Deadlines are looming, bank statements are on the printer – it is tax time! The official "tax season" is February 15 - April 15. However, this year April 15 lands on a Saturday, and the following Monday is a holiday. Therefore, the official 2017 tax deadline for individuals and corporations is Tuesday, April 18. There is one exception: for Partnerships and S Corporations filing Form 1065 and Form 1120S, respectively, the deadline is March 15. Please visit the IRS 2017 Federal Tax Calendar for more information.
In order to prepare accurate business tax returns, corporations need to review and finalize financial statements. Most companies maintain one set of books but make tax adjustments to convert accrual basis to cash basis, inventory, and fixed assets. GAAP rules intend to promote uniform statements that accurately convey the financial history, health, and prospects of a business, while the tax code intends to generate revenues for the government, but also to achieve certain public policy goals.
This article explores areas that deserve special scrutiny when preparing your business returns.
Most companies use accrual-based accounting to recognize revenue and expenses in the period incurred. These companies need to convert their earnings from accrual-based to cash-based so that they can accurately represent their cash position and tax liability. Under the accrual method, a company recognizes the revenue they earned once they have performed the obligation by debiting accounts receivable and crediting sales revenue. To convert the books to a cash basis, a company would need to remove their accounts receivable, allowance for bad debts, and accounts payable, and recognize only cash increases and decreases as revenue and expenses.
Inventory valuation methods can have substantial impacts on costs of goods calculations and ending inventory. For book purposes, there are four methods to calculate the cost:
- Specific Identification Method
- First In First Out (FIFO)
- Last in First Out (LIFO)
- Weighted average method
FIFO assumes that the first unit to enter stock is the first one sold, which means that the earliest costs assigned to inventory are the first ones charged to expense when items are sold. If prices are rising, this means the remaining inventory will have a relatively high price, which in turn means the cost of inventory charged to expense is low. This creates more taxable income. In Last In, First Out, the costs of goods is greater because prices rise, which provides a lower income and subsequently provides a tax advantage. Due to this advantage, the IRS, in Section 472, requires financial reporting for tax purposes to use the LIFO inventory valuation method.
Most of the time, companies recognize the same original cost but are allowed to use different depreciation methods. The main difference in book and tax depreciation is the timing of the depreciation, but the overall depreciation expense is the same throughout the life of an asset.
The legally mandated tax depreciation method is the Modified Accelerated Cost Recovery System (MACRS). The IRS specifies both useful lifespans for different classes of assets and the depreciation methods to use to calculate depreciation expense based on those useful lifespans. It uses the double-declining depreciation method, which decreases the net value of assets more rapidly than other book depreciation methods. Publication 946, How to Depreciate Property provides additional information about MACRS.