Comprehensive Tax Allocation
Comprehensive tax allocation is an analysis that identifies the effect of taxation on revenue-generating transactions during a non-standard reporting period. Four classes of transactions can lead to a temporary discrepancy between tax and accounting periods: Accelerated reporting of taxable income Delayed reporting of taxable income Accelerated reporting of deductible expenses Delayed reporting of deductible expenses As mentioned, comprehensive tax allocation is also known as interperiod tax allocation, which is a reference to the two sets of reporting periods that firms use in accounting. Comprehensive tax allocation is an analysis that companies use to identify discrepancies between their accounting for business purposes and their accounting for tax purposes. Comprehensive tax allocation allows for the reconciliation of these temporary differences that arise between tax reporting and financial performance reporting timelines.
What Is Comprehensive Tax Allocation?
Comprehensive tax allocation is an analysis that identifies the effect of taxation on revenue-generating transactions during a non-standard reporting period. Also known as an interperiod tax allocation, this technique allows a firm to compare the impact of taxation during an accounting period to that of a particular financial reporting period.
Understanding Comprehensive Tax Allocation
The income and expenses a company reports in its own books versus its tax filings often differ because there are tax advantages to accelerating or delaying certain transactions on paper. For example, a company may internally write off a cost over several years but choose to claim the expense more rapidly for tax purposes based on changes in income requirements or tax laws.
Comprehensive tax allocation allows for the reconciliation of these temporary differences that arise between tax reporting and financial performance reporting timelines. As mentioned, comprehensive tax allocation is also known as interperiod tax allocation, which is a reference to the two sets of reporting periods that firms use in accounting.
Four classes of transactions can lead to a temporary discrepancy between tax and accounting periods:
The most common source of temporary differences is in the handling of asset depreciation, which is considered a deductible expense for tax purposes. The Internal Revenue Service (IRS) grants companies some freedom in how they elect to report these expenses, which can often lead to the type of temporary difference that may require resolution via comprehensive tax allocation.
Example of Comprehensive Tax Allocation
Companies often use straight-line depreciation and accelerated depreciation for the same piece of equipment for different purposes. A firm will typically use straight-line depreciation for accounting purposes while it applies accelerated depreciation principles for tax purposes.
Say, for example, the Acme Construction Company buys a $200,000 crane. IRS laws allow depreciation of the equipment from the time it is put into service until the company recovers its cost-basis. This allows Acme a $40,000 depreciation for five years. On the accounting side of Acme's books, however, the firm uses a 10-year straight-line accounting method, which appears as an annual expense of $20,000 for 10 years. Eventually, both methods meet in the same place: a full depreciation of the asset. The temporary difference over the financial life of the crane is resolved using a comprehensive tax allocation.
In practice, firms carry a portfolio of assets subject to a temporary allocation and their accountants must decide how aggressively to allocate the discrepancy. Some firms choose to strictly report tax expenses in the year that they make those payments. If Acme were such a company, it would stick to the $40,000 annual deduction granted by the IRS. Other firms prefer to allocate according to the book value of depreciation. The IRS has demonstrated some flexibility in this area, and it favors consistency above all.
Related terms:
Accelerated Depreciation
Accelerated depreciation is any depreciation method used for accounting or income tax purposes that allow for higher deductions in the earlier years. read more
Amount Recognized
Amount recognized is income or loss you must report on your tax return or on a financial statement. read more
Business Expenses
Business expenses are costs incurred in the ordinary course of business. Business expenses are deductible and are always netted against business income. read more
Deferred Tax Liability
A deferred tax liability is a line item on a balance sheet that indicates that taxes in a certain amount have not been paid but are due in the future. read more
Depreciation
Depreciation is an accounting method of allocating the cost of a tangible asset over its useful life and is used to account for declines in value over time. read more
Future Income Taxes
Future income taxes are expected future tax costs or savings from differences between financial and taxable income or expenses. read more
What Is the Internal Revenue Service (IRS)?
The Internal Revenue Service (IRS) is the U.S. federal agency that oversees the collection of taxes—primarily income taxes—and the enforcement of tax laws. read more
Modified Accelerated Cost Recovery System (MACRS)
MACRS is a depreciation system allowed by the IRS for tax purposes. read more
Self-Employment
A self-employed individual does not work for a specific employer who pays them a consistent salary or wage. read more
Straight Line Basis
Straight line basis is the simplest method of calculating depreciation and amortization, the process of expensing an asset over a specific period. read more