The field of Tax Technology involves the integration of technology with tax processes. Tax Technology represents a collaboration between IT and tax professionals. In this partnership, technology plays a crucial role in designing and implementing innovative solutions. Because many tax departments do not have the technological expertise needed to achieve significant efficiencies, they partner with IT professionals who have strong backgrounds in information technology but often possess limited knowledge of tax and financial principles. To be effective partners, IT professionals must identify and recommend areas within the tax processes where automation can add value. To do that, they need to understand where and how tax data originates, comprehend what the financial data represents at a high level, and know how the data is ultimately presented on tax returns.

This article provides an overview of the tax data flow, aiming to equip IT professionals with the knowledge needed to develop transformative solutions that will significantly enhance the efficiency and effectiveness of tax operations.

From Subledger to Filing Tax Returns

1. Subledgers: The Initial Data Sources
Subledgers are specialized systems that maintain detailed records of specific financial transactions within a corporation’s operational areas. They serve as a supplementary ledger, capturing and tracking detailed information related to various aspects of the corporation’s finances, such as accounts payable, accounts receivable, fixed assets, and inventory. Subledgers provide granular details for each transaction, ensuring accuracy and traceability, which are essential for both internal accounting and external reporting purposes.

Accounts Payable (AP): In financial and accounting terms, accounts payable refers to the money a corporation owes to its suppliers or vendors for goods and services purchased on credit. It is a liability account on the corporation’s balance sheet, representing the corporation’s obligation to pay off short-term debts to creditors. The AP subledger keeps detailed records of each transaction, such as invoices received and payments made, ensuring that the company accurately tracks its obligations and maintains good relationships with its suppliers. For example, when the corporation purchases supplies, the invoice and payment details are recorded in the AP subledger.

Accounts Receivable (AR): Accounts Receivable (AR): This term refers to the money owed to a corporation by its customers for goods or services delivered but not yet paid for. The AR subledger monitors all transactions related to these receivables, ensuring that the corporation accurately tracks incoming payments. For instance, when a corporation sells its products or services on credit, it issues invoices to customers. These invoices and their subsequent payments are meticulously recorded in the AR system, helping the corporation manage its cash flow and maintain financial health.

Fixed Assets: The fixed asset subledger maintains detailed records of a corporation’s tangible long-term assets, such as buildings, machinery, and vehicles. The fixed asset subledger tracks the value of tangible assets as they depreciate over time by tracking their acquisition, depreciation, and disposal over their lifespan. This subledger is crucial for calculating depreciation and ensuring accurate financial reporting.

Depreciation is calculated according to two different rules—Book Depreciation and Tax Depreciation.

• Book Depreciation: Book depreciation refers to the method corporations use to allocate the cost of tangible assets over their useful lives for financial reporting purposes. This method follows accounting standards such as GAAP (Generally Accepted Accounting Principles) or IFRS (International Financial Reporting Standards). The primary goal of book depreciation is to represent the true and fair value of the asset’s consumption and wear in the financial statements, ensuring that the financial health and performance of the corporation are accurately reflected.

• Tax Depreciation: Unlike book depreciation, which follows accounting standards like GAAP or IFRS, tax depreciation is governed by tax laws and regulations. The primary goal of tax depreciation is to allow businesses to recover the cost of assets through tax deductions, thereby reducing taxable income. This can provide financial incentives for businesses, as it often allows for accelerated depreciation methods that enable higher deductions in the earlier years of an asset’s life. This approach can lead to significant tax savings and improve cash flow, aiding in business growth and investment.

Inventory Subledger: The inventory subledger tracks the stock levels and valuations of inventory items within a corporation. It provides detailed records of purchases, movements, and sales of inventory items, ensuring accurate tracking and management of inventory. This subledger is crucial for maintaining optimal inventory levels, reducing overhead costs, and improving the efficiency of supply chain operations. By capturing granular details, the inventory subledger supports internal audits and external reporting, contributing to the overall financial health and operational effectiveness of the corporation.

To summarize, subledgers maintain detailed transaction-level information but are not directly integrated with the corporation’s primary financial reports. Rather, they function as sources of summarized data for a centralized system known as the general ledger (GL). Utilizing subledger data ensures that specific transaction details can be traced and reviewed when necessary.

