What Tax Provisioning Means for Companies (and What Actually Matters to Their Investors)

What is a Tax Provision?

A tax provision is the estimated amount that your business will pay in income taxes for the current year. Let’s face it: The process of estimating this amount, also known as corporate income tax provisioning, is complicated. And it can have enormous implications for your business.

That being said, many large enterprises keep this process siloed in the tax department. Because this operation requires input from outside of the tax team, and the output of this operation is highly regarded by stakeholders outside of the tax team, it begs the question: Is that really a best practice?

Let’s take a look at why tax provisioning matters, especially to investors, and how you can optimize your corporate tax provisioning workflow.

Why Tax Provisioning Matters

What is a tax provision? Tax provisioning is the process of estimating the amount that a business expects to pay in income taxes for the current year. This involves calculating the value of current and deferred tax assets and liabilities.

At face value, corporate tax provisioning may seem like a simple enough accounting process that can be siloed away in the tax department. However, your company’s income tax report shouldn’t matter just to the tax department—it should also be a top priority for every stakeholder.

That’s because the total expense of a company’s corporate tax provision isn’t set in stone. With a bit of time devoted to tax planning, your organization can significantly lower the total expense of its corporate tax provision. But although skilled tax planning and provisioning can make a noticeable difference to your company’s bottom line, the process is often permeated with regulatory risks and operational challenges.

Tax Provisioning Challenges Faced by Modern Businesses

Corporate tax provisioning represents a key consideration of every company’s profitability planning; however, the process presents some unique hurdles. Here are a few of the most pressing challenges faced by companies looking to optimize their income tax provisioning.

The Increasing Complexity of Tax Provisioning

Even in the best of circumstances, corporate income tax provisioning is a complicated and risk-laden task. And in recent years, the complexity of tax provisioning has only grown. This is primarily due to increasing international regulatory scrutiny, the growing complexity of tax law, and rigid deadlines for company income tax reports.

This is especially true in today’s global economy, where more and more businesses seek to compete at an international scale. Companies are running into regulations from a greater number of countries as they seek to expand their supply chains or acquire foreign competitors.

As a result, an organization’s tax department can no longer be siloed. For companies to stay competitive and compliant, they must give the tax department a more central role. This should include opening the lines of communication between the chief tax officer and the CFO as well as the CEO and the rest of the C-suite.

Reconciling Different Reporting Approaches

Regular communication between your tax department, office of the CFO, and C-suite can go a long way. But this won’t help if there’s a fundamental disconnect between the stakeholders in your company.

A company provides value among a wide range of stakeholders, including investors, shareholders, employees, customers, suppliers, and even society at large. It can sometimes be difficult to balance these competing interests.

When it comes to tax provisioning, this can manifest itself in different (and sometimes conflicting) reporting approaches taken by internal stakeholders and investors. For investors, the tax provision is often viewed through the lens of the profit motive and the belief in shareholder primacy, whereas internal stakeholders may take a more purpose-driven approach.

Striking the right balance will require investors, the board, and management as well as community members to work together to define the company’s purpose and how they will measure success outside of traditional financial indicators. In terms of corporate tax provisioning, this represents a significant challenge, but it can be done.

Reputational Risk

Balancing interests isn’t just about philosophical differences between stakeholders. If you get this balance wrong in the case of your corporate tax provision, it could invite regulatory scrutiny and do lasting damage to your company’s reputation.

In the last several years, there has been an ongoing discussion in the media about large companies participating in tax avoidance. Tax avoidance differs substantially from tax evasion. But the legal practice of minimizing your tax burden can be detrimental to your company’s public image when taken to the extreme.

A number of high-profile cases involving multinational companies such as Amazon, Starbucks, and Google have made headlines and ignited a new public debate on how to define an acceptable level of corporate tax payment.

The bottom line is that an aggressive tax avoidance approach can result in a public relations nightmare. Your organization’s tax and accounting decisions should be aligned with overall corporate goals and image in mind.

