taxes

Understanding Percentage-of-Completion Method

Understanding the Percentage-of-Completion Method
Understanding the Percentage-of-Completion Method 850 500 smolinlupinco

If your business handles projects that take longer than a year to complete, you’ll need the “percentage-of-completion” method to recognize the associated revenue.

Let’s get into how and why to do this.

Percentage-of-completion vs. completed contract

Individuals and businesses who perform work on long-term contracts—like developers, engineering firms, creative agencies, and homebuilders—typically report financial performance with one of the two following methods:

  • Percentage-of-completion: Revenue recognition is tied to the incurrence of job costs.
  • Completed contract: Revenue and expenses are recorded upon completion of the contract terms.

Per U.S. Generally Accepted Accounting Principles (GAAP), companies that can make a “sufficiently dependable” estimate must use the more complicated percentage-of-completion method.

Those who use this method for reporting typically use the same method for taxes, as well. 

However, the federal tax code makes an exception for certain small contractors with average gross receipts of less than a certain amount over the previous three years.

For 2023, this amount is $29 million, and the number is adjusted annually for inflation. 

Estimating percentage-of-completion

Typically, companies that use the percentage-of-completion method report income sooner than those that use the completed contract method.

To estimate how much of a project is complete, companies usually compare the actual costs incurred to their total expected cost. Job cost allocation policies, change orders, and changes in estimates can complicate the process.

As an alternative, some companies choose to estimate the percentage completed via an annual completion factor.

In either scenario, the IRS requires detailed documentation to support estimates used in the percentage-of-completion method. 

Balance sheet impacts 

If your company uses the percentage-of-completion method, you’ll see an impact on your balance sheet.

You’ll report an asset for costs in excess of billings if you underbill customers based on the percentage of costs incurred. On the other hand, you’ll report a liability for billings in excess of costs if you overbill based on the costs incurred.

Imagine you’re working on a two-year projected valued at $1 million. You incur half of the expected costs in Year 1 ($400,000) and bill the customer $450,000. From a cash perspective, it appears as if you’re $50,000 ahead because you’ve collected more than the costs you’ve incurred. In reality, you’ve underbilled based on the percentage of costs incurred.

At the end of Year 1, you would have reported $500,000 in revenue, $400,000 in costs, and an asset for costs in excess of billings of $50,000. However, if you’d billed the customer $550,000, you’d report a $50,000 liability for billings in excess of costs.

Questions? Smolin can help.

The percentage-of-completion method can be complicated. Still, if your estimates are reliable, this method provides a more accurate picture of the financial performance of your long-term contracts.

If you’d like extra help navigating the percentage-of-completion method and interpreting the insights it provides, contact the helpful team at Smolin.

How Investment Swings Affect Taxes

How This Year’s Investment Swings May Affect Your Taxes
How This Year’s Investment Swings May Affect Your Taxes 850 500 smolinlupinco

If you’ve noticed market fluctuations leading to significant gains or losses on your investments this year, you might be wondering how this will impact your 2023 tax returns.

It’s hard to say with complete certainty since nothing is decided until the final results of your trades at year’s end. However, you can still take measures to avoid tax surprises.

Here’s what you need to know. 

Retirement accounts: tax-favored and taxable accounts

Investment swings in tax-favored retirement accounts, such as 401(k)s, traditional IRAs, Roth IRAs, and SEP IRAs, have no immediate tax impact. Although your account balance is affected by market fluctuations, you won’t be taxed on that balance until you begin withdrawing money.

After you turn 59 ½, qualified withdrawals from your Roth IRA will be federal income tax-free.

What about taxable accounts?

Unrealized gains and losses won’t affect your tax bill. Cumulative gains and losses from trades executed during the year, however, will. 

Overall loss in 2023

If your losses for the year have outpaced your gains, you have a net capital loss. To determine the loss and apply it, take the following three steps.

