There are three things you should consider when forecasting taxes
Taxes are harder to forecast than most other items. One reason is that the final tax expense is based on tax accounting - a separate set of books from financial accounting, with adjustments made for tax rules. Another reason is that Chart of Accounts typically only include one account for everything tax-related, which ends up with a lot of noise from end-of-year adjustments and similar. This guide explains how to forecast taxes more effectively by structuring your accounts properly and applying the right forecasting logic.
When forecasting taxes, it’s important to remember that the final tax expense is based on tax accounting - a separate set of books from financial accounting, with adjustments made to comply with tax rules.
Examples of common tax adjustments include different depreciation methods (e.g., accelerated for tax but straight-line for financial reporting), disallowance of certain expenses (like fines), and timing differences in revenue recognition (cash basis for tax vs. accrual for financials).
For SMBs, accountants typically manage the tax books in parallel with financial accounting and perform the necessary adjustments at year-end to estimate the final tax expense.
To forecast taxes effectively, finance teams often use financial accounting figures as a basis for forecasting - typically by multiplying pre-tax income by the corporate tax rate. The consideration is that the resources required to include the tax adjustments typically does not outweigh the improved accuracy on expense and cash flow forecasting. If specific items are expected to result in material tax adjustments, those adjustments can potentially be incorporated into the forecast.
Most Charts of Accounts start with a single “Tax expense” account, bundling everything tax-related. This limits visibility and makes forecasting harder.
Instead, separate your tax accounts. Focus on splitting the recognized tax expense for the year from adjustments, so you have a clean, forecastable number. Here are some suggestions:
Prepaid taxes
Residual tax
EOY adjustments
Other accounts could cover deferred tax assets/liabilities, etc.
The categories follow different patterns, so it makes sense to separate them. It’s a small structural change, but makes forecasting far more manageable.
Example
Here’s one way to use the accounts for a Danish company:
Once you have a clean account for this year’s tax expense, you can forecast properly. Typically, teams evolve through three stages:
Your forecast pattern must match your bookkeeping pattern. Otherwise, you won’t be able to meaningfully compare budget versus actuals. If not feasible, forecasting by payments will still capture cash flow but will misalign monthly profitability.
Tax expense
Forecasted tax expenses are typically calculated by multiplying pre-tax profit by the applicable tax rate.
Other methods include using actuals from prior years if operations are stable, forecasts provided by the tax authorities, applying a forecasted effective tax rate based on historical data or external advisor input, or incorporating specific tax adjustments.
Tax payables
The account “Tax payables, current year” can be forecasted as the difference between forecasted tax expenses and expected tax payments during the year.
The idea is that recognized tax expenses from the P&L are credited to the tax payable account, and the balance is debited whenever (aconto) payments are made to the tax authorities.