Tax Provision Challenges

Calculating tax provisions can be complex and fraught with challenges, as organizations must navigate intricate tax regulations and accounting standards like ASC 740. These challenges often stem from evolving tax laws, intricate corporate structures, and the need for precise alignment between financial reporting and tax compliance. Several key difficulties stand out in tax provision calculations:

1. Navigating Regulatory Changes: Tax laws are constantly changing, and companies must stay updated on new regulations that impact tax liabilities, deductions, and credits. For instance, recent international tax reforms and updates in the U.S. tax code can significantly alter tax provision calculations. Keeping track of these changes and incorporating them accurately into tax provisions requires continuous monitoring and expertise.

2. Handling Temporary Differences: ASC 740 requires the identification and tracking of temporary differences between financial reporting and tax reporting, which can be challenging for businesses with complex transactions. Differences in revenue recognition, depreciation, and stock-based compensation methods can lead to deferred tax assets or liabilities, which must be accurately calculated and reported.

3. Managing Uncertain Tax Positions: Uncertain tax positions (UTPs) add complexity to tax provision calculations, as companies must assess the probability of tax authority challenges on specific positions taken on their tax returns. Under ASC 740, if a position is uncertain, a reserve must be created, adding to the financial and administrative burden of tax provision calculations.

4. Applying Valuation Allowances: Valuation allowances for deferred tax assets (DTAs) must be assessed to determine whether future tax benefits will likely be realized. This involves analyzing projections of future taxable income, which can be subjective and prone to estimation challenges, especially in volatile economic conditions.

5. Integrating Multiple Data Sources: Accurate tax provision calculations often require data from multiple systems, including accounting, finance, and tax software. Ensuring data accuracy and consistency across these systems can be challenging, as discrepancies can lead to errors in tax provision reporting and potential compliance issues.

These challenges underscore the importance of robust tax provision processes and systems that can handle complex data integration and regulatory changes. For many organizations, addressing these challenges involves collaborating closely with tax experts, investing in advanced tax software, and maintaining an agile approach to regulatory compliance.

Using the Right Tool for the Job

These challenges require significant transparency and flexibility in order to adhere to tax laws, meet the needs of every stakeholder, and avoid public and regulatory scrutiny. But even simple mistakes made during the income tax cycle can lead to financial statement errors, repercussions from Wall Street, and potential regulatory enforcement actions.

Finding the right tool for the job is a key step in optimizing your tax reporting process. Fortunately, new improvements in automation and connectivity mean you can significantly reduce provisioning challenges and risks for your organization.

DIY Tax Software

Most companies are still relying too heavily on Excel spreadsheets to connect their tax and financial reporting. But using more modern, specialized tax software can help ease the pain of tax provisioning and bridge the gap between finance, tax, and the rest of your stakeholders.

If you’re still relying on spreadsheets, you may have considered building your own software solution to support the tax function. Your company might think it can save on costs by designing a custom solution built to its specific needs. But a custom software design and build can be time-consuming, requires significant IT resources, and doesn’t necessarily eliminate the risk of formula or regulatory errors in a meaningful way.

Out-of-the-Box Solutions

Out-of-the-box software offers several advantages over DIY solutions. Once installed, out-of-the-box software is ready to go with the ability to adapt to the needs of your business. This plug-and-play usability saves your tax team significant time up front.

Out-of-the-box tax solutions can also help you stay seamlessly up to date when it comes to the constantly changing tax code with the flexibility to address specific jurisdictional needs. And cloud-based software makes it easy to share your tax data with different stakeholders across the company, getting everyone in your organization on the same page.

The biggest concern is often cost, but significant benefits can be realized with a relatively minor investment. Cloud-based software—which is quickly becoming the new standard—can be implemented affordably.

The more important question may be, “What will be the cost if my company chooses to do business as usual?” With a faster time to value, an out-of-the-box tax solution is likely to be the most cost-effective and least risk-laden option in the long run.

