Definition
Under the income tax basis, financial statements apply the entity's tax return rules (the Internal Revenue Code and regulations) for recognizing and measuring assets, liabilities, income, and expenses. Many passthrough entities, such as partnerships and S corporations, use it because the tax records already exist. It is a special purpose framework, not GAAP, so there is no deferred tax accounting.
Why it matters in an audit or review
Auditors confirm that the entity actually follows the tax rules, including method elections such as Section 179 expensing and bonus depreciation, not a loose "tax-like" approach. Notes disclose the basis, significant differences from GAAP, and the tax-return treatments that matter to users, such as fixed asset methods. Statement titles reflect the basis, for example "statement of assets, liabilities, and equity-income tax basis". Reports follow AU-C 800.
Example
A partnership (illustrative) buys equipment for $120,000 and deducts it fully under Section 179 for tax. On the income tax basis the asset carries a zero net book value and the expense hits the year of purchase. GAAP would capitalize and depreciate the cost over, say, five years at $24,000 a year.
Common mistakes
- Mixing GAAP and tax methods without disclosing the departure.
- Recording deferred taxes on a tax-basis statement.
Sources
- AICPA, AU-C Section 800, Special Considerations-Audits of Financial Statements Prepared in Accordance With Special Purpose Frameworks (income tax basis)
- 26 U.S.C. 179, Election to expense certain depreciable business assets
Definitions paraphrase AICPA and FASB guidance; read the standard itself before relying on a requirement. Example figures are illustrative. This page is guidance, not professional advice. Report an error