures

EITF 21-A mandates specific disclosures in the footnotes to the financial statements for entities that elect the proportional amortization method. These disclosures are designed to give stakeholders a clear picture of the company’s involvement in tax credit investments and the financial impact.

• The nature of their tax credit investments, describing the types of programs they are invested in, such as renewable energy or historic rehabilitation projects.
• The carrying amount of the tax credit investments as reported on the balance sheet, either as a separate line item or within other assets.
• The remaining amount of tax credits the company expects to receive in future years, which provides insight into future tax benefits.
• The amount of amortization and the value of tax credit benefits recognized in the income statement for the period, presented as a single net amount. Any impairment charges recorded during the period must also be separately disclosed.

Effective Date and Transition Guidance

The Financial Accounting Standards Board established specific effective dates for the adoption of Accounting Standards Update 2023-02, which contains the EITF 21-A consensus. For public business entities, the standard is effective for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. For all other entities, the guidance becomes effective for fiscal years beginning after December 15, 2024, and interim periods within fiscal years beginning after December 15, 2025. Early adoption is permitted for all entities.

Companies adopting the new standard have a choice between two transition methods: retrospective application and modified retrospective application. Retrospective application involves applying the new guidance to all prior periods presented in the financial statements, which provides comparability but can require significant effort to restate historical data.

The modified retrospective approach offers a more simplified transition. Under this method, a company applies the new guidance to its existing tax credit investments as of the beginning of the fiscal year of adoption. The cumulative effect of the accounting change is recorded as an adjustment to the opening balance of retained earnings in that period. This avoids the need to restate prior-period financial statements.

When using the modified retrospective method, the entity must evaluate all of its existing investments as of the adoption date to determine if they qualify. This assessment is based on the conditions that existed when the investment was initially made. If an investment qualifies, its carrying value is adjusted to what it would have been had the proportional amortization method been used from the start, with the offset recorded to retained earnings.