While most business owners are concerned with the accounting impact for certain transactions, they are equally as interested in the impact it will have to their taxes. While many transactions are treated the same for both financial and tax purposes, there are various transactions that, due to the nature or timing, are treated differently. Accordingly, most companies can’t look at the earnings from a financial reporting perspective and assume that is what is going to be taxable income for the period. Here is a list of the common book-to-tax differences we see so that you can understand the differences between your book and taxable income.
Depreciation and amortization
This is the most common difference as it affects pretty much all businesses. For GAAP basis financial statements, fixed assets should be depreciated using an acceptable method (most often, this is straight-line) over the asset’s estimated useful life. For tax purposes, fixed assets are depreciated using accelerated methods over prescribed lives by the IRS. In addition, the IRS allows for bonus depreciation and Section 179 deductions, which is a complete deduction for a new capital addition in the year of purchase. Accordingly, depreciation on a tax basis is often greater than books in the earlier life of an asset.
Also, most intangible assets acquired in a business combination, including goodwill, are amortized over 15 years. For GAAP basis financial statements, the useful lives for these can vary for amortization purposes or may not be amortized at all but, rather, reviewed annually for impairment.
Allowance for doubtful accounts
The expense that you recognize when recording an allowance for accounts receivable that are doubtful of collection cannot be deducted. These will be deducted once the receivable is written off against the allowance.
Inventory reserves for slow-moving, excess or obsolete inventory
Expenses recorded for books that are associated with inventory reserves are often not allowed deductions. For tax purposes, the deduction cannot be taken until the inventory is physically disposed of. However, permanent impairments of inventory to record at net realizable value when that is below cost may be fully deductible for tax purposes.
Expenses recorded for certain accrued accounts, such as accrued bonuses, accrued vacation and accrued profit sharing, cannot be deducted for tax purposes unless these are paid out within two-and-a-half months of your company’s year-end (March 15th for calendar year-ends).
Travel and entertainment
This is another difference that is common for a lot of companies. Travel and entertainment costs are recognized fully as an expense for book purposes but have limitations on deductibility.
Deferred and stock-based compensation
Expenses recorded in connection with deferred compensation or stock-based compensation plans cannot be deducted for tax purposes. These will be deducted for tax purposes once the recipient receives the compensation or stock (equity) and recognizes the income on his or her personal income tax return.
This is just a summary of the more common book-to-tax differences we encounter with our clients. There are various others that could be encountered and will be determined on a company-by-company basis. Be sure to check with your tax advisor to understand the book versus tax treatment for your company’s transactions based upon your specific facts and circumstances.
Jonathan Poppel, CPA