cash vs tax basis financials

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#1
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Have a client that I prepare monthly financials and I say the statements are on the cash method, but I am calculating depreciation on declining balance method. Am I really preparing these statements on the tax method? And if so, what about other book - tax difference (50% of meals and entertainment, etc.)?
 

#2
makbo  
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There is no such thing as "the tax method of accounting". I can only interpret your question as asking about an officially or commonly recognized term for the method you are using. I don't know if there is an official definition somewhere, but I would say you are preparing a modified cash method, or a tax accounting cash method, report.

§446(c) says,

"Subject to the provisions of subsections (a) and (b), a taxpayer may compute taxable income under any of the following methods of accounting-

(1) the cash receipts and disbursements method;
(2) an accrual method;
(3) any other method permitted by this chapter; or
(4) any combination of the foregoing methods permitted under regulations prescribed by the Secretary."


Backing up, §446(a) says,

"Taxable income shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books."


So if we look to book cash method, do we include depreciation? As far as I can tell, yes, but technically this would be considered a modified cash method. If you look, say, at Form 1065, it is clear that even under cash method, depreciation expense is considered part of book income, although there could be an adjustment on Schedule M-1 for book-tax depreciation differences.

Now I hope someone who has an advanced degree in accounting will come along with the definitive answer. 8-)
 

#3
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The big difference between the cash, accrual, and income tax bases are the revenue recognition and matching principle (expense) rules. The income tax method of accounting is the group of rules that your client uses -- cash/accrual, tax revenue recognition and matching rules, §263A/no §263A required, MACRS/ADS (not book depreciation), de minimis levels, and so forth. As makbo said, there is not just one tax method of accounting; different taxpayers have different methods of accounting.

But as a general rule, those of us who work with small businesses (which don't have their financial statements audited or reviewed) do our financial statements on the income tax basis of accounting.

The 50% meals is a tax limitation, but you record all meals & entertainment at 100% even on a tax basis P&L. Same with nondeductible penalties; record them at 100%.
 

#4
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Great explanation! Thank you
 


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