2023 Tax Provisions – Important State + Local Tax Considerations

For businesses that operate across multiple states and local tax jurisdictions, the tax provision process can be extremely complex. Each state or local municipality the business operates in may have different tax regulations. Also, businesses aren’t static: they constantly grow and evolve––and so do their tax obligations.

Tax provisions, particularly the calculations for state and local taxes, contain multiple layers of complexity for accounting and finance professionals to navigate. Doing so without the support of an external tax provision expert can be extremely challenging.

In a tax provision, precision with a quick turnaround is extremely important. Depending on the regions in which a business operates, its state tax liability may be anywhere from 1% to 9% of its taxable income. For a business with significant income, seemingly innocuous miscalculations can quickly add up to material financial misstatements.

With such high levels of complexity, businesses must understand the factors that impact their state and local tax provision calculations. In this overview, we outline exactly what those factors are and explore the value of partnering with accountants who understand this complex topic.

Tax Provision: A Brief Overview

Under U.S. Generally Accepted Accounting Principles (GAAP), businesses are required to record their current taxes payable, taxes they expect to pay in the next 12 months, and their deferred tax assets or liabilities: the expected future tax liabilities as of the balance sheet date.

The most significant element of any tax provision calculation is federal income taxes. In addition to federal taxes, businesses are also required to calculate their state and local income tax obligations and factor them into tax provision calculations and footnotes.

U.S. GAAP requires each tax-paying entity to calculate every tax jurisdiction separately, but GAAP also recognizes that aggregating U.S. state and local taxes into a blended rate may be acceptable with proper consideration for items that would not be captured using a blended rate.

Some states have high levels of corporate income tax, such as Minnesota, which has a flat rate of 9.8%. Others, including Wyoming and South Dakota, have no corporate income tax at all. Because many businesses operate across multiple states, with different regulations, preparing a blended rate can become extremely complex.

Key State Tax Considerations for Tax Provision Calculations

With 50 states, each in charge of their own corporate income tax regulations, there are many considerations finance leaders must take into account when calculating their blended state income tax rate.

Business Footprint and Activity

One of the first concepts businesses must consider is the nature of their business activities across different states. Each state has different rules that determine whether a business has a state income tax filing obligation.

Many states use a factor-presence standard to determine whether a business has income tax nexus. These standards typically assess a combination of a business’s property, payroll, and sales in a state, with thresholds ranging from $250,000 to above $1 million.

Understanding these standards is a critical step in determining where the business has state income tax liability. As businesses grow and evolve, it’s necessary to revisit these issues. Often, decisions such as opening a new facility or hiring a new employee may put businesses above thresholds they previously did not meet, creating new income tax liabilities. A tax advisor can help the business weigh the benefits and potential drawbacks of these decisions when consulted in advance.

Without the right technology and processes, tracking the business’s activities and their relation to tax laws in all 50 states is extremely challenging. For this reason, many businesses partner with an outsourced tax provision provider that can assess your business’s activity for every state in which it operates to provide a complete tax provision calculation.

Related: Guide to State Income Tax Nexus

Changes to State Laws

Businesses don’t stand still, and neither do state lawmakers. Many states are actively changing their state income tax laws. At the time of this writing, Pennsylvania was on the path to cutting their rate over the next nine years, while North Carolina was in the process of cutting corporate income tax rates to zero.

It takes a considerable amount of time and effort for internal finance and accounting teams to monitor the latest tax regulations in every state in which the business operates. Tax provision specialists with access to the right software and research services can provide businesses a centralized, cost-efficient way to track how changes to state laws affect their tax provision calculations. 

Federal Conformity

The passage of the 2017 Tax Cuts and Jobs Act ushered in a range of new provisions at the federal level that have not been adopted uniformly by individual states. This means that some states have differing laws around concepts such as GILTI income inclusion, FDII deductions, interest limits, and other areas of the tax code.

This can create differences in income inclusion and deductions between federal and state taxes. U.S. GAAP recognizes the need for a blended rate to calculate state and local taxes, but also requires calculations to count for differences in federal conformity.

In addition to this, businesses must also factor in separate calculations for federal and state tax credits. If a business receives a federal R&D tax credit, its state tax liability is unaffected. There may be state R&D credits that can be applied, but these should be incorporated into separate calculations for each state.

Lastly, businesses must consider the differences between federal and state net operating loss limitations, carryback periods, and carryforward periods. These differences could impact both current and deferred taxes as well as generate the need to record a valuation allowance, reducing certain deferred tax assets to their expected realizable amount.  

Local Tax Considerations

In most instances, local tax considerations do not have a material impact on tax provision calculations. However, if a business primarily operates in high-tax municipalities, local taxes are more likely to be material.

Many municipalities across the United States have significant local tax requirements, including major cities, such as New York City and Philadelphia, as well as smaller cities across states such as Michigan, Kentucky, and Ohio.

Smith + Howard: Your Outsourced Tax Provision Expert

Producing an accurate tax provision in a timely manner is an extremely important task for accounting and finance teams. With such high stakes and so many factors to consider, many businesses opt to partner with an external tax provision team. This offers businesses increased peace of mind and streamlines the tax provision process.

At Smith + Howard, our tax provision team assists businesses in a wide variety of industries with tax provision services. Our tax professionals have significant experience navigating all state and local tax considerations and bring a sophisticated, rigorous approach to producing precise tax provisions for our clients.

To learn more about Smith + Howard’s tax provision services, contact an advisor today.