Tax Cuts and Jobs Act Impact on State and Local Governments

The recently signed Tax Cuts and Jobs Act of 2077 brings about many changes to the rules on taxation of individual taxpayers for tax years through 2025, including establishing new income tax rates and brackets, increasing the standard deduction, suspending personal deductions, and limiting state and local tax deductions, among others. The leg­islation also provides numerous changes for businesses and other entities. State and local governments are impacted by the legislation in direct and indirect ways on these matters:

  • Advance refunding
  • Other bond
  • New tax withholding tables for employees.

Advance Refunding Bonds

State and local governments fund many types of activities through the issuance of tax-exempt bonds, which are favorable to investors because the interest received on state and local bonds is generally not included in gross income. The inter est income exclusion on state and local bonds extends to refunding bonds, as well as advance refunding bonds with some limits. While there is no statutory limit on how many times tax-exempt  bonds may be refunded, there were limits on advance refundings.

A refunding bond is defined as any bond used to pay principal, interest, or redemption price on a prior bond issue (the refunded bond). A current refund- ing occurs when the refunded bond is redeemed within 90 days of issuance of the refunding bond. On the other hand, a bond is classified as an advance refund­ ing bond if it is issued more than 90 days before the redemption of the refunded bond. Proceeds from advance refunding bonds are generally placed in an escrow account and held until a future date when the refunded bond may be redeemed. The ability to issue advance refunding bonds allowed state and local governments to issue and have outstanding two sets of tax-exempt debt related to the same activity.

To eliminate this duplicative exclusion of interest, the Tax Cuts and Jobs Act repeals the interest exclusion on advance refunding bonds issued after December 31, 2017. The removal of the tax-exempt status of advance refunding bonds may cause them to be a less attractive funding source for governmental entities.

 Practical Consideration:

Interest on advance refunding bonds issued on or before December 31, 2017, are subject to pre-Tax Cuts and Jobs Act rules and generally continue to be tax-exempt.

Other Bonds

For 2009 and 2010, state and local governments could issue Build America bonds (a type of tax credit bond) that could have been treated as tax-exempt bornds, but that the issuer elected to treat as taxable governmen­tal bonds with a tax credit taken by the bond holder or the bond issuer. For state and local bonds that were qualified bonds, the issuer could elect to receive a refundable tax credit in the form of a direct payment from the IRS in place of any credit otherwise allowed to the bond holder, also known as direct-pay bonds. The Tax Cuts and Jobs Act repeals the IRS Code provisions that  authorized  the issuance of tax credit bonds and the provision that allowed direct-pay bonds. While no new tax credit bonds may be issued after 2017, current rules continue to apply to tax credit bonds issued before January 1, 2018.

New Tax Tables and Other Impacts

The Tax Cuts and Jobs Act revised the income tax rates and brackets for individuals, and all employers must change the tax tables used to  withhold federal taxes for employees throughout the year. The four tax rate schedules for individuals are based on filing status (single, married filing jointly/surviving spouse, married filing separately, and head of household) that are then divided into income ranges which are taxed at higher marginal tax rates as income increases. Under the Tax Cuts and Jobs Act, individuals are subject to seven tax rates: 10%, 12%, 22%, 24%, 32%, 35%, and 37%. These rates are in effect beginning after December 31, 2017, and before January 1, 2026, when the previous tax rates are reinstated, unless new legislation extends or changes the rates.

The Tax Cuts and Jobs Act provides a new measure of inflation applied to annually adjust the tax bracket amounts, standard deduction amounts, personal exemptions, and various other tax figures that affect the tax tables used to determine withholding amounts. For tax years beginning after December 31, 2017, dollar amounts that were previously indexed using the Con­sumer Price Index for all urban consumers will instead use the chained Consumer Price Index for all urban consumers. The new measure of inflation is a perma­nent change.

