Tax accounting is that area of accounting that specializes in tax-related activities of all kinds of entities.
It deals with tax compliance and reporting rather than traditional financial statements.
The Internal Revenue Code governs tax accounting, which includes the regulations and practices required to administer taxes, such as monitoring funds related to different entities and ensuring accurate tax payments and filings.
Tax accounting prepares the associated information and calculations regarding income rather than full financial records.
It is used by businesses to properly calculate their tax liabilities and produce tax documents in time with compliance to any tax laws that are applicable. This kind of accounting also minimizes the burden of taxes on individuals and businesses alike.
Key Principles of Tax Accounting
Tax accounting is governed by the Internal Revenue Service (IRS) and directed by core principles.
All taxpayers then are expected to follow these principles when preparing and filing tax returns.:
Transparency: Proper rendering of financial statements by companies allows for the provision of room for correct decisions by shareholders, creditors, and the public. The greater the transparency of financial statements, the more credible they are.
Consistency: Once an accountant chooses a method to prepare an accounting record, it should be followed consistently from one period to another. If applied consistently, tax calculations and accounting become easier for tax experts; frequent changes will hassle the company.
Matching Principle: Under this principle, direct matching of all expenses and investments in a company must be accompanied by corresponding income so that the cause-and-effect relationship can be clearly established between earnings and expense.
Financial Statements: Companies with more than one entity can consolidate into an overview through this method. Companies that have wholly-owned subsidiaries often operate with this tradition.
Purpose of Tax Accounting
The objective of tax accounting is to make taxable income clear for an individual or an organization and calculate their liability for taxes.
The key objective is to ensure tax compliance by preparing the returns in good time and accurately.
Tax accounting is therefore very instrumental in financial planning, as individuals and businesses must make proper decisions on financial matters considering the tax implications brought about by their activities and investments.
Moreover, tax accounting allows taxpayers to leverage some deductions, credits, and exemptions to minimize total liabilities in taxes.
Types of Tax Accounting
Individual Tax Accounting: This is individual taxpayers; it calculates tax liability through income slab rates. All sources of income must be reported, and expenses must be documented, with allowable deductions claimed. It also ensures conformity to individual tax laws.
Corporate Tax Accounting: Corporate tax accounting deals with the tax liabilities of a firm. It is relatively complex compared to individual tax accounting because of factors such as depreciation and inventory valuation. This encompasses calculating taxable income, business deductions, and adherence to corporate tax regulations.
Tax Accounting for Tax-Exempt Organizations: As the tax-exempt organizations have lesser compliance requirements than the for-profit entities, they are, therefore compelled to file and report annual returns that disclose sources of income which include donations and grants and, more so the way funds are utilized according to the regulations on the use of the tax-exempt entity.
Tax Accounting Methods and Calculations
The difference in tax accounting method might thus impact an assessee’s taxable income and tax liability. To this end, there are mainly two preferred methods the revenue authorities allow:
Cash Method: The cash basis is usually used by single proprietors and professionals; they account for income and expenses when they receive or pay cash. The cash basis is preferred for small businesses because it sharpens tax liabilities and deductions into exact cash flow.
Accrual Method: Under accrual, income is recorded when earned and expenses are recorded when incurred, irrespective of the time cash flows are realized. It is largely used by large firms; it is also an application of the matching principle. However, this could more accurately depict earnings than under other methods because it may lead to mismatches between taxable income and cash flows.