Interperiod Income Tax Allocation

Definition

The financial accounting term interperiod income tax allocation refers to the distribution of income tax expense between accounting periods.  This occurs due to a timing difference between taxable income and the accounting income appearing in the company's financial statements.

Explanation

Also referred to as a comprehensive tax allocation, an interperiod tax allocation is required to ensure alignment between the income tax expense appearing in financial statements and the obligation determined when calculating accounting income.  The interperiod allocation aligns Generally Accepted Accounting Principles with federal and state income tax rules.

While it might seem logical to align the company's financial statements with the tax guidelines outlined by the IRS, doing so can actually distort the true financial performance of the business.  The use of accelerated depreciation for tax purposes versus straight line for book purposes is a good example of how this distortion can occur.

An interperiod allocation is achieved by accruing income taxes to align with accounting income whenever there is a timing difference that impacts taxable income or expenses.

Example

Company A purchases a new machine for $100,000 in Year 1.  Tax laws allow Company A to depreciate the asset over 5 years at $20,000 per year.  Company A will use 10 years for book purposes; thereby incurring an expense of $10,000 per year.  The table below demonstrates how the interperiod tax allocation aligns what is shown on Company A's financial statements (Income Tax Expense) and its tax records (Tax Depreciation).

  Tax Expense Tax Depreciation Deferred Income Taxes
Year 1 $10,000 $20,000 $10,000
Year 2 $10,000 $20,000 $20,000
Year 3 $10,000 $20,000 $30,000
Year 4 $10,000 $20,000 $40,000
Year 5 $10,000 $20,000 $50,000
Year 6 $10,000   $40,000
Year 7 $10,000   $30,000
Year 8 $10,000   $20,000
Year 9 $10,000   $10,000
Year 10 $10,000   $0

Related Terms

income statement, Generally Accepted Accounting Principles, income taxes, depreciation, deferred income taxes