Book Vs. Tax Accounting

When sole proprietors are asked to think about accounting, the first thing that comes to mind for many is taxes. However, did you know that in addition to tax basis accounting there is another set of accounting guidance that is widely used? The Generally Accepted Accounting Principles of the United States (GAAP or US GAAP) is a set of accounting rules designed to help business owners across all industries create accurate, reliable and comparable financial statements. As a business owner, it is important to understand the differences between GAAP and the Internal Revenue Code (IRC) and know when each method should be applied.


Amy is an author who has a small office in a co-working space downtown but also has a qualifying home office. Throughout the year when Nina maintains her GAAP books she would want to record the rent expense from her co-working space, but she typically would not include her home office expenses in her GAAP books. However, when she prepares her tax return she could add the costs associated with her qualifying home office to her GAAP expenses. By handling her accounting this way she gets a more accurate picture of her business on a daily basis but also gets to maximize her tax deductions at the end of the year.


Emily is a sole proprietor structural engineer who is thinking about buying out a competitor. Emily's competitor provided her with his three most recent Schedule C's so Emily could assess his results and see what she is about to buy. While reviewing these documents could certainly help emily do her diligence, she should also request to review his financial accounting records for the same period, or hire an accountant to convert his Schedule C's from tax basis to GAAP so she could get a more accurate picture of how well his business actually did over the last three years.


Will is a part-time courier for Postmates who drove 1,000 business miles last year. When Will keeps his books he would not record the $545 ($0.545 / mile x 1,000 miles) mileage expense anywhere, since recording the cost of mileage is not a part of the financial accounting framework (he could however record actual vehicle expenses in his books). At the end of the year though when Will prepares his Schedule C he could add an additional $545 of mileage costs on to his book expenses to maximize his tax deductions.


Nina is a tasker who helps her neighbors with gardening. On January 1st Nina spent $1,000 on tools with a useful life of five years and no salvage value. When Nina prepares her books she could depreciate the cost of her tools over their useful life, so her financial statements would show a $200 ($1,000 / 5 years) depreciation expense each year for five years. When Nina prepares her taxes she can make the Section 179 election, which would allow her to deduct the entire $1,000 she spent on tools the first year she starts using them. Nina would already have an $800 book to tax difference just from depreciation before taking any other differences into account. Even though this may appear to be unfavorable, it is really win-win since Nina gets the benefit of recording the tool expense in her books over the period of time she will use the tools (increasing the accuracy of her financial statements), but she will also get to knock an additional $800 off her taxable income in the current year.


Phil is a sole proprietor and founder of an application that provides daily deals to his users. Since Phil constantly reviews his financial results to help inform his business decisions, he keeps his books on an accrual basis. However, during Phil's first year in business he elected to report his business's results on his Schedule C on a cash basis. Now Phil simply has his accountant adjust for book to tax differences once per year when his Schedule C is being prepared and he gets the best of both worlds (useful financial information on a daily basis and compliant tax filings on an annual basis).


  • Tax basis accounting is defined by the Internal Revenue Code (IRC) and related revenue rulings / precedents. The IRC is designed to help you determine your taxable income and deductible expenses. At its core tax basis accounting is rooted in financial accounting, however, it also includes thousands of "add on calculations", exceptions, special expenses / deductions and is constantly changing. While tax basis accounting is very important, many sole proprietors don't necessarily realize how nuanced and specific it actually is.
  • Financial accounting or "Book Accounting" is primarily based on GAAP, which is defined by the Financial Accounting Standards Board (FASB). The main goals of financial accounting are to provide business owners, investors, and other stakeholders with accurate, relevant and comparable financial information. If your goal is to leverage your financial information to understand how well your business is doing, financial accounting will provide you with a better read than tax accounting. In Fact, many businesses, both small and large use GAAP on a daily basis and convert to tax basis once per year when they prepare their returns.
  • While GAAP is the most widely used authoritative financial accounting guidance in the U.S., there are other book accounting methods available to entrepreneurs. Of the many other comprehensive basis of accounting entrepreneurs could implement, the financial reporting framework for small and medium sized entities (FRF for SMEs) may be particularly useful. FRF for SMEs falls somewhere in between accrual tax basis accounting and US GAAP. It was designed to provide small business owners with a more consistent and comprehensive view of their financial results than tax accounting, but be less onerous than GAAP.
  • While there are many differences between book and tax accounting, some of the most glaring inconsistencies include include how you should depreciate your assets and record expenses for your meals, entertainment, travel and home office.
  • If your business is organized as a partnership or corporation, Forms 1065, 1120 and 1120S all include Schedule M-1, which is used to reconcile your book net income with your tax net income. Further, often times financial statements will include "deferred tax asset" and "deferred tax liability" accounts to help track temporary book to tax differences.

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