A State By State Accounting Guide

Tax Accounting

Tax accountants understand tax reporting requirements and prepare tax returns for both individuals and businesses, but this alone doesn't reveal the wide range of services they provide. The specialty area of tax accounting encompasses services that range from the simple preparation of individual returns to highly complex tax planning services for multinational corporations.

Within the niche of tax accounting, sub-specialization is common. Tax accountants may opt to serve corporate entities or provide their services exclusively to those with high-incomes and focus on the more complex tax issues associated with trusts, large estates or tax shelters.

In addition to preparing corporate tax returns during tax season, corporate accountants are involved in tax planning and decision-making throughout the year. In this capacity they offer strategic advice on tax-planning based on business objectives.

Accounting Principals: Financial Accounting Vs Tax Accounting

Business and corporate tax accountants understand the differences between the generally accepted accounting principles (GAAP) used for creating financial statements and the accounting principals used for tax purposes. The IRS defines tax accounting requirements in Internal Revenue Code Title 26.

The tax rules for expenses, revenues, depreciation, and costing for capital budgeting are not exactly the same as GAAP rules. For this reason, pretax income shown on an income statement and actual taxable income can, in fact, be different.

Income tax accounting is categorized within the Other Comprehensive Basis of Accounting (OCBOA) designation, which applies to any accounting system other than GAAP.

The fundamental differences between the rules that govern financial and tax accounting result in some incongruence between financial and tax statements:

  • Temporary differences between financial and tax statements as a result of timing: GAAP recognizes financial transactions as having taken place in a given year, which results in the transaction appearing on the financial statement for that same year. However, tax accounting allows that transaction to be accounted for in the year in which debts were settled, which may be in a year before or after the actual transaction took place. This creates a situation in which the transaction appears on the tax accounting statement and affects taxes in a different year than it appears on the financial statement. But, since both GAAP and tax accounting recognize the transaction as having taken place, the difference it causes between the statements is only temporary.
On the other hand, permanent differences between financial and tax statements can exist when GAAP recognizes transactions that tax accounting cannot, or vice versa. As an example, if a business expense is accounted for through GAAP, but does not qualify for an IRS tax deduction, it will create a permanent difference between the financial statement and the tax statement.

Corporate and Small Business Tax Accounting

Small business tax accountants often establish independent practices in which they provide tax planning and tax return preparation services to a number of clients, while corporate tax accountants are more likely to work as internal employees within a single corporation. Public accounting and CPA firms also employ both small business and corporate tax accountants contracted to work with small business and corporate clients.

In addition to tax planning services, corporate tax accountants also handle business payroll tax accounting, which is the preparation and filing of both federal and state payroll tax returns. While an accountant in a small business might deal with both payroll taxes and income tax planning and returns, in a large corporation, these jobs belong to several different specialized accountants.

Corporate tax accountants also prepare state income tax returns for revenue generated, and handle property tax issues when a business or corporate entity owns property. Sales and use taxation applies to certain states and requires specialized corporate tax accountants known as tax analysts who handle transactional returns, which involve reporting and paying sales tax collected by the business, or paying use tax owed on items purchased by the business in the event that sales tax wasn’t charged in the original transaction.

International Tax Accounting

U.S. companies that do business internationally or U.S. citizens who live outside the U.S. will have tax obligations in other countries, in addition to their U.S. tax obligations. International tax accountants are knowledgeable of both U.S. tax laws and the tax laws of other countries. Most international tax accountants will specialize in a group of countries or a region of the world, as it's nearly impossible to keep up with the tax laws of every country.

Services that are part of international tax accounting performed for U.S. corporations and expatriates include:

  • Choosing a tax entity and form of ownership and tax registration in a foreign country
  • Creating a U.S. entity owned by a foreign corporation
  • Tax planning for cross-border transactions
  • Foreign national and expatriate tax services
  • Foreign tax credit planning
  • International estate planning and offshore trusts and entities
  • International financial reporting standards (IFRS) accounting
  • Registration for value-added tax (VAT) and related services
  • Tax services for U.S.-based subsidiaries of offshore companies

International Financial Reporting Standards

Multinationals and other businesses involved in international commerce are fast adopting international financial reporting standards in place of GAAP. The International Financial Reporting Standards (IFRS) Foundation set up the International Accounting Standards Board (IASB) to develop a set of globally accepted financial reporting standards. According to the CPA firm Feeley & Driscoll, PC, IFRS and GAAP differ in the following areas related to income tax accounting and reporting:

  • GAAP uses tax laws and rates in effect at the reporting date to determine taxes on deferred tax assets and liabilities, while IFRS uses the rate of taxation expected to apply when the deferred tax asset is realized or when the deferred tax liability is paid.
  • GAAP classifies a deferred tax asset or liability as either short-term or long-term, while IFRS records all deferred tax assets and liabilities as long-term.
  • GAAP does not require that non-public companies reconcile the expected tax expense to actual tax expense in detail, and only requires that the companies disclose the nature of the reconciling items. Conversely, IFRS does require a complete reconciliation.

There may come a time when more businesses use IFRS than GAAP. Both the Financial Accounting Standards Board (FASB) and the Securities and Exchange Commission (SEC) support converting from U.S. GAAP to IFRS in an effort to have consistent worldwide financial reporting standards. In fact, as of 2011, IFRS questions have been included in the Uniform Certified Public Accountancy Exam, which all U.S. CPAs sit for.