  1. Divide your gains and losses into short-term gains and losses from investments held for one year or less and long-term gains and losses from investments held for more than one year.
    • You have a net short-term capital loss for the year if your short-term losses exceed your short- and long-term gains.
    • You have a net long-term capital loss for the year if your long-term losses exceed the total of your long- and short-term gains.
  2. Claim your allowable net capital loss deduction of up to $3,000 ($1,500 if you use married filing separate status).
  3. Carry over any remaining net short-term or long-term capital loss after Step 2 to next year, when it can be used to offset capital gains in 2024 and beyond.

Overall gain in 2023

If your gains for the year exceed your losses, congratulations! To calculate your net capital gain, do the following.

  • Divide your gains and losses into short-term gains and losses from investments held for one year or less and long-term gains and losses from investments held for more than one year.
    • If your short-term gains exceed the total of your short- and long-term losses, you have a net short-term capital gain for the year.
    • If your long-term gains exceed the total of your long- and short-term losses, you have a net long-term capital gain for the year.

Net long-term and short-term gain

Your regular federal income tax rate (which can be up to 37%) applies to net short-term capital gain. In addition, you may owe an additional 3.8% on net investment income tax (NIIT), as well as state income tax.

Net long-term capital gain (LTCG) is taxed at the lower federal capital gain tax rate of 0%, 15%, or 20%.

Most people pay 15%. If you’re a high-income individual, you’ll owe the maximum rate of 20% on the lesser of:

1) net LTCG

OR

2) the excess of taxable income, including any net LTCG, over the applicable threshold.

In 2023, the thresholds are: 

  • Married filing jointly: $553,850
  • Single filers: $492,300
  • Heads of household: $523,050

Again, you may also owe the NIIT and state income tax.

NIIT Impact

The 3.8% Net Investment Income Tax (NIIT) applies to the lesser of your net investment income, including capital gains, or the amount by which your modified adjusted gross income (MAGI) exceeds the following thresholds:

  • Married filing jointly: $250,000
  • Singles and heads of household: $200,000
  • Married filing separately: $125,000

Year-end is still months away

While these figures are helpful to avoid end-of-year sticker shock, your 2023 tax outcomes won’t be apparent until all of the gains and losses for the year’s trades are completed and added up. 

Have questions? Smolin can help. 

If you want a clearer picture of what to expect come tax time, we can help. Contact the friendly staff at Smolin to learn more.

Tax Rules depreciating business assets evolving. What to expect.

Tax Rules for depreciating business assets are evolving. Here’s what to expect.
Tax Rules for depreciating business assets are evolving. Here’s what to expect. 850 500 smolinlupinco

The Tax Cuts and Jobs Act relaxed the rules for depreciating business assets. Each year, the amounts change in proportion to inflation adjustments. With the remarkably high inflation rate we saw in 2023, this year’s adjustments are significant.

Here’s what you need to know for your small business.

Section 179 deduction amounts

The maximum Sec. 179 deduction is $1.16 million for qualifying assets placed in service in 2023. If your business puts qualified assets worth more than $2.89 million in service, though, that deduction begins to dwindle. 

What assets are eligible?

Eligible assets include depreciable personal property such as:

  • Machinery and equipment
  • Office furniture
  • Fixtures like refrigerators, signs, air conditioners, or heaters
  • Eligible improvements to commercial property like roofs, security systems, and HVAC
  • Computer hardware and peripherals
  • Vehicles (with some restrictions)
  • Commercially available software

Considerations for real estate

You may also claim Sec. 179 deductions for real estate qualified improvement property (QIP) up to the maximum allowance of $1.16 million. To do this, the improvements must be on the inner portion of a non-residential building and must take place after the date the building was placed in service.

However, it’s worth noting that expenditures relating to making a building bigger—such as elevators, escalators, or other internal structural changes—don’t count as QIP. They usually must be depreciated over 39 years.

There’s no separate Sec. 179 deduction limit for QIP, so deductions reduce your maximum allowance dollar for dollar.

Sec. 179 deductions are also allowed for qualified expenditures for security systems, fire protection systems, HVAC equipment, and alarm systems. 

Depreciable personal property used primarily to furnish lodging, like furniture and appliances in certain rental properties, may also qualify.

