How to Calculate a Tax Provision

From calculating tax liabilities to understanding disclosure requirements, businesses must stay ahead to avoid costly mistakes. Join our small business accountants at C.E. Thorn, PLLC, CPA as we explore tax provision best practices to streamline the process.

What is Tax Provision?

A tax provision is an estimate of the amount a business expects to owe in taxes for a specific reporting period. 

Here’s a simplified breakdown of how to calculate a tax provision:

1. Estimate the net income for the year.
2. Determine the applicable tax rates—consulting an accountant is advisable since tax brackets can be surprisingly complex.
3. Multiply the net income by the tax rate.
4. Add a small buffer to account for potential discrepancies.

Examples of Tax Provisions 

To better understand tax provisions, let’s look at a few examples of how businesses calculate and apply them.

Quarterly Tax Estimates

A small consulting firm estimates its net income for the quarter to be $50,000. With an applicable tax rate of 21%, they calculate their tax provision by multiplying $50,000 by 0.21, arriving at $10,500. To ensure accuracy and cover any unexpected adjustments, they add a $500 buffer, bringing their total tax provision to $11,000.

Deferred Tax Liabilities

A manufacturing company uses accelerated depreciation for tax purposes but straight-line depreciation for its financial statements. This creates a timing difference that results in a deferred tax liability. They calculate the provision based on the difference between the two methods and allocate the tax accordingly for future periods.

Multistate Business Operations

A retail business operating in multiple states must account for varying state tax rates. By allocating revenue and expenses to each state, they calculate tax provisions for each jurisdiction separately. For example, if $200,000 of revenue is earned in a state with a 5% tax rate, they set aside $10,000 as the tax provision for that state.

Tax Adjustments for New Legislation

A tech startup reviews recent changes in tax legislation that affect research and development tax credits. After recalculating their provision based on these new rules, they adjust their estimate to reflect the increased credit, reducing their tax liability. For instance, a $20,000 credit might lower their total tax provision from $50,000 to $30,000.

How Can You Calculate a Tax Provision?

Calculating a tax provision involves a straightforward formula that ensures your business sets aside the appropriate amount for its tax obligations. 

The formula looks like this:

Income Tax Provision = (Net [Taxable] Income Before Taxes) × (Applicable Tax Rates) + Buffer

Here’s a closer look at the process:

1. Net [Taxable] Income Before Taxes: Start with the company’s estimated income before taxes. This figure should reflect deductions and adjustments specific to the reporting period.
2. Applicable Tax Rates: Determine the tax rates that apply to your business. This could include federal, state, and local tax rates, which vary based on your business type, income level, and location. Working with a Raleigh tax consultant can help navigate these rates and ensure accuracy.
3. Multiply Net Income by the Tax Rate: Multiply the net income figure from Step 1 by the applicable tax rate(s) determined in Step 2. This provides the base tax liability.
4. Add a Buffer: Incorporate a small buffer to account for any unforeseen tax adjustments or calculation errors. This helps your business avoid underestimating its tax liability.

This formula provides a baseline estimate of your tax provision, but complexities like deferred taxes, credits, and specific accounting rules may require additional adjustments. For the most accurate results, regular reviews and professional guidance from an experienced CPA are recommended.

Two Main Aspects of a Tax Provision

A tax provision typically consists of two main components: the current year income tax expense and the deferred income tax expense. These components work together to provide a comprehensive view of a company’s tax obligations. 

Current Year Income Tax Expense

The current year's income tax expense represents the taxes a business expects to pay for the current reporting period based on its taxable income. 

The calculation is straightforward:

Income Tax Expense = Taxable Income × Current Tax Rate

Here’s how it works:

1. Taxable Income: This figure represents the portion of your business’s earnings subject to taxation after deductions and adjustments.
2. Current Tax Rate: This rate is determined by applicable federal, state, and local tax regulations.

For example, if a business has taxable income of $100,000 and a current tax rate of 21%, the income tax expense would be $21,000. This figure is included in the company’s financial statements as part of its current liabilities.

The current tax expense is crucial for cash flow management, as it reflects the immediate tax obligation for the year. Regularly reviewing and updating this calculation helps businesses avoid surprises at tax time.

Deferred Income Tax Expense

Deferred income tax expense arises from timing differences between when income and expenses are recognized for accounting purposes versus tax purposes. 

These timing differences create either deferred tax liabilities or deferred tax assets:

1. Deferred Tax Liabilities: These occur when income is recognized earlier in financial statements but taxed later. For instance, accelerated depreciation for tax purposes often results in higher taxable income in the future.
2. Deferred Tax Assets: These occur when expenses are recognized for tax purposes earlier than in financial statements, reducing taxable income in future periods.

Deferred tax expense reflects the net change in these liabilities or assets for the reporting period. For example, a company using accelerated depreciation might defer $10,000 of taxes to future years. This $10,000 is recorded as a deferred tax liability and affects the company’s overall tax provision.

Understanding deferred tax expenses is critical for long-term tax planning and accurate financial reporting. It ensures that financial statements reflect a complete picture of the company’s tax obligations over time.

How to Prepare for Tax Provisions 

Preparing for tax provisions requires organization, attention to detail, and a proactive approach. Ensuring your business is ready to calculate its tax obligations accurately can save time, prevent common mistakes that cost the company money, and promote compliance. The process typically involves gathering critical documents and seeking professional guidance to navigate the complexities of tax regulations.

Compile and Gather Relevant Documents

The first step in preparing for tax provisions is to collect all necessary financial and tax-related documentation. Having accurate and comprehensive records ensures that calculations are based on reliable data.

For example, a small retail business gathers the following documents to prepare for its tax provision:

• Income Statements: To determine net income for the reporting period.
• Expense Records: Including receipts, invoices, and proof of deductible expenses.
• Tax Returns from Previous Years: For reference and to identify potential carryovers or adjustments.
• Payroll Records: To account for employee-related tax liabilities.

By organizing these documents early, the business can efficiently estimate its taxable income and applicable tax rates, laying the foundation for an accurate tax provision.

Work with a CPA

Outsourcing your accounting to a CPA can be an effective way to prepare for tax provisions. At C.E. Thorn, CPA, PLLC, we have decades of experience with tax laws, regulations, and accounting principles, allowing us to help small businesses navigate complex tax situations.

Our Raleigh CPAs: 

• Review financial statements for accuracy and identify potential deductions.
• Analyze applicable tax rates, including federal, state, and local levels.
• Assess deferred tax liabilities and assets.

With the guidance of a CPA, small business owners take the steps needed to avoid missteps in calculations while gaining valuable insights into optimizing tax strategies. 

Outsource Your Tax Needs to Our Raleigh CPA Firm

Navigating tax provisions can be challenging, but you don’t have to do it alone. At C.E. Thorn, PLLC, CPA, we provide tailored accounting and tax services to help businesses in the Raleigh area stay tax-compliant. Whether you need assistance with tax calculations or year-end reporting, we’re here to simplify the process and provide guidance every step of the way.

Contact us today by calling  919-420-0092 or filling out the form below to see if we are a good fit for your tax needs.