Interim Tax Reporting: Avoiding Surprises in the Quarters

For many smaller SEC filers, interim income tax provisions can be surprisingly challenging, particularly for companies with limited internal tax resources. Variances in assertion or assumptions, discrete events, changes in judgment on a valuation allowance and/or acquisition(s) are just a few items in a long list that can cause a surprising wrinkle in the interim tax provision process and resulting taxes.

It’s strongly recommended that finance and accounting teams become aware of the top seven challenges that SEC filers frequently encounter during the interim tax provision process, particularly among smaller and emerging growth companies.

Underpinning Interim Tax Calculations

Interim tax calculations generally estimate income tax expense for quarterly reporting periods. ASC 740 generally prescribes the use of an estimated annual effective tax rate (AETR) to allocate projected annual income tax expense to the interim period. However, not all items fit neatly into this framework. Practical tensions can arise between the development of an AETR and reality. Forecast volatility, pressure to “true-up” amounts later in the year and earnings impacts are often sensitive topics. 

Top Seven Common Pitfalls

Interim tax reporting introduces unique timing and judgment challenges, particularly for smaller reporting entities with limited internal resources. Here’s what can commonly go wrong for those organizations during the interim tax process:

Shortcuts and estimates are applied often in interim reporting and can be appropriate when adequately supported. Companies should maintain constant communication about expectations with both their external auditors and their tax advisors, who are experienced in income tax accounting for public companies.  

Valuation Allowances and Naked Credits

The assessment and adjustment of valuation allowances for deferred tax assets (DTAs) is a judgment-intensive process and a key area of focus for external auditors and the SEC alike. Companies must evaluate at each reporting period whether it is “more likely than not” that DTAs will be realized based on all available evidence that is consistent with the rest of the company profile. Furthermore, recording a valuation allowance can lead to a net deferred tax liability, or “naked credit,” and may surprise even seasoned finance professionals. A naked credit arises when deferred tax liabilities remain after valuation allowances are reserved against deferred tax assets.

Uncertain Tax Positions: Evolving Judgments

Interim periods require companies to revisit their uncertain tax positions (UTPs) in light of new information or developments. Transfer pricing is one of the most common areas of exposure for companies operating globally and can materially impact the income tax provision.

It’s recommended that companies maintain policies to review and revisit or update their uncertain tax positions each quarter.

Changes in Tax Law: Immediate Effects

Newly enacted tax legislation or regulatory guidance can impact interim tax calculations, sometimes requiring immediate accounting as a discrete item. Under ASC 740, the effects of tax law changes are recognized in the period of enactment, not spread over multiple interim periods through the AETR. Companies often need help assessing whether these items are included or excluded from the AETR based on all the facts and circumstances. 

Final Thoughts

With continued regulatory changes, accelerated reporting timelines and the fact that accounting for income taxes is, in and of itself, a complex topic, companies should maintain a well-developed interim provision process.  Smaller reporting companies need to be aware of these common hurdles and align with auditors ahead of each reporting period.  Withum has a dedicated team of skilled tax professionals who have experience guiding smaller reporting companies through the many intricacies and challenges.