Heavy SUVs are deducted differently

There is a special limitation for heavy SUVs with gross vehicle weight ratings (GVWR) between 6,001 and 14,000 pounds. If your heavy SUV was put into service during 2022, you may be able to claim 100% of the first-year bonus depreciation percentage.

For tax years starting in 2023, though, the maximum Sec 179 deduction is $28,900. First-year bonus depreciation has been decreased to 80%. This percentage is expected to drop further each year leading up to 0% in 2027.

Exception: These percentage cutbacks will be delayed by one year for certain assets with longer production periods. 

Limitations for passenger autos 

For federal tax purposes, passenger vehicles are defined as cars, light trucks, and light vans. 

Special depreciation limits apply to these vehicles undo luxury auto depreciation rules. 

The maximum luxury auto deductions for used and new passenger autos placed in service during 2023 are:

  • $12,200 for Year 1 ($20,200 if bonus depreciation is claimed)
  • $19,500 for Year 2
  • $11,700 for Year 3
  • $6,960 for Year 4 and thereafter until fully depreciated

Of course, these allowances assume 100% business use and will be further adjusted for inflation in future years.

Heavy vehicles may come with an advantage

Heavy SUVs, pickups, and vans (those with GVWRs above 6,000 pounds) are considered transportation equipment and, as such, are considered exempt from the luxury auto depreciation limitations.

However, at least half of their use must be for business purposes to be eligible for the Sec. 179 deductions and first-year bonus depreciation we discussed above.

If these vehicles are used a significant amount for personal use, their cost must be depreciated using the straight-line method over the course of six tax years.

Otherwise, the business-use percentage of the vehicle’s cost must be depreciated using the straight-line method, and it’ll take six tax years to fully depreciate the cost.

Questions about your business taxes? Smolin can help.

The depreciation rules for business assets can be confusing, but working with a professional can help you get the maximum depreciation tax breaks for your business.

If you want to learn more about what to expect for your specific assets, contact the friendly tax professionals at Smolin.

Planning sell property How profits taxed

Planning to sell your property? Here’s how your profits could be taxed.
Planning to sell your property? Here’s how your profits could be taxed. 850 500 smolinlupinco

Across the United States, home values have risen dramatically over the last few years. The median price of existing home sales increased 1.9% between July 2022 and July 2023, and there were even larger increases in previous years.

While the upward trend appears universal, median home prices have varied by region:

Northeast: $467,000
Midwest: $304,600
South: $366,200
West: $610,500

If you hope to take advantage of these higher home sales pricetags by putting your house on the market, educate yourself about the tax planning implications first. You could be responsible for capital gains tax and Net Investment Income Tax (NIIT). 

A large chunk of your profits could be protected

If the house you plan to sell is your primary residence, some or all of the profit may be tax-free. Single filers can exclude $250,000 (or twice that for joint filers), but must meet certain requirements first: 

  • The seller must have owned the home for at least two of the five years leading up to the sale
  • The property must have been the seller’s principal residence for two or more years out of the last five

While these time periods don’t necessarily have to overlap to be eligible for the exclusion, they may.

Worth noting is the fact that homeowners may only use this exclusion once every two years. If you’re moving around more frequently than that, you won’t be able to claim it every time.

What happens to profits above the exclusion amount? 

What happens if the sale of your home generates more than $250,000 or $500,000 in profit? 

Providing you’ve owned the home for a year or longer, any cash exceeding these baseline amounts will be taxed at your long-term capital gains rate.

If you’ve owned the home for at least a year, the cash amount in excess of these baselines will likely be taxed at your long-term capital gains rate. If you acquired your house more recently, the profit will be deemed a short-term gain and subject to your ordinary income rate, which could double or even triple your long-term rate.

If the house you’re selling isn’t your primary residence (i.e. it’s a vacation home), the sale may not be eligible for the capital gains exclusion. However, it’s important to ask your accountant.

If you own more than one home and rent them out, they may be considered business assets. If so, this would allow you to defer tax or any gains through an installment sale or a Section 1031 like-kind exchange. You could potentially deduct a loss, as well—something you can’t do on the sale of a principal residence.

How does the 3.8% NIIT apply to home sales? 

