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Companies Starting to See a Need for State-by-State Tax Provisioning

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Mar 30th 2015
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Audit and compliance issues are on the rise concerning blended, or averaged, state tax rates in Accounting Standards Codification (ASC) 740-10. That’s prompting more corporations to move to a state-by-state approach, but it’s been a tough task.

Years ago, companies began using the blended-rate approach in the state tax provision arena to average tax rates in multiple states without major differences in their tax laws.

Until about 10 years ago, “100 percent of corporations used the blended rate,” says Diane Tinney, senior project manager at Bloomberg BNA. But since then, auditors have looked more closely at the tax provision and how it’s put together. “It does impact financial statements, which in turn impacts earnings per share, and when [corporations] use a blended rate, you mix apples and oranges, and you aren’t being very exact,” she says.

Tinney believes the matter has been exasperated by the states themselves. “In the old days, states followed the same rules and were more similar than they are today. Today, they have economic challenges and need to increase the taxes they collect to balance budgets. So they all have done different things. And most states are very different from one another,” she says.

Blended rates became more of a sore point in 2006 to 2008 when the economic downturn affected state budgets, and states created other taxation methods. “It became more apparent that each jurisdiction has a different approach to computation,” she says. And states have moved further away from federal tax calculations and compete with each other for revenue sources.

Tinney offers the following example: There are 44 states that have income tax and they all start their tax computation with federal taxable income on Form 1120, US Corporation Income Tax Return. Each state will have its own adjustments to that number. Some states will follow bonus depreciation. Other states don’t use the federal bonus depreciation rules and will re-compute based on their state rules for subtracting out federal depreciation numbers.

“So there are somewhere between 25 and 30 different adds and subtracts across the states that they require companies to do to re-compute expenses and income,” she says.

Corporations Have Had Ample Warning
For auditors, blended rates have become more of a material-review point. And auditors have become increasingly aggressive about moving companies away from that tactic and heeding the ASC rules, Tinney says.

It’s not as if corporations haven’t had ample warning, though. The ASC codifies Financial Accounting Standard (FAS) 109 and others, pulling them together into one place. FAS 109 was issued in 1992; the codification took place in the early 2000s. So corporations have known of these rules for decades.

Specifically at issue are two rules: ASC 740-10-55-25 and 740-10-45-6. The first provides that deferred taxes must be determined separately for each entity and for each taxing jurisdiction. The second requires that “an entity cannot offset deferred tax liabilities and assets attributable to different tax-paying components of the entity or to different tax jurisdictions.”

Doesn’t that read to mean blended rates have been banned all along? Yup, says Tinney. “Accounting firms to a certain degree have bucked the system by saying ‘we don’t have the ability, and the state rules are so difficult and changing so often,’” she says.

When asked why so many companies have used an approach for so long that rules disallow, US Securities and Exchange Commission spokeswoman Judith Burns said the agency “had nothing to provide and would decline comment.”

From a compliance perspective, using the blended-rate approach for material states and transactions puts the state tax provision at risk of being materially inaccurate, according to a paper that Tinney wrote on the topic.

3 Keys to a Smooth Transition
In July, Bloomberg BNA expects to launch a cloud software state income tax planning and provision tool that will allow corporations to move away from blended rates to “something more accurate” in managing and calculating the taxation details of 44 states, Tinney says.

She offers three considerations for the transition:

  1. Re-think the information flow. Re-evaluate the tax process down to the source information used for calculating deferred assets and liabilities.
  2. Prioritize. Preparing the tax provision means considering the materiality by each entity and state. It’s easier to work on the provision by concentrating first on the most profitable entities, or states with the largest tax burden.
  3. Bolster technology and tools. Simplified data management, automated tax provision steps, and centralized state tax information are key.
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