14.7 Pro Forma Financial Statements

14.7.1 Change in Tax Status to Taxable: Pro Forma Financial Reporting Considerations

In certain situations, an entity may be required to disclose, in the financial statements included in an SEC filing, pro forma information regarding a change in tax status. The objective of providing such information is to enable investors to understand and evaluate the continuing impact of a transaction (or a group of transactions) by showing how the transaction might have affected the registrant’s historical financial position and results of operations if the transaction had been consummated on an earlier date. If a transaction (or a group of transactions) includes a change in tax status, the impact of that change should be reflected in the pro forma financial information.

One example would be an entity (e.g., an S corporation) that changes its tax status in connection with an IPO. The financial statements presented in the registration statement for the periods in which the entity was a nontaxable entity are not restated for the effect of income tax. Rather, the entity must provide pro forma disclosures to illustrate the effect of income tax on those years.

Therefore, there may be certain income tax reporting considerations for an entity that changes its status from nontaxable to taxable. Paragraph 3410.1 of the SEC Financial Reporting Manual (FRM) states that if a registrant was formerly an S corporation, a partnership, or a similar tax exempt enterprise, it should present pro forma tax and EPS data for the following periods:

If necessary adjustments include more than adjustments for taxes, limit pro forma presentation to latest fiscal year and interim period
If necessary adjustments include only taxes, pro forma presentation for all periods presented is encouraged, but not required.

The pro forma information should be prepared in accordance with SEC Regulation S-X, Rule 11-02. The tax rate used for the pro forma calculations should normally equal the “statutory rate in effect during the periods for which the pro forma statements of comprehensive income are presented,” as stated in Section 3270 of the FRM. However, Section 3270 of the FRM also indicates that “[c]ompanies are allowed to use different rates if they are factually supportable and disclosed.”

If an entity chooses to provide pro forma information for all periods presented under the option in paragraph 3410.1(b) of the FRM, the entity should continue to present this information in periods after the entity becomes taxable to the extent that the earlier comparable periods are presented.

With respect to the pro forma financial information, any undistributed earnings or losses of an S corporation are viewed as distributions to the owners immediately followed by a contribution of capital to the new taxable entity. ASC 505-10-S99-3 states that these earnings or losses should therefore be reclassified to paid-in capital.

See Deloitte’s Roadmap Initial Public Offerings for additional guidance on pro forma financial information.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.