The 3.8% Net Investment Income Tax (NIIT) generally doesn’t apply to capital gains from the sale of your main home, up to the exclusion limits of $250,000 for single filers and $500,000 for married couples filing jointly.

Still, if your modified adjusted gross income (MAGI) exceeds the amounts below, gains beyond the exclusion limit may be subject to the tax:

  • Married taxpayers filing jointly: $250,000
  • Surviving spouses: $250,000
  • Married taxpayers filing separately: $125,000
  • Unmarried taxpayers and heads of household: $200,000

The gain from the sale of a vacation home or other second residence that does not qualify for the main home exclusion is also subject to the NIIT tax. 

Two additional factors to consider

1. The actual value of your home once all factors are considered

Keep thorough records to support an accurate tax basis. Include documentation of your original cost, home improvements, casualty losses, and depreciation claimed for business use. 

2. Losses (generally) aren’t deductible

If you unfortunately fail to turn a profit on selling your principal resident, it generally isn’t deductible.

However, if you rent a portion of your home out or use it exclusively for business, any loss attributed to that portion of the home could be deductible. 

Clearly, taxes can vary between sales. Depending on your income and the profit of your home sale, some of all of the gain could be tax-free. However, higher-income homeowners with more expensive homes might be looking at a hefty, postsale tax bill. 

Have questions? Smolin can help 

If you’re considering selling your house, it pays to be prepared. To learn more about the tax impacts you may be facing, contact our knowledgeable team at Smolin for personalized advice.  

Tax Consequences Employer-Provided Life Insurance

The Tax Consequences of Employer-Provided Life Insurance
The Tax Consequences of Employer-Provided Life Insurance 850 500 smolinlupinco

When considering whether to accept your current position, you probably viewed employer-provided life insurance as a perk. If your benefits package includes group term life insurance with coverage above $50,000, though, you could feel differently come tax time. 

Invisible “income,” higher taxes

The IRS doesn’t include employer-provided life group term life insurance coverage up to $50,000 in your taxable income, and won’t increase your income tax liability. If your policy exceeds $50,000, though, the employer-paid cost is included in the taxable wages reported on your Form W-2.

This is called “phantom income.” You may not see the funds in your bank account, yet they’ll come back to haunt you nonetheless. 


For tax purposes, the cost of group term life insurance is set by a table prepared by the IRS. Even if your employer’s actual cost is lower than what’s listed on the table, your taxable income is determined by the one pre-established in the table. As a result, the amount of phantom income an older employee could be taxed for, is often higher than that which they’d pay for similar coverage under an individual term policy.

As an employee ages and their compensation increases accordingly, this tax trap worsens. 

Is your tax burden higher due to employer-paid life insurance?

If you’re concerned that the cost of employer-provided group term life insurance could be impacting your taxes, look at Box 12 of your W-2 (With code “C”). Does a specific dollar amount appear?

If so, that dollar amount indicates your employer’s cost for group term life insurance coverage you receive in excess of $50,000, less any amount you paid for the coverage. You’ll be liable for local, state, and federal taxes on the figure seen here, as well as any associated Social Security and Medicare taxes. 

Of course, the amount in Box 12 is already included as part of your total “Wages, tips and other compensation” in Box 1 of the W-2. It’s also the Box 1 amount reported on your tax return.

Tax-saving alternatives 

Is the ultimate tax cost disproportionate to the benefits you’re receiving? If so, ask your employer whether they have a “carve-out” plan (a plan that excludes selected employees from group term coverage). If they don’t, ask whether they’d be willing to create one. After all, some of your coworkers may be interested in opting-out, too!

Carve-out plans can be quite flexible. Here are two ways one could work in your favor for tax purposes: 

  • Your employer could continue providing you with $50,000 of group term insurance (which won’t count towards your taxable income). Then, they could provide you with an individual policy for the rest of the coverage.
  • Your employer could provide the funds they’d spend on the excess coverage as a cash bonus, which you could then use to pay the premium for an individual policy. 

If you or your employer have questions about how group term coverage impacts employees’ tax bills, we can help! 

