Do Federal Tax Incentives Make a Difference in U.S. Corporate CapEx?
Recent regulatory changes have done little to simplify corporate tax and accounting procedures and plenty to create new layers of complexity. These process pains are magnified in the early months of the calendar year, when tax and accounting departments are busy closing the books on the previous year, providing for expected tax liabilities, and preparing their first quarter estimates.
In particular, rules in the Accounting Standards Codification (ASC) section 740-10, Accounting for Income Tax, have triggered the most disruption in the state tax provision area — especially around how organizations calculate deferred tax assets and liabilities. As auditor scrutiny intensifies and the stakes of noncompliance rise, corporate tax and accounting professionals need to understand the challenges posed by the ASC sections 740-10-55-25 and 740-10-45-6 and how to confront them.
State Tax Provision Primer
According to ASC 740-10-55-25, deferred taxes must be determined separately for each entity and for each taxing jurisdiction. Further, ASC 740-10-45-6 stipulates that “an entity cannot offset deferred tax liabilities and assets attributable to different tax-paying components of the entity or to different tax jurisdictions.” In practice, most companies have traditionally used a blended rate, which is possible where there are no significant differences between the tax laws of the jurisdictions. But finding states that have the same exact NOL carryover, adds, subtracts, apportionment, and allocation rules is less and less frequent these days as states move further away from the federal tax calculation and compete with each other for new revenue sources.
Financial audit scrutiny of state tax provision calculations is on the rise. Use of a blended rate may be convenient, but such use for material states and transactions puts the state tax provision at risk of being materially inaccurate. For tax and accounting departments that are already balancing a dizzying number of tax rules across multiple states, this can present a significant challenge.
The Struggle with State Tax Provisioning
For organizations navigating ASC 740 compliance, one of the biggest tasks is figuring out how to manage an exponentially larger volume of information.
Every state has its own tax rate, method of apportionment, starts with a variant on Federal Taxable Income, adds and subtracts from that number, and specifically allocates certain amounts to their state, not to mention a dizzying array of unique guidelines for net operating loss (NOL) carryovers and credits. Staying current on each jurisdiction's regulations (and updates to them) is a year-round burden for corporate tax departments.
Moving from a blended rate method to the state-by-state method is impossible without some degree of automation, and most turn to Excel to conduct state-by-state analysis.
For organizations filing tax returns in multiple states, extracting data from their last filed tax return (data that is frequently 4-6 quarters old) and entering manually into home-grown state tax provision spreadsheets is a quick recipe for disaster. Such tax departments leave themselves open to auditor criticism, risk of material misstatement in the tax provision, and the potential for interest and penalties for underpayment of estimated taxes on the current tax provision.
Moving Away from the Blended Rate Method
The risks of using a blended rate far outweigh the effort organizations must exert to modernize their tax and accounting operations. Here are three key considerations for a painless transition from a blended rate method to a more accurate separate entity, state-by-state tax provision approach:
- Rethink the flow of information: Organizations should first reevaluate the process their tax department follows, all the way down to where they source data for calculating deferred assets and liabilities. In many ways, the tax provision is the true start of the compliance process, informing a number of decisions that come later in the year. Business leaders should ensure that the provision isn't isolated to a few tax specialists working behind closed doors. Structures should be put in place that let relevant provision information flow downstream to compliance teams, who can document it accordingly for audits.
- Prioritize: When preparing the provision, corporate tax and accounting departments should consider materiality on an entity-by-entity and state-by-state basis. By prioritizing efforts to entities that are the most profitable, or states in which you have the largest tax burden, organizations can systematically work through the provision rather than rush through everything simultaneously.
- Double down on data management: Successfully moving away from a blended rate method hinges on having the data tools and technology to support it. Investing in resources that simplify internal data management, and automate certain steps in the tax provision, and centralize state-specific tax information is likely to pay dividends. Involve tax and accounting teams when selecting any new technology in order to guarantee end user buy-in and understanding.
To learn more about a new solution to expedite state tax provision in your company, check out State Tax Analyzer™.