Allison asks:
Why do tax returns and financial statements for the same year sometimes show significant differences?
Linda says:
There are legitimate reasons for differences between tax returns and financial statements for the same year:
- Different fiscal years: The financial statements and tax returns might cover different 12-month periods.
- Cash basis vs. accrual basis: Financial statements often use the accrual basis, while tax returns may use the cash basis. Significant changes in receivables or payables can lead to different representations.
- Tax rules vs. GAAP: Tax returns follow tax laws, which allow certain deductions like the Section 179 depreciation write-off, whereas GAAP financial statements require spreading the cost over the asset’s useful life.
- Different estimates: Businesses might use different methods (like LIFO vs. FIFO inventory or various depreciation methods) to minimize or defer taxes.
Should you be concerned? Not necessarily. If the differences are significant, check if they align with the factors above. If you’re unsure, consult a more experienced lender and ask the borrower for clarification.
Want to Learn More About the Differences Between Tax Returns and Financial Statements?
- Purchase our Lender Training Manuals
- Enroll in Lender’s Online Training. We have six modules on the pass-through entities, and two specifically on K-1s.
