Don’t Make These 3 Mistakes with Accounting for Income Taxes

Restating financial statements is among a CFO’s worst nightmares.

As accounting for income taxes (ASC 740) is one of the leading causes of financial restatements, it’s imperative to get it right. And as challenging as it is, ASC 740 is only becoming more complex as the business environment, regulations and accounting rules continue to change.

Here are three common mistakes public companies make when preparing an ASC 740 tax provision and what you can do to can avoid them.

1.      Uncertain tax positions

Accounting for income taxes requires a two-step process.  Step one is recognition. Step two is the measurement of tax benefits associated with the tax position.  However, some companies miss a disclosure requirement that is now an area of focus for the SEC and has been the cause of restatements and material weaknesses – uncertain tax positions.

Companies are required to disclose:

• The nature of the uncertainty
• Events that could cause a change
• Estimate of the range of the change

Subsequent recognition and measurement should be reassessed each reporting date.

 2.      Material tax issues

Public companies sometimes fail to recognize material tax issues such as IRC Section 382 limitation, which can lead to an incorrect reporting of deferred tax assets. Generally, mergers, acquisitions and certain other ownership changes give rise to IRC Section 382 limitation, which limits the realizability of net operating losses. Properly evaluating the tax consequences of transactions that result in ownership changes is critical for enabling you to accurately report your company’s deferred tax assets.

3.      Valuation allowance

Companies sometimes record a valuation allowance in the wrong circumstances. For example, it’s not appropriate to record a valuation allowance to create a reserve for an uncertain tax position. A company should record a valuation allowance if it believes it will not have enough future taxable income to realize its deferred tax assets against.

The bottom line

Accounting for income taxes is a complex compliance challenge that requires in-depth knowledge of both tax and financial accounting, which some public companies may not have. If your company doesn’t have the required expertise to prepare the ASC 740 provision in-house, contact Kaufman Rossin’s tax team to learn how we can help.