Comprehensive Tax Allocation Definition

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Comprehensive Tax Allocation Definition

What Is Comprehensive Tax Allocation?

A comprehensive tax allocation study is one that determines the impact of taxes on revenue-generating transactions within a non-standard reporting period. This strategy, also known as interperiod tax allocation, enables a company to evaluate the effect of taxes during an accounting period to that of a specific financial reporting period.

Key Takeaways

  • Comprehensive tax allocation is a method used by businesses to uncover disparities between their accounting for business and accounting for tax reasons.
  • The majority of the inconsistencies stem from variances in the reporting and tax filing times.
  • The disparities shown by comprehensive tax allocation are due to the acceleration or deferral of deductions and/or taxable income.

Understanding Comprehensive Tax Allocation

The revenue and expenditures reported in a company’s books and those reported in tax filings sometimes vary because there are tax benefits to accelerating or postponing certain transactions on paper. For example, a corporation may internally deduct a cost over time but chose to declare the expenditure more quickly for tax reasons due to changes in income requirements or tax rules.

Comprehensive tax allocation enables the reconciliation of transient disparities between tax reporting and financial performance reporting schedules. As previously stated, comprehensive tax allocation is also known as interperiod tax allocation, which refers to the two sets of accounting reporting periods used by corporations.

There are four types of transactions that might cause a temporary difference between tax and accounting periods:

The most prevalent cause of temporary discrepancies is the treatment of asset depreciation, which is a tax-deductible expenditure. The Internal Revenue Service (IRS) allows businesses considerable flexibility in how they choose to record these costs, which may often result in the kind of temporary disagreement that may need resolution via comprehensive tax allocation.

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Example of Comprehensive Tax Allocation

For the same piece of equipment, companies often utilize straight-line depreciation and accelerated depreciation for different objectives. For accounting reasons, a company will normally utilize straight-line depreciation, whereas for tax purposes, it will adopt accelerated depreciation principles.

Assume Acme Construction Company purchases a $200,000 crane. IRS regulations allow for depreciation of equipment from the moment it is installed until the corporation recovers its cost-basis. This gives Acme a $40,000 depreciation over a five-year period. Acme’s books, on the other hand, utilize a 10-year straight-line accounting approach, which shows as a $20,000 yearly cost for ten years. Both techniques eventually lead to the same result: a complete asset depreciation. A complete tax allocation is used to settle the transitory disparity throughout the crane’s financial life.

In reality, businesses keep a portfolio of assets subject to a temporary allocation, and their accountants must determine how aggressively to allocate the difference. Some businesses prefer to record all tax costs in the year in which they are paid. If Acme were such a firm, it would adhere to the IRS’s $40,000 yearly deduction. Other businesses choose to apportion based on the book value of depreciation. The IRS has shown some flexibility in this area, and it prioritizes consistency above everything else.

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