Your question:
Why are tax returns and financial statements for the same year sometimes so different?
Linda says:
There are legitimate differences between tax return and financial statement presentation of the same underlying facts.
- A different fiscal year (12 month period).
- Cash basis vs. accrual basis. (See accrual basis in Linda’s glossary.) To the extent that receivables or payables are significantly different from the beginning of the year to the end, the accrual basis may give a very different picture than the cash basis.
- Tax rules vs. GAAP (Generally Accepted Accounting Principles). For example: The business can write off up to $108,000 of the cost of most equipment through depreciation in the year purchased for tax purposes (called Section 179) but has to write the cost off over the useful life of the asset for GAAP financial statements.
- Different estimates for the tax return to minimize taxes or defer them to a later date by selecting estimates or elections that are beneficial. LIFO versus FIFO inventory, selection of useful life for depreciation, or even simple versus accelerated depreciation methods are good examples.
So, should you worry about it? No. But if the differences are significant, see if you can tie it down to one of the factors listed above. If not, you might want to run it by a more experienced lender first…and then ask the borrower to help you understand the differences.