Sweeping Changes  Proposed to Auditor’s Reports

The AICPA recently proposed major changes to the auditor’s reporting model. On November 28, 2017, exposure drafts of five proposed statements on auditing standards were issued:

  • Forming an Opinion and Reporting on Financial Statements
  • Communicating Key Audit Matters in the Independent Auditor’s Report
  • Modifications to the Opinion in the Independent Auditor’s Report
  • Emphasis-of-Matter Paragraphs and Other-Matter Paragraphs in the Independent Auditor’s Report
  • The Auditor’s Responsibilities Relating to Other Information Included in Annual Reports

Proposed Changes to the Standard Auditor’s Report

The exposure draft proposes the following changes to the standard report:

  • Requires the first section of the auditor’s report to have the heading “Opinion” and to include theauditor’s opinion on the financial statements, followed directly by the “Basis for Opinion” section (unless a different order is prescribed by law or regulation). For governmental entities with multiple opinion units, the authors believe the pluralized headings “Opinions” and “Basis for Opinions” will be permitted, consistent with current practice.
  • Requires the “Basis for Opinion(s)” section to include an affirmative statement about the auditor’s independence and fulfillment of the other ethical responsibilities in accordance with relevant ethical requirements.
  • Adds an option to communicate key audit matters (KAMs).
  • Expands the description of management’s responsibilities for the financial statements. It requires a section with the heading “Responsibilities of Management for the Financial Statements” that, in addition to the description of management’s responsibilities now included in auditor’s reports, is also required to identify those responsible for oversight of the financial reporting process when those responsible for oversight differ from those responsible for preparing the financial statements, and to state management’s responsibility for assessing the entity’s ability to continue as a going concern and whether use of the going concern basis of accounting is appropriate.
  • Expands the description of the auditor’s responsibilities for the audit and of key features of an audit. The expanded requirements would be included in a section with the heading “Auditor’s Responsibilities for the Audit of the Financial Statements .”
  • Requires the section of the auditor’s report that describes the auditor’s responsibilities to also state that the auditor communicates with those charged with governance about the planned scope and timing of the audit and significant audit findings, including any significant deficiencies and material weaknesses in internal control that were

When applicable, the auditor’s report would include:

  • A separate section when the auditor concludes there is substantial doubt about the entity’s ability to continue as a going
  • A separate section that includes the auditor’s report on financial and nonfinancial information included in an entity’s annual

In addition, the proposal would require the auditor to communicate with those charged with governance about (a) significant risks identified by the auditor and (b) circumstances that affect the form and content of the auditor’s report.

Modifications to the Report

The proposals would make the same changes to the auditor’s report when the auditor’s opinion is modi fied.

Key Audit Matters

Under the proposed standards, the auditor may be engaged to communicate KAMs in the auditor’s report; however, communicating KAMs wouldn’t be required. The proposal describes KAMs as matters that (a) the auditor concludes were of most significance in the audit of the financial statements and (b) are selected from matters communicated to those charged with governance.

KAMs may include the following:

  • Areas of higher assessed risks of material misstatements.
  • Areas in the financial statements that involve significant management judgments, such as accounting estimates having high estimation uncertainty.

When the auditor communicates KAMs in the auditor’s report, the auditor would do so in a separate section of the auditor’s report under the heading “Key Audit Matters.” An emphasis-of-matter paragraph isn’t a substi­tute for describing KAMs in the auditor’s report when the proposed SAS on communicating KAMs applies.

Emphasis of Matter

The proposed guidance would require the heading of the emphasis-of-matter paragraph to include the term “Emphasis of Matter.”

Supplementary and Other Information

Governmental financial statements often include required supplementary information (RSI), supplemen­tary information (SI), and other information (01.) The proposed SAS, The Auditor’s Responsibilities Relating to Other Information Included in Annual Reports, would supersede the current guidance on 01 by providing (a) clarification as to what other information is within the scope of the auditor’s procedures, (b) additional guidance on the auditor’s objectives in reading other information, (c) direction regarding the group auditor’s responsibilities for reading other information when reference is made to a component auditor in the group auditor’s report, and (d) new reporting requirements. It defines other information as information other than financial statements and the related auditor’s report included in the annual report. It also adds a new report­ ing requirement to include an “Other Information” section to the auditor’s report when the auditor obtains such information prior to the date of the auditor’s report.

Effective Date

The proposed SASs would be effective no earlier than for audits of periods ending on or after June 15, 2019, with no early adoption. That being said, given the perva­ siveness of the changes to auditor’s reports the propos­als would require, the authors believe it likely that the effective dates could be postponed up to an additional six months, to periods ending on or after December 15, 2019.

Practical Consideration:

The SAS exposure drafts are available at or in the Advanced and Proposed Documents section of the AICPA Professional Standards on Checkpoint (

Thomson Reuters Checkpoint . March 2018 . Volume 25. No. 3