At a Glance
Accounting Standards Codification 740, also known as ASC 740, is a set of guidelines regulating how companies recognize the impact of income taxes under Generally Accepted Accounting Principles (GAAP). One of the fundamental principles of the U.S. tax system is that state income taxes are generally a tax-deductible expense in the federal income tax calculation.
Learn how companies must calculate state income tax deductions to determine deferred and current tax assets and liabilities. Accurate and timely calculations are critical for reliable financial statements and maintaining compliance with ASC 740.
How Does ASC 740 Apply to State Income Taxes
ASC 740 governs how businesses recognize their income taxes in financial statements under U.S. GAAP. Specifically, ASC 740 provides guidance on how companies should account for state income taxes, which they can deduct when calculating their federal income tax.
To comply with ASC 740, companies must calculate their state income tax deductions to determine their current and deferred tax assets or liability position. This calculation involves understanding each state’s tax laws and regulations in which the company operates in conjunction with the federal tax laws that govern deductions for state income taxes.
Companies must ensure that their tax accounting processes and documentation meet ASC 740 requirements, such as recording deferred tax assets and liabilities and disclosing tax uncertainties within those transactions.
How to Account for State Income Taxes Under ASC 740
Under ASC 740, companies account for state income taxes by calculating their state income tax liability, which influences the appropriate figure for current federal income taxes payable. State income taxes are deductible for federal income tax purposes, so companies must first calculate this liability to arrive at an accurate aggregate figure.
Companies determine their deferred taxes by combining federal and state tax rates and subtracting the federal benefit from the state tax deduction. They often report the effective tax rate impact of state income taxes net of the federal tax benefit.
Most states use federal taxable income as the starting point for calculating state taxable income. However, state income tax laws often differ significantly from federal tax laws. As a result, states calculate separate adjustments, known as additions and subtractions, which companies must consider when computing their state income tax obligations.
What Impact Do Federal and State Tax Differences Have on ASC 740?
The differences between federal and state tax laws significantly impact ASC 740. For example, certain states may not let taxpayers file consolidated tax returns. This means companies must file separate tax returns for each entity that conducts business in that particular state.
Some states, like California, allow certain corporations to file combined returns. However, the principles determining which corporations can file combined returns may differ from those applied for consolidated federal returns, resulting in instances where a state-combined return includes corporations not included in the federal group or omits corporations included in the consolidated federal return.
State-Level Net Operating Losses and Credits
State net operating losses (NOLs) are similar to federal NOLs and are accounted for as deferred tax assets. However, they often have different carryforward or carryback periods and are generally based on modified state income after apportionment. Furthermore, some states may limit the use of NOLs.
To account for state NOLs and credits, they are recorded net of the federal benefit because they reduce current and future state income taxes, increasing future federal income.
Enacted State Laws and Rates
Companies must comply with ASC 740 and account for any state tax law changes that impact the income tax provision when the law is enacted. A state tax rate change can result in a deferred impact on the effective rate, requiring a company to re-price its deferred tax assets and liabilities.
When a law change happens after the reporting period but before the financial statements are issued, the company should use the law that is in effect as of the balance sheet date to determine its income tax provisions. However, it must disclose any known material impact of subsequent changes in the law, especially if it is predictable.
ASC 740 requires companies to determine income tax provisions for each jurisdiction where it is subject to tax. However, companies sometimes use a blended state rate to simplify the process to account for their state income tax provision.
Taxes for Pass-Through Entities
In the past, pass-through entities were not required to pay income tax. Instead, the tax implications of the transactions were passed on to the owners. However, some states have started imposing an entity-level income tax on pass-through entities. Circumstantially, these entities need to consider the impact of this tax on their tax provisions if they issue financial statements based on U.S. GAAP.
Ensure ASC 740 Compliance for Your Business
ASC 740 compliance can be challenging to navigate, even for experienced financial professionals. At Windes, our ASC 740 Income Tax services can help ensure your income tax reporting is seamless and accurate.
Our tax professionals have expert technical knowledge and experience across various industries, including FIN 48 analysis, quarterly provisions, foreign income tax considerations, and merger and acquisition impacts.
Connect with us today so we can assist you in ASC 740 and state income tax implementation and compliance to prevent costly errors and improve your bottom line.