How To Calculate ASC 740 Tax Provisions

ASC 740, "Accounting for Income Taxes," is a standard set by the Financial Accounting Standards Board (FASB) for calculating and reporting income tax provisions. It involves recognizing and measuring deferred tax assets and liabilities, as well as understanding current tax expenses to provide a comprehensive view of a company's tax obligations. Calculating ASC 740 tax provisions can be complex, as it requires aligning financial statement tax calculations with U.S. Generally Accepted Accounting Principles (GAAP) while considering tax implications over time. Here are the main steps involved:

1. Calculate Current Tax Expense: Begin by determining the current income tax expense, which is the estimated tax due on taxable income for the reporting period. This typically involves multiplying the taxable income by the applicable tax rate. Adjustments for any prior period changes may also be needed here.

2. Identify Temporary Differences: ASC 740 requires identifying temporary differences between financial statement and tax return income due to differences in timing (e.g., depreciation methods or revenue recognition). These differences will either create deferred tax assets (DTAs) or deferred tax liabilities (DTLs).

3. Calculate Deferred Tax Assets and Liabilities: Once temporary differences are identified, apply the enacted tax rates to calculate DTAs and DTLs. Deferred tax assets represent future tax reductions, while deferred tax liabilities indicate future tax obligations.

4. Assess Valuation Allowances: A valuation allowance is applied to deferred tax assets if it is more likely than not that some portion of the assets won’t be realized. This step involves analyzing the company’s future income projections to decide whether a valuation allowance is necessary to offset unrealizable assets.

5. Account for Uncertain Tax Positions: Under ASC 740, uncertain tax positions must be evaluated. These are positions that may be contested by tax authorities. If a position is uncertain, a reserve may be created to reflect potential exposure.

6. Recognize the Total Tax Provision: Finally, combine the current tax expense and the net deferred tax asset or liability to arrive at the total tax provision. This total is recorded on the income statement as the tax provision, providing a comprehensive view of the company’s tax liability.

ASC 740 compliance requires careful analysis of tax rules and accounting standards, often requiring collaboration between tax and finance teams to ensure accuracy and alignment with GAAP principles.

Clear Your Tax Provision Hurdles with an Elevated Tax Solution

Corporate tax provisioning is a complex process that can have a real effect on your company’s bottom line, but it can also be fraught with challenges. Finance professionals face significant hurdles in the tax provisioning process, including increasingly complex tax codes at home and abroad, heightened scrutiny from the public and regulatory agencies, and the need to balance the interests of investors with those of other important stakeholders.

How do you strike a balance? Modern tax management software solutions can help your tax team eliminate the burdens of data gathering and validation, stay ahead of regulatory changes, and keep your stakeholders informed and up to date.

Still on the fence about whether to build or buy a more advanced tax solution? Take a look at our guide To Build or Not to Build?, for a more in-depth discussion on whether your organization should build or buy software to support the tax function.

FAQ

What is an example of a tax provision?

A tax provision example is when a company estimates its income tax expense for the year and records a liability on its balance sheet. Suppose a company expects to owe $50,000 in taxes at the end of the fiscal year. The company will create a tax provision by recording an expense on the income statement and a corresponding liability on the balance sheet to account for this anticipated tax obligation. This provision ensures that the financial statements accurately reflect expected tax costs, even if the payment has not yet been made.

What is the difference between tax expense and tax provision?

The difference between tax expense and tax provision lies in their specific focus and timing:

• Tax Expense: This is the actual amount of taxes a company incurs based on its taxable income for the reporting period. It includes both current taxes due and deferred taxes that result from timing differences between financial reporting and tax reporting. Tax expense appears on the income statement and represents the cost of taxes for that period.

• Tax Provision: This is an estimated amount set aside to cover future tax liabilities. It’s a liability recorded on the balance sheet, reflecting an anticipated tax obligation based on current income and potential tax adjustments. While the tax expense represents the actual incurred amount, the tax provision is an estimate to ensure adequate funds are allocated for taxes when they become due.