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What is Tax Accounting?

Tax accounting is a subsection of accounting methods that specifically centers itself around preparing tax returns and tax payments. This method of accounting can be used by individuals, businesses, and corporations alike. Tax accounting is also different from financial accounting in the sense that it is not governed by the same rules that financial accounting is. Financial accounting is primarily concerned with the appearance of public financial statements and follows the rules set forth by GAAP (Generally Accepted Accounting Principles). On the other hand, tax accounting is governed by the Internal Revenue Code which sets forth the guidelines that companies and individuals must follow when filing their taxes. Tax accounting is known to be somewhat more complex than financial accounting and a tax advisor is often recommended when filing one’s taxes.

The Basics of Tax Accounting

The purpose of tax accounting is to track funds going in and out of a business or individual. Tax accounting is practiced by everyone, even tax-exempt organizations, because everyone must do it at least once a year when they file taxes. The basic rules of tax accounting are described in detail in section 446 of the Internal Revenue Code. There are different types of tax accounting methods that vary depending on how the method counts and tracks assets. Additionally, the IRS has the discretion to adjust which method is used in order to clearly reflect the taxpayers income. For this reason, many consult a tax expert to make sure that their taxes are filed correctly.

Tax Accounting Principles vs Financial Accounting

Under Financial Accounting, companies must follow a set of guidelines and procedures set by GAAP that dictate how the company compiles their financial statements. With financial accounting, every single transaction must be accounted for. Financial accounting is often used for managerial purposes and internal business decisions because of this. 

Tax accounting, while it still keeps track of many of these transactions, is only concerned with financial transactions as they pertain to filing taxes and the individuals or companies tax burden. Financial accounting and tax accounting can work together but for different purposes and via different methods. Financial accounting can be used to prepare a balance sheet with, for example, the FIFO (first-in-first-out) method of accounting. Tax accounting can be used by the same business to prepare their tax payable but with, for example, the LIFO method (last-in-first-out) in order to reduce the current year’s tax payable.

tax accounting

Tax Accounting for the Individual

Tax Accounting when done by or for an individual is primarily concerned with income, qualifying deductions, and investment gains or losses. Significantly fewer documents are needed to file one’s own tax return; this makes individual tax accounting easier to do, however an accounting advisor is still recommended to make sure compliance with the IRS is being followed.

Tax Accounting for a Business Entity

Tax accounting is much more complicated for businesses than it is for the individual. Because of this an accounting advisor is often required. For a business, they must track their earnings similar to how an individual tracks their income. The difficult part with businesses is tracking outgoing funds which can include specific business expenses as well as funds directed to shareholders. While it’s not required to use a tax accountant, it is strongly recommended for larger businesses due to the complexity of the records involved for preparing the businesses tax payable.

Even for tax exempt organizations, a tax accountant is necessary for their annual tax returns. This is because even the tax exempt businesses must keep track of incoming funds such as donations and grants as well as how they allocate those funds within their own business.

Accounting Considerations Following 2020

Following 2020, there are new changes to tax accounting thought. 2020 was a challenging year for everyone involved and their businesses due to Covid-19. Some businesses were able to do well facing the pandemic, but many businesses struggled and incurred losses. With many businesses still feeling the impact of the pandemic today, changes have been made to some aspects of tax accounting. 

In March of 2020, the US government passed the CARES Act giving relief to businesses and consumers alike in response to the Covid-19 pandemic. Some of the major parts of the act affect income tax accounting and tax law was changed, making businesses have to change their records following the changes being enacted. However, companies should continue to evaluate which aspects of the CARES Act continue to be applicable and adjust estimates accordingly; there are some situations where the effects of the Act have changed due to the actual earnings of the business. 

Additionally, continued tax reform in the US adds to the complexity of the tax accounting. This is because the Treasury department and the IRS issued final and proposed regulations that provide varying effective dates along with the ability to retroactively apply for tax returns in certain circumstances. Companies must be able to assess the impacts of 2020 and determine if amended returns will be filed for the application of the final regulations of the prior tax years. 

Tax positions for a company should be continued to be assessed regularly throughout and at the end of each fiscal year. In 2020 alone there were new developments in case law (Whirlpool, Altera, and Coca-Cola), changes to tax law (with the CARES Act), and the Treasury’s tax reform in the proposed and final regulation. In general, as tax law is refined through these processes, the effects are recorded in the financial statements in the same period the guidance is issued.

The Solution: Wealth Management Forward

Tax accounting is already extremely complex yet necessary for every business; it is required for most businesses to work with a tax accounting expert inorder to make sure that proper regulations are being followed. Wealth Management Forward provides this service, along with countless other features, so that businesses do not need to worry about having to find a specific tax accountant every time they need taxes to be filed. Additionally with Wealth Management Forward, the entire financials of a business are all in one place which makes filing taxes each year simple and easy. With the rate that tax regulations have been affected within the past year, the only way to stay on top of all of the changes is with Wealth Management Forward.

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