Goldman Reaps $475M Tax Benefit From New Accounting Rules

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By Allyson Versprille

Goldman Sachs & Co. reaped a nearly $500 million tax benefit in its first quarter, thanks to a new accounting standard for share-based employee compensation.

Many companies will supplement cash compensation by awarding business shares or the right to buy business shares to employees. In March 2016, the Financial Accounting Standards Board simplified various provisions related to how share-based payments are accounted for and presented in a company’s financial statements. These new rules—Accounting Standards Update (ASU) 2016-09—became effective for public companies in 2017 with opportunities for early adoption.

This new standard led to Goldman’s $475 million tax benefit in the first quarter of 2017, which was included in the company’s overall net earnings of $2.3 billion, R. Martin Chavez, Goldman’s deputy chief financial officer, said in an April 18 conference call to discuss the company’s first-quarter earnings. “This benefit increased annualized return on common equity by 250 basis points,” Chavez said.

Lower Effective Tax Rate

The new accounting rules also helped the company lower its overall effective income tax rate in the first quarter to 11.2 percent, down from the full-year rate of 28.2 percent for 2016, according to the first-quarter earnings report. “If you exclude the tax benefit related to the settlement of equity awards, our effective tax rate for the first quarter would have been nearly 30 percent”—more than 18 percent higher, Chavez said.

Goldman was originally one of several large companies, including behemoths like Google Inc. and Apple Inc., that opposed the new accounting change, citing predictions of swings in earnings.

Facebook Inc. has benefited even more from the new accounting standard, which the tech giant adopted early. The company saw a $1.67 billion increase to retained earnings as of Jan. 1, 2016. And its full-year 2016 effective tax rate dropped by 7 percent, according to the company’s 2016 fourth-quarter earnings report.

Takis Makridis, president and CEO of Equity Methods LLC, said while companies are seeing the positive effects of the simplified accounting rules for share-based compensation, that could easily reverse in a bear market. The new standard “inserts volatility into our financial statements based on stock price movements, and I think that’s dangerous,” he said.

Windfalls Now, Shortfalls Later

The Internal Revenue Service’s tax rules differ from FASB’s accounting rules for calculating the value of share-based payments to employees. Under the accounting rules, the cost is generally established when an award is granted, but under tax rules, the cost is established at settlement, which occurs many years later.

In the past, when there were tax benefits in excess of the accounting calculation—a windfall—that excess amount was placed in an additional paid-in capital pool, commonly referred to as the “APIC pool.” This would occur when a company’s stock prices were rising.

This was basically a “piggybank for a rainy day,” Makridis told Bloomberg BNA. Because if the opposite scenario occurred—stock prices fell and there was a shortfall—that negative amount had to be included in the company’s earnings unless the company had prior credits in its APIC pool, he said.

The new accounting standard means that companies no longer have to track an APIC pool, which can be complex. All the tax benefits and tax deficiencies now go through the income statement.

“We have now tethered earnings to stock prices,” Makridis said, noting that he always learned the opposite should happen—stock prices should follow earnings. “The big deal that I think is at risk of getting missed is that we are seeing these windfalls right now, but that’s because we’re in a bull market,” he said. “We might not be in a bull market in three years.”

In this more volatile world, forecasting how future earnings could unfold given different stock price scenarios will become extremely important, he said.

Makridis also pointed out that this change isn’t some sort of “sweet loophole” for companies because those positive numbers being reported now could turn negative if stock prices fall.

To contact the reporter on this story: Allyson Versprille in Washington at aversprille@bna.com

To contact the editor responsible for this story: Meg Shreve at mshreve@bna.com

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