2. General Ledger: Centralizing Financial Records
A general ledger (GL) is a critical component of a corporation’s accounting system. It centralizes financial records by consolidating data from various subledgers, such as accounts receivable, fixed assets, and inventory subledgers. The GL categorizes transactions into specific account types defined by the corporation’s chart of accounts.

Periodically, GLs produce reports called trial balances.  A trial balance is an accounting report that lists the balances of all ledger accounts at a specific point in time. It is used to verify that the total debits equal the total credits in the general ledger, ensuring that the accounting records are mathematically accurate. The trial balance is typically prepared at the end of an accounting period, such as monthly, quarterly, or annually. It serves as a preliminary step towards preparing financial statements and facilitates the identification and correction of any discrepancies in the ledger accounts. A trial balance is generated for each subsidiary of a corporation that has financial activity. Trial balances are essential for producing accurate financial statements and represent the primary data source for tax applications.

3. Financial Statements: Converting Data into Insights
Financial statements are derived from the GL and provide a high-level overview of the corporation’s financial performance. The main types of statements are:

Income Statement (Profit & Loss Statement): An Income Statement, also known as a Profit & Loss Statement, is a financial document that summarizes a corporation’s revenues, expenses, and net income over a specific period. This statement is essential for measuring the financial performance of a corporation and provides insights into its profitability. The key components of an Income Statement include:

• Revenues: The total income generated from the sale of goods or services before any expenses are deducted.

• Expenses: The costs incurred in the process of earning revenues, including operating expenses, cost of goods sold, and other overhead costs.

• Net Income: Net Income is the final profit or loss after all expenses have been deducted from revenues.

The Income Statement is crucial for calculating taxable income and is often the starting point for preparing tax filings for Federal and State jurisdictions.

Balance Sheet: A Balance Sheet is a financial statement that provides a snapshot of a corporation’s financial position at a specific point in time. It lists the company’s assets, liabilities, and equity, offering insights into the company’s financial stability and liquidity. Key Components of a Balance Sheet are:

• Assets: Resources owned by the corporation that have economic value and can be converted into cash. This includes items such as cash, accounts receivable, inventory, and property.

• Liabilities: Obligations or debts the corporation owes to external parties, such as loans, accounts payable, and mortgages.

• Equity: The residual interest in the assets of the corporation after deducting liabilities. Equity represents the ownership value held by shareholders and includes retained earnings and common stock.

The Balance Sheet is divided into two sections that must balance: total assets on one side and total liabilities plus equity on the other. This alignment ensures that the corporation’s financial statements are accurate and that the company maintains a solid financial foundation.

Cash Flow Statement: A Cash Flow Statement is a financial document that tracks the movement of cash within a corporation over a specific period. It categorizes cash flows into three main activities:

• Operational Activities: This section captures cash generated or used by a corporation’s core business operations. It includes receipts from sales, payments for goods and services, payroll expenses, and other operating costs.

• Investing Activities: Investing activities encompass cash transactions related to assets acquisition and disposal. This includes purchases of property, equipment, and investments, as well as proceeds from selling such assets.

• Financing Activities: This section reflects cash flows from transactions with the corporation’s owners and creditors. It includes issuing and repaying debt, paying dividends, and raising capital through equity.

The Cash Flow Statement ensures transparency in liquidity and helps assess the corporation’s ability to generate cash, manage debts, and invest in growth opportunities.

4. Tax Data Integration: Transitioning to Tax Software
Once the GL financial data is prepared, corporations use specialized tax software to bridge the gap between accounting (Book) and tax calculations (Tax). This transition involves:

1. Exporting GL Financial Data: The Income Statement (IS) and Balance Sheet (BS) of every subsidiary is extracted from GL to import into tax application.
2. Mapping GL Data to Tax Software: Each GL transaction is mapped to an appropriate tax software account and category.
3. GL Data Import to Tax: GL data is loaded to the tax software and reconciled to ensure accurate and complete mapping of legal entities and accounts between the two systems.
4. Manual/Automated Tax Adjustments: In the tax software, tax preparers modify the GL data according to tax calculation regulations. For example:
    – The amounts for fixed asset depreciation recorded in the books are reversed and recalculated according to the tax depreciation method.
    – Expenses for Meals and Entertainment are modified according to the limitations set by tax regulations.
5. Applying Form-based Tax Rules: For every tax form that is part of a return, the tax software utilizes calculation rules to produce the return based on legal entity and jurisdiction.

