Securing long-term success and stability for your business is not just limited to generating sales and revenue. It is also determined by how well you can fulfill your federal and state obligations, and that includes properly accounting for your tax provision.

Fulfilling your taxes is a must if you want to continue operating your business and avoid an audit from the IRS.

Understandably, tax provisions are quite a daunting task to take on for any business. If you want to know how to properly calculate the provisions for your taxes, this article will serve as a comprehensive guide.

Let’s start!

Key Takeaways

• Tax provision refers to the estimated taxable income amount that a company pays to federal, state, and local authorities annually.
• Calculating tax provisions entails two parts: Current income tax expense and deferred income tax expense.
• Current income tax expense focuses on the income tax to be paid by the business within the current year.
• Deferred income tax includes the liabilities in a company’s balance sheet that are yet to be paid.
• It is essential to ensure data accuracy, use a tax provision checklist, and implement the proper criteria in calculating tax provisions.

What is a Tax Provision?

Tax provision is a company’s estimated amount of taxable income paid for federal and state taxes in a year. It is one of the financial considerations that businesses take into account when regulating expenses.

When accounting for tax provisions, estimated income taxes are listed as tax liabilities.

Calculating tax provisions can be complicated as it entails necessary adjustments to the permanent and temporary differences in net income.

Provisions may be financially burdensome, but they provide leverage and a security blanket from a business perspective. If you estimate your tax provisions correctly, you create a ripple effect of steady growth and financial stability for your business.

If not, any mistake in determining your taxes due will negatively affect your forecast for your company’s budget and costs.

How Can You Calculate a Tax Provision?

Calculating your tax provision is complicated and requires careful evaluation. One of the main reasons behind the complexity of estimating tax provisions is the difference between the standards for accounting income taxes and implementing Generally Accepted Accounting Procedures (GAAP).

Typically, you only get an accurate value of your net income at the end of the year, making it tricky to assess the amount you have to set aside for your tax obligations.

There are also two parts to account for your business’s provisions: current income tax expense and deferred income tax expense. With the current income tax expense, the core focus is the income tax your company will fulfill for the current tax year.

Deferred income tax expense refers to liabilities on your company’s balance sheet that you are yet to compensate

How to Calculate Your Current Year Income Tax Expenses

It is necessary to factor in your net income and all differences, then multiply the values by your tax rate, as elaborated in the steps below:

#1. Estimate Your Business’ Net Income

Use the GAAP rules to assess your total net income for the current year. Your net income includes the following:

• Operating expenses. All expenses, such as wages, utilities, repairs, and administrative costs, that indirectly affect your business operations.
• Non-operating costs. It refers to any company expense unrelated to your core operations, including inventory write-offs and payments on debt interest.
• Cost of goods sold (CoGS). The direct expenditure is coupled with your operations and revenue.
• Taxes. Your company’s federal, state, and local taxes.

#2. Calculate the Permanent Differences

Expenses under permanent differences are life insurance proceeds, penalties, and municipal bond interests. According to GAAP instructions, permanent differences are expenses that cannot be filed for your income taxes. This means the expenditure cannot be reversed or reported on a tax return.

#3. Calculate Your Temporary Differences

Temporary differences are allowed for both GAAP and income tax purposes. These are the resulting differences between an asset and/or liability and taxable earnings. To calculate your temporary differences, check your balance sheet and get the difference between the values generated for your income tax and the values yielded from GAAP calculations.

#4. Apply Your Tax Credits and Account for Net Operating Losses (NOL)

Both tax credits and net operating losses are subtracted from your taxable income. The resulting value represents the basis for calculating your taxes due.

#5. Apply the Current Tax Rate

To get the correct current tax rate, all you have to do is multiply your taxable income for the current year by the present federal tax rate.

Here’s a more elaborate formula you can follow:

Taxable income for the current year - (Tax credits + Net operating losses) X Federal tax rate

How to Calculate Deferred Income Tax Expense

Calculating your deferred income tax expense is relatively simpler than determining your current year’s income tax expense. Your deferred income tax expense is either a liability or an asset on your balance sheet.

The reason behind that is that deferred income tax accounts for the suspended impact of your business expenses, net operating losses, tax credits, and income. In calculating your deferred income tax expense, get the sum total of all your temporary differences.

Next, implement the federal tax rate for the current year, then review whether your business is supposed to make a tax payment or receive a tax benefit at the end of the year.

Knowing whether you are to receive a tax benefit or pay taxes determines whether you are to list your deferred income tax as a liability or an asset on your GAAP balance sheet.

Tips for Calculating Your Tax Provision

There are ways to simplify and boost the accuracy of estimating your tax provision:

#1. Ensure Your Data is Accurate

Always verify the accuracy of all the values needed to calculate your tax provision, meaning you must backtrack your accounting books.

Whether the data represents your operating and non-operating costs, cost of goods sold, assets, or liabilities, a minor mistake could complicate the calculating process and even lead to major financial consequences for your business.

#2. Use a Tax Provision Checklist

A tax provision checklist guarantees you do not miss any important detail or value in provisioning your taxes. A comprehensive checklist highlights your business’s risk assessment factors, reviews all requirements in gauging your income taxes, and examines the key criteria for reporting your income taxes.

#3. Use the Correct Criteria

It is easy to mix up the criteria used in estimating tax provisions. Make sure you are calculating the values you need using the appropriate formula.

If you are unsure, it is best to seek the expertise of a tax accountant to avoid making any mistakes in your estimation.

#4. Be Proactive

Monitor your business expenses, assets, and liabilities. Check whether there is a steady cash flow in your business or if you need to regulate some expenditures to balance your gains and losses.

Furthermore, you must always be in the know when it comes to any changes in IRS taxation rules. Obliviousness to your tax obligations is never an excuse.

Tax Provision FAQ

#1. What is an example of a tax provision?

An example of provisioning in taxes involves multiplying your tax rate with your pretax income rate. Your pretax income also includes interest payments, depreciation, and operating expenses.

#2. Is tax provision the same as tax expense?

A tax provision is basically the same as tax expense because it pertains to your total federal, state, local, and foreign income tax expense in a given year or tax period.

#3. How do you treat provision for tax?

Provision for tax is typically treated as a current liability and will appear under Liabilities and Provision in the balance sheet. In a cash flow statement, tax provision is treated as an outflow from business operations.

#4. What is the difference between tax provision and accrual?

Tax provisions are essentially estimates with uncertain values despite being included in a company’s expected annual expense. An accrual covers all costs and revenue that have specified values and are easily anticipated.

Final Thoughts

Tax provisions tend to be tricky and require a tedious process. It is important to give it your full attention and ensure you prepare all the financial data you need to yield accurate values.

By calculating your tax provisions, you are also taking a closer look at your company’s earnings in the long run. You get to see how imposed federal, state, and local tax rates and regulations impact your operations as a whole.

It also allows you to scrutinize your business’s financial health in such a way that you pinpoint operating activities that affect your profitability and assess how to better prepare your company for fulfilling your tax responsibilities.

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