Comprehensive Tax Allocation

Comprehensive tax allocation is an analysis that identifies the effect of taxation on revenue-generating transactions during a non-standard reporting period. Also known as an interperiod tax allocation, this technique allows a firm to compare the impact of taxation during an accounting period to that of a particular financial reporting period.

Comprehensive tax allocation allows for the reconciliation of temporary differences that arise between tax reporting and financial performance reporting timelines. Comprehensive tax allocation is also known as interperiod tax allocation, a reference to the two sets of reporting periods that firms use in accounting.

Four classes of transactions can lead to a temporary discrepancy between tax and accounting periods:

• Accelerated reporting of taxable income
• Delayed reporting of taxable income
• Accelerated reporting of deductible expenses
• Delayed reporting of deductible expenses

The most common source of temporary differences is in the handling of asset depreciation, which is considered a deductible expense for tax purposes. The Internal Revenue Service (IRS) grants companies some freedom in how they elect to report these expenses, which can often lead to the type of temporary difference that may require resolution via comprehensive tax allocation.

Companies often use straight-line depreciation and and accelerated depreciation for the same piece of equipment for different purposes. A firm will typically use straight-line depreciation for accounting purposes while it applies accelerated depreciation principles for tax purposes.  

For example, the Acme Construction Company buys a $200,000 crane. IRS rules allow accelerated depreciation of the equipment over 5 years. This gives the Acme a $40,000 depreciation for 5 years. On the accounting side of Acme’s books, however, the firm uses a 10-year straight-line accounting method, which appears as an annual expense of $20,000 for 10 years. Eventually, both methods meet in the same place: a full depreciation of the asset. The temporary difference over the financial life of the crane is resolved using a comprehensive tax allocation.

In practice, firms carry a portfolio of assets subject to a temporary allocation and their accountants must decide how aggressively to allocate the discrepancy. Some firms choose to strictly report tax expenses in the year that they make those payments. If Acme were such a company, it would stick to the $40,000 annual deduction grated by the IRS. Other firms prefer to allocate according to the book value of depreciation. The IRS has demonstrated some flexibility in this area, and favors consistency above all.