At this point, the tax software starts to transform the unprocessed financial information into organized tax returns.

5. Tax Consolidation
For federal income tax return filing purposes, the tax software aggregates data from all legal entities into a unified corporate view on a single tax return known as the federal consolidated return. A consolidated return represents the corporation’s overall profitability and tax obligation. It is this tax return that is electronically filed with the Internal Revenue Service (IRS).

After completing the federal returns, the tax software transfers the federal return data of each legal entity to their respective state tax forms, in compliance with state regulations. This process ensures that the corporation’s subsidiaries can file their state returns as required.

6. Tax Filing Application: From Preparation to Submission
Once tax-related adjustments are finalized in the tax software, the data is used to populate tax forms. The tax application streamlines compliance by generating tax forms and facilitating submissions:

Federal Tax Filing: The tax application generates forms like IRS Form 1120 (corporate income tax return) that calculates:
  – Taxable income after applying adjustments and deductions.
  – Federal tax liability using the corporate tax rate.

State Tax Filing: Each state has unique rules. The tax application:
  – Allocates income across states based on apportionment formulas (e.g., sales, payroll, property).
  – Applies state-specific tax credits and deductions.
  – Generates state-specific tax forms for submission.

7. Supporting Financial IT Applications
The financial data journey relies on a robust IT infrastructure to ensure data integrity through automated workflows and enabling compliance. Key systems include:

• ERP Systems: An ERP system (Enterprise Resource Planning system) is a software solution that helps businesses manage and integrate their core processes in one place. Think of it as the central nervous system for a company’s operations. An ERP system typically includes modules for areas like:
  • Finance and Accounting: Tracks budgets, expenses, and financial reports.
  • Supply Chain Management: Manages procurement, inventory, and logistics.
  • Human Resources: Handles payroll, employee records, and recruitment.
  • Customer Relationship Management (CRM): Supports sales and customer service efforts.

By streamlining data and processes across departments, ERP systems improve efficiency, accuracy, and decision-making. Popular examples of ERP systems include SAP, Oracle NetSuite, and Microsoft Dynamics 365.

• Tax Software: Corporate tax software is a specialized application developed to assist businesses in efficiently managing their tax compliance and obligations. This software is tailored to address the intricate requirements of enterprises, including multinational corporations with international presence.

• Data Integration Tools: A data integration tool is software designed to combine and connect data from different sources into a unified, cohesive system. It ensures that information from various databases, applications, or systems can work together seamlessly, allowing businesses to access, manage, and analyze their data more effectively.

• Data Warehousing: A data warehouse is a centralized repository that stores large amounts of structured data from multiple sources. It is specifically designed for analysis and reporting, making it easier for businesses to access and interpret their data for decision-making purposes. Unlike a standard database, which is optimized for day-to-day operations, a data warehouse is built for strategic, analytical purposes to help organizations uncover patterns and insights.

From inception to the end, IT professionals play a critical role in maintaining financial systems by troubleshooting issues and ensuring accurate and compliant processes.

8. Post-Filing and Audit Preparation
After filing taxes, corporations must be prepared for potential audits. A tax audit is a review or examination conducted by a tax authority, such as the IRS (Internal Revenue Service) in the United States, to verify the accuracy of a taxpayer’s financial information and ensure compliance with tax laws. The purpose of a tax audit is to confirm that income, deductions, credits, and other tax-related figures are reported correctly.

Conclusion
From subledgers to tax filings, the flow of financial data reflects a complex but meticulously organized process. It’s a symbiotic relationship between accounting principles, tax regulations, and IT systems. By seamlessly integrating these elements, corporations ensure compliance, mitigating risks, and optimizing their financial operations.