Tax-Adjusted Basis Vs. Book-Adjusted Basis

Tax-Adjusted Basis Vs. Book-Adjusted Basis
••• Thinkstock/Comstock/Getty Images

Accountants record a firm's financial data in specific ways, based on generally accepted accounting principles (GAAP). However, a company's internal financial reporting needs may differ from the methodologies required by the IRS for tax filings. Companies stand to save money on taxes by presenting certain items on a tax-adjusted basis for the IRS. Meanwhile, internal reports may rely on the book-adjusted basis numbers to compare against historical data and provide more analytical insights.

Accounting Basis

A firm records the value of assets such as buildings, machinery and equipment on its balance sheet at the acquisition price, also known as the cost basis or book value. A company's financial statements serve as an information source for filing federal income taxes. In most respects, the company maintains records for its own use, called book accounting, that largely use the same data as accounting for taxes, or tax accounting. A few differences arise when the company adjusts its financials for internal, or book, purposes versus tax purposes.

Excluded Revenue and Expenses

IRS guidelines require accountants to exclude certain types of income and expense in the financial data submitted on tax returns. For tax purposes, the IRS limits the amount of tax-exempt income reported from government bonds. It also limits the amount of charitable contribution expense a company can claim. The timing of information recording also affects tax- and book-basis accounting. Tax guidelines require income and losses to be recognized in time periods that may differ from what the company uses for its book accounting.

Tax-Basis Changes

Accountants may treat assets differently, making adjustments for tax purposes to take advantage of tax savings. However, the book value of assets is adjusted in ways that meet other accounting guidelines or reporting needs for the company. Depreciation methods, the value of inventory and treatment of costs for maintenance and repairs drive much of the differences. These different sets of adjustments can become complex, requiring companies to maintain a separate ledger to record the different depreciation rates and bases. For example, in book accounting, a company might use straight-line depreciation to reduce the value of an asset over its useful life of 10 years. For tax purposes, the IRS allows the company to accelerate depreciation over seven years, resulting in a tax benefit for the company and another depreciation method to track.

Reconciliation Reports

A company's controller or manager of tax will need to complete a reconciliation of the firm's tax-adjusted basis net income to its book-adjusted basis net income as part of the federal income tax return. Management must also maintain an ongoing system to record and reconcile the tax-adjusted versus book-adjusted account balances to maximize tax-lowering opportunities and maintain the integrity of the accounting data.