Word: taxed
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While individuals are not faced with this perplexing choice of how to characterize your income depending on the audience, corporations do find themselves in this curious situation. Dual books for accounting and tax purposes are standard in corporate America and, judging from recent analysis, are the province of much creative decision-making. Firms’ characterizations of income to investors and to tax authorities have increasingly diverged during the 1990s for reasons that we still don’t fully understand. While the overstatement and manipulation of accounting earnings by firms has come to light, there is growing concern over...
This dual system has had a historic rationale. Separate tax books allow for differential accounting of expenses that can provide a fiscal policy tool without distorting the way in which income is reported to capital markets. While historically relevant, this argument has outlived its usefulness for several reasons. For starters, these different definitions of such expenses no longer account for much of the difference between book and tax income. Other factors—such as the peculiar accounting treatment of stock option compensation, differential treatment of overseas income, subsidiary income and pension obligations—account for large amounts...
...economic situation in two divergent ways that would serve your best interests. While guilt and shame and the possibility of detection might deter you, you might find yourself coming up with all kinds of curious rationalizations for why something is income (to the lender) or an expense (to the tax authorities...
...fact, you do not have this opportunity and for good reason. Your lender can rest assured that the 1040 they review in deciding whether you are credit-worthy would not overly inflate your earnings given your desire to minimize taxes. Similarly, tax authorities can rely on the use of the 1040 for other purposes to limit the degree of income understatement given your need for capital. In that sense, the uniformity with which you are forced to characterize your economic situation provides a natural limit on opportunistic behavior that serves the interests of prospective lenders and tax authorities. Indeed, given...
...true that firms are forced to do some minimal reconciliation on their tax forms and accounting statements do contain well-buried footnotes that similarly try to reconcile these figures. Yet, these reconciliations provide very limited detail (in tax forms) or are completely opaque to even the most nuanced analysts (take a look at the tax footnotes of any major corporation). As such, a minimal solution would be the clarification and elaboration of these differences in public documents. More generally, a wholesale revisiting of the rationale for departing from book-tax conformity seems long overdue...