Tax provisions under ASC 740 are difficult to manage, but understanding how and when to report them is half the battle.
By Stacey Roberts and Meredith Smith
What businesses need tax provisions and when do they need them?
When a public company registered with the SEC or trading on any type of stock exchange may owe taxes down the road, and this tax liability is uncertain but probable, it needs to be disclosed as a contingent liability. Under ASC 740, these companies are required to file a tax provision letting investors know about potential, material tax impacts on financial statements. This reporting is mandatory.
The best option for companies to meet this obligation is to start building tax provisions 18-24 months before transactions such as going public in an Initial Public Offering (IPO) or a Special Purpose Acquisition Company (SPAC). Provisions are reported quarterly and must be comparable to previous quarters. As a result, building and reporting tax provisions is easier to do concurrently than retrospectively.
Companies in contention for sale are best served by building a provision history early, at least 12 months before selling. This will help ease the selling process, improve company value, and fulfill a potential banking requirement. Buyers will usually ask for deferred tax assets, tax payables and tax receivables. With a provision set up, this should be a quick and easy answer for the selling business.
Another benefit of setting up a provision is that the company will seem more valuable by recognizing deferred tax assets. These assets are usually overlooked or undervalued if a company does not build a tax provision.
Finally, the buyer can require a company to issue relevant financial statements. This is both a bank and tax requirement. Setting up the provision will satisfy a piece of those requirements.
What is ASC 740?
ASC 740 has a lot of nuances, but oversimplified, this subgroup of accounting rules defines the threshold for recognizing deferred tax assets (future benefit) or deferred tax liabilities (future detriment).
Because of the focus on assets and liabilities, ASC 740 largely pertains to the balance sheet and the changes in taxes payable and receivable over multiple periods. What is left over from period to period on the balance sheet is expensed.
One important thing to note is that franchise taxes, those based on equity, are not part of an ASC 740 current tax provision.
How does ASC 740 vary across states?
The minutia of ASC 740 changes from state to state. In Texas, margin tax is an income tax for ASC 740 purposes despite not being listed as an income tax elsewhere.
Meanwhile, states like Washington report business and occupation tax as an income tax, while overlooking margin tax entirely. North Carolina legislation is considering getting rid of income tax altogether.
This creates a discrepancy between reporting for federal purposes and reporting for state purposes.
How to handle the changing legislation of ASC 740?
When it comes to tax returns, most mistakes can be amended. This is not true for reporting for ASC 740. If there is a mistake on your provision, you will potentially have to reissue your financial statements, which introduces a lot of new problems.
This makes it even more important to be aware of legislative changes in the filing process. If the apportionment factor or another coefficient shifts, your blended deferred tax rate will need to reflect that change.
Because of this changing legislative landscape, filing a tax provision should be a process that is updated yearly despite consistent income or growth. This does not mean to completely move on from the prior year’s apportionment, but it does mean that taxpayers must adjust those numbers to fit the current year’s tax rates.
What are some best practices?
Like with all taxes, the most important thing is to keep track of company activity. If a company had a big sale in a new state, that would need to be factored into your deferred tax rate and auditors will notice if this sale is misrepresented in your provision.
Despite tax returns being frequently overlooked, your return to provision accruals that will run through next year are reliant on correctly filed returns. If there is something missing on a return, auditors will start questioning the validity of your business.
Taxpayers who build a solid working relationship with auditors can ease this process. It is easy for a combative relationship to form between a company’s tax department and auditors but trying to maintain a healthy partnership will be a great help when amending issues with your reporting. While auditors can’t tell you how to do your provision, they can vet your provision positioning to help mitigate potential problems with your reporting.
For more guidance, reach out to the tax professionals at taxops.com.
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