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Overview

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.

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Basics

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Tax accounting vs financial accounting

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.

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Organizing your tax accounts

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

  • Tax expense, prepaid: Tax expense, prepaid taxes: Debit tax expenses during the year.
  • Tax payables, taxes: Credit expenses during the year, debit prepayments. Should net to zero at year-end if expenses match prepayments.

Residual tax

  • Tax expense, residual: Debit any difference between prepaid and EOY estimated tax expenses.
  • Tax payables, residual: Credit expenses during the year, debit payments. Should clear once paid.

EOY adjustments

  • Tax expense, EOY adjustments: Debit the difference between prepaid and residual expenses vs. final tax expenses once it is known.
  • Tax expense, interest rate expense: Debit the interest rate expense due to late payments.
  • Tax payables, EOY adjustments: Credit the difference, debit payments. Should clear once paid.

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:

  • Monthly booking: Record monthly tax expenses to Tax Expense, Prepaid and Tax Payables, Prepaid. The total for the year should equal your aconto payments, which ideally match your expected tax liability for the year.
  • Aconto payments (March and November): When you pay aconto taxes in March (1st installment) and November (2nd installment), credit the bank account and debit Tax Payables, Prepaid. If the aconto payments match the recognized expenses, the Tax Payables, Prepaid account will be cleared by year-end.
  • Residual tax (November - January): If you plan to pay residual taxes before February of the following year (3rd installment), debit Tax Expense, Residual and credit Tax Payables, Residual.
  • Paying the residual tax: When the payment is made, credit the bank account and debit Tax Payables, Residual.
  • Year-end adjustments: When external accountants prepare the annual report in the six months following year-end and calculate the final tax expense, record the difference between the total paid and the final tax expense by debiting Tax Expense, EOY Adjustments and crediting Tax Payables, EOY Adjustments.
  • Interest expenses (if any): Debit Tax Expense, Interest Rate Expense and credit Tax Payables, EOY Adjustments.
  • Final payment (November the following year): When you pay the EOY adjustment and any interest expense, credit the bank account and debit Tax Payables, EOY Adjustments. This account should then be cleared.

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Forecasting tax expenses

Once you have a clean account for this year’s tax expense, you can forecast properly. Typically, teams evolve through three stages:

  1. Ignoring taxes: No tax expense or cash flow forecast. Fine for loss-making startups.
  2. Forecasting based on payments (cash-basis): Forecast March and November aconto payments and a potential November residual payment. Reflects cash movement but distorts profitability.
  3. Forecasting monthly taxes (accrual, recommended). Create monthly tax expenses and use tax payable accounts to separate recognition from payments, giving a clearer view of profitability and cash flow.

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.

= -"Profit before taxes"[0] * "% tax rate"[0]

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.

= -"Tax payables, current year"[-1] - "Tax expense, current year"[0] + if(if_month(3) = 1 or if_month(11) = 1, -"tax payment"[0],0)

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.