IRS Careers

Tax accountants work for the IRS in a number of different positions:

  • Tax compliance officers examine and investigate individual and business taxpayers to ensure compliance with tax laws. They also offer advice about tax law and tax accounting.
  • Internal Revenue Agents audit tax returns for accuracy, usually dealing with the complicated income, sales, and excise tax returns of businesses and large corporations.
  • Tax specialists help taxpayers who have questions about filing returns and engage in other activities that help people voluntarily comply with the tax code.
  • Appeals officers conduct conferences to settle cases when taxpayers appeal IRS rulings on their tax case or file a petition in U.S. Tax Court.

Methods Employed in Tax Accounting

The primary methods used for tax accounting are the cash method, accrual method, or a combination of the two. The cash method is the one most individuals are familiar with. Most individual tax payers use the cash method as a matter of standard protocol, reporting income in the tax year it's received and taking deductions in the tax year they are paid.

Businesses can also choose to use the cash method, with some exceptions that include:

  • Corporations with over $5,000,000 in gross receipts
  • Corporations engaged in farming, with a few exceptions
  • Partnerships who have at least one C corporation partner (considered a separate corporate entity under tax laws) and over $5,000,000 in gross receipts
  • Tax shelters
  • Businesses that maintain an inventory of products

Under the accrual method, the business taxpayer generally reports income in the tax year it's earned based on the contractual understanding of what they will be paid for a product or service, regardless of when payment is actually received. Under the accrual method a business may also deduct expected expenses in the tax year expenses are determined, even if these expenses are actually paid in forthcoming years. For example, if in December 2011 the business sells and receives payment for services to be performed in January 2012, the income and expense is reported in 2012, not in 2011.

Another option for businesses is a hybrid cash/accrual accounting method, where some items are reported on a cash basis and other items reported on an accrual basis. For example, a business that maintains inventory may choose to use the accrual method for new inventory they intend to purchase, allowing them to take deductions in the current year, although they haven’t yet made the actual purchase. They may then choose the cash method for income and other operating expenses like payroll. This is done as part of a tax strategy that achieves an optimal balance to maximize the companies operating capital.

IRS rules require taxpayers to calculate taxable income using the same accounting method they used for keeping books so as to maintain some consistency throughout their financial records. The IRS also requires that taxpayers are consistent with the method of accounting they use from year to year, since changing the accounting method can directly impact their tax obligations. Taxpayers who want to change accounting methods must notify the IRS and, in some cases, receive approval before filing a return under the new method.

Strategic Decisions in Tax Accounting

In addition to choosing an accounting method, tax accounting and planning includes making many other strategic choices:

  • Accounting period: Most individuals file tax returns on a calendar year basis, that is, reporting for January – December of a given year. Businesses can choose to report taxes using a fiscal year, which does not have to correspond to the calendar year.
  • Timing of income and deductions: Sometimes receiving income sooner or delaying it to the next tax reporting period can have a significant effect on taxes owed, as can the timing of deductions taken.
  • Capitalization versus expensing: Businesses sometimes have the choice of either capitalizing a purchase (making it an asset) or expensing a purchase (taking deductions based on depreciation).
  • Inventory accounting techniques: A business may choose first-in-first-out (FIFO), in which the oldest products in inventory are recorded as the first ones sold, or last-in-first-out (LIFO), in which the most recently manufactured products are recorded as the first ones sold.

Tax Accounting Degrees

Getting started as a tax accountant generally requires a bachelor's degree in accounting or a related field with tax accounting courses taken as electives or with a post-graduate certificate in taxation. In fact, according to a 2009 trends report by the American Institute of Certified Public Accountants (AICPA), 35 percent of new accounting program graduates with bachelors degrees and hired by CPA firms were assigned to work in taxation.

Advanced degrees in tax accounting include:

  • Master's degree in accounting with a taxation track
  • Master of Tax Accounting (MTA)
  • Master of Science in Taxation
  • Taxation MBA

Aspiring tax accountants interested in an education that includes a concentration in tax law, pursue a Master of Laws (LLM) in Taxation or a JD-LLM Joint Degree in Taxation.

While a tax accountant does not have to be a CPA, as with other areas of accounting, earning the CPA credential generally offers more prestige, more job opportunities, and a higher salary potential.

Tax Accounting Credentials and Certification

Designations through the Accreditation Council for Accountancy and Taxation are most applicable to accountants working with individuals and small businesses:

  • Accredited Tax Preparer® (ATP) requires passing an exam specific to the preparation of individual tax returns.
  • Accredited Tax Advisor® (ATA) requires five years of experience in tax accounting and an exam.

Enrolled Agents are federally licensed by the IRS and have the unique ability to represent taxpayers before the IRS during audits or disputes. Although CPAs can also represent taxpayers in this capacity, they can only practice in the state in which they are licensed. Unique to enrolled agents is the ability to practice free of jurisdictional limitations. Becoming an enrolled agent requires either passing a comprehensive three-part exam specific to US tax code or gaining five years experience working for the IRS.

Additional support for tax accountants is available through national accounting associations, including: