Tax Accounting Definition

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Tax Accounting Definition

What Is Tax Accounting?

Tax accounting is a set of accounting processes that is primarily concerned with taxes rather than the presentation of public financial statements. The Internal Revenue Code governs tax accounting, which specifies the particular procedures that businesses and individuals must follow while completing their tax returns.

Key Takeaways

  • Tax accounting is the branch of accounting concerned with the preparation of tax returns and payments.
  • Individuals, enterprises, corporations, and other organizations all employ tax accounting.
  • Individual tax accounting focuses on income, eligible deductions, gifts, and any investment profits or losses.
  • Tax accounting is more complicated for businesses, with increased scrutiny on how money are spent and what is or isn’t taxed.

Understanding Tax Accounting

Tax accounting is a method of accounting that is used for tax reasons. It is applicable to all persons, enterprises, corporations, and other organizations. Even people who are not required to pay taxes must participate in tax accounting. The goal of tax accounting is to monitor monies (both coming in and leaving out) linked with persons and corporations.

Tax Accounting Principles vs. Financial Accounting (GAAP)

When it comes to accounting in the United States, there are two sets of principles that are applied. The first are tax accounting standards, and the second are financial accounting principles, often known as widely accepted accounting principles (GAAP).

Companies must follow a standardized set of accounting principles, standards, and processes while compiling their financial statements by accounting for all financial transactions under GAAP. When producing financial statements and tax payables, balance sheet elements might be accounted for differently. Companies, for example, may compile their financial statements using the first-in-first-out (FIFO) technique to record their inventory for financial reasons while using the last-in-first-out (LIFO) method for tax purposes. The latter technique lowers the current year’s tax liability.

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Accounting, to some extent, involves all financial activities; however, tax accounting focuses only on those transactions that influence an entity’s tax burden and how those items relate to correct tax computation and tax document production. The Internal Revenue Service (IRS) regulates tax accounting to guarantee that all relevant tax rules are followed by tax accounting professionals and individual taxpayers. To correctly submit tax information as required by law, the IRS also mandates the use of specified paperwork and forms.

Hiring a professional tax accountant is optional for an individual, but it is sometimes required for a company since corporate taxes are more difficult than personal taxes.

Types of Tax Accounting

Tax Accounting for an Individual

Tax accounting for an individual taxpayer focuses primarily on income, eligible deductions, investment gains or losses, and other activities that influence the person’s tax burden. This reduces the amount of information required for a person to prepare an annual tax return, and although an individual may utilize a tax professional, it is not a legal obligation.

Meanwhile, general accounting is recording all cash moving into and out of a person’s possession, regardless of the purpose, including personal spending with no tax repercussions.

Tax Accounting for a Business

More information must be reviewed as part of the tax accounting process from a business standpoint. While the company’s revenues, or entering money, must be handled in the same way as they do for individuals, any departing monies directed towards specific corporate commitments add an extra layer of complication. This includes monies allocated to particular company costs as well as funds allocated to shareholders.

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While it is not mandatory for a firm to engage a tax accountant to execute these activities, owing to the complexity of the records involved, it is very prevalent in bigger businesses.

Even legally exempt businesses employ tax accounting since they must submit yearly filings.

Tax Accounting for a Tax-Exempt Organization

Tax accounting is required even when an organization is tax-exempt. This is because most companies are required to submit yearly returns. They must report information on any incoming finances, such as grants or gifts, as well as how the funds are utilized throughout the functioning of the organization. This assists in ensuring that the organization complies with all rules and regulations regulating the appropriate functioning of a tax-exempt business.

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