Using Your Financial Statements to Improve Your Tax Planning and Compliance Strategies

Your financial statements are filled with information that can significantly assist in your tax planning and tax compliance. “The financial statements are basically your balance sheet, income statement, statement of cash flows (SCF), and the statement of changes in equity and the related footnote disclosures. These are tremendous sources of information for tax planning,” says Lawrence G. Silver, Director, Tax Strategies at Kreischer Miller.

We interviewed Silver for the November issue of Insights from Kreischer Miller about how a business’s financial statements can be used to enhance its tax planning and compliance strategies.

What types of items should you look for as you begin to review your balance sheet and income statement?

When reviewing your balance sheet, you might see a spike in prepaid expenses. This may result in the ability to accelerate an income tax deduction for certain expenses as opposed to following the book treatment. Similarly, the deferred revenue account may be a source to determine if income can be deferred or should be currently recognized. The income statement may specifically state the amount of research and development expenses incurred during the year. This should cause one to think about the research credit for income tax purposes. Does the research qualify for the credit? If so, what needs to be done to secure and properly support the credit?

How can the SCF and statement of changes in equity be used to assist with tax planning?

The SCF is a treasure trove of information for income tax purposes. The SCF contains information such as the amount spent on purchasing property, plant, and equipment during the year. This information is instrumental, and you can compare these amounts to the forms on the tax return to make sure that all of the purchases during the year have been captured and are being depreciated in the most advantageous income tax manner. Also, some amounts that are capitalized for financial reporting purposes may actually be able to qualify as a repair expense for tax purposes. The SCF also contains information on the proceeds from the sale of property, plant, and equipment during the year which must be reported for tax purposes, but depending on the nature of the property, could yield an eventual capital gain or ordinary income.

The statement of shareholders’ equity may yield information related to distributions made by the entity during the year, and this information will affect the shareholders’ basis depending on the type of entity.

What information is contained in the footnotes to the financial statements, and how can this be beneficial to the planning process?

The footnotes to the financial statements contain perhaps more tax information than the formal financial statements. The first footnote usually contains information related to what the business does, where it conducts business, and the accounting methods associated with its business(es).

This can assist in tax planning by reviewing the accounting methods used in the financial statements to assess whether they are appropriate and advantageous for income tax accounting. A business may have the opportunity to adopt income tax accounting positions that are different from the book accounting. An example is revenue recognition. Many companies may have changed their book method of accounting for revenue recognition, but for income tax purposes this new method may or may not be appropriate. Depending upon this result the business may need to change its tax accounting policies.

The footnotes to the financial statements may disclose an acquisition the company made during the year. Depending upon the nature of the acquisition (asset or stock), there can be significant income tax consequences and differences in how the acquisition is reported for book versus income tax purposes.

The footnotes will usually contain information about transactions between related parties for the business being reported on. This information is important because if these entities are foreign parties, there can be information that needs to be disclosed on special foreign reporting forms. There are severe penalties for not properly and timely reporting these transactions and relationships.

Other footnote disclosures such as the retirement plans sponsored by the company provide significant tax opportunities. If the retirement plan is a defined benefit plan, can a greater contribution be made to the plan to perhaps accelerate an income tax deduction?

Lastly, the subsequent event footnote may yield tax planning opportunities if the business has committed to an acquisition in the upcoming year.

Overall, a business’s financial statements contain a vast amount of information that can assist in income tax planning and in making sure the income tax returns are prepared properly.

Lawrence G. Silver can be reached at Email or 215.441.4600.

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