Have questions? Smolin can help

Contact the team at Smolin to learn how you can make the most of employer provided benefits﹘without suffering unnecessary tax penalties. 

Moving mom or dad to nursing home? Tax implications.

Moving mom and dad into a nursing home? Consider the tax implications of this new situation
Moving mom and dad into a nursing home? Consider the tax implications of this new situation 850 500 smolinlupinco

According to reports, nearly 1.5 million Americans are living in nursing homes. This is a big number, even if it represents just half of a percent of our population, so it’s difficult to imagine—until it becomes a reality for your family.  

If you have a parent moving into a nursing home or long-term healthcare facility, there are so many logistics to consider, plus the emotional aspects, and you’re probably not thinking about the tax implications of the situation. 

It’s important to do so, however, so here are five tax-related points for you to ponder as you navigate the transition to a nursing home for your parents.

Five tax implications of nursing homes

1. Long-term medical care costs

Expenses incurred for qualified long-term care, including nursing home care, are counted as deductible medical expenses to the extent that they, along with any other medical costs, exceed 7.5% of adjusted gross income (AGI).

Treatments that are eligible as qualified long-term care services are:

  • Diagnostic
  • Preventative
  • Therapeutic
  • Curing
  • Mitigating
  • Rehabilitative
  • Maintenance or personal care for chronically ill patients

To qualify as chronically ill, a physician or other licensed healthcare practitioner must certify a patient as unable to perform at least two daily living activities for 90 days due to a loss of functional capacity or severe cognitive impairment.

. These activities include:

  • Eating
  • Toileting 
  • Transferring
  • Bathing
  • Dressing
  • Continence

2. Nursing home payments

Payments made to a nursing home are deductible as medical expenses if the person staying at the facility is there primarily for medical care rather than custodial care. If a person isn’t staying in the nursing home primarily for medical care, only the portion of the fee that’s related to actual medical care is eligible for a deduction.

However, if the person is chronically ill, all qualified long-term care services, including maintenance or personal care services, are deductible.

If your parent qualifies as a dependent, you may include any medical costs you incur for your parent along with your own when determining the amount of your medical deduction.

3. Long-term care insurance

The premiums you pay for a qualified long-term care insurance contract can be deducted as medical expenses if they, together with other medical expenses, exceed the percentage-of-AGI threshold. However, they are subject to limitations.

The qualified long-term care insurance contract only covers qualified long-term care services and doesn’t pay costs covered by Medicare, is guaranteed renewable, and doesn’t have a cash surrender value.

You may include qualified long-term care premiums as medical expenses up to specific amounts:

  • For individuals over 60 but not over 70 years old, the 2023 limit on deductible long-term care insurance premiums is $4,770
  • For those over 70, the 2023 limit is $5,960.

4. The sale of your parents’ property

If your parent sells their primary residence, up to $250,000 of the gain from the sale may be tax-free. To qualify for the $250,000 exclusion ($500,000 if married), the seller must have used and owned the home for at least two years out of five years before the sale.

There is an exception to the two-out-of-five-year use test, which is if the seller becomes mentally or physically unable to care for themselves during the five-year period.

5. Head-of-household filing status 

Provided you aren’t married and meet certain dependency tests for your parents, you might be qualified for head-of-household filing status, which comes with a higher standard deduction and lower tax rates than single filing status.

You may be eligible to file as head of household even if the parent you’re claiming as an exemption doesn’t live with you.

Have questions? Smolin can help

These are just a few of the tax issues you might need to deal with if your parents move into a nursing home. If you’re looking for other ways to improve your tax situation and make things easier during this transition, contact the team at Smolin, and we’ll help you navigate the ins and outs of long-term healthcare tax breaks.

Catch a tax break for making energy-efficient home improvements this summer
Catch a tax break for making energy-efficient home improvements this summer 850 500 smolinlupinco

According to the National Weather Service, nearly 190 million Americans have been under a heat advisory this summer. These scorching months might have you thinking about ways to make your home more energy efficient so that you don’t pay utility prices that are just as high as the heat index.

If you do decide to make some upgrades, there’s a new tax break that could ease some of the financial burden of the process. The Inflation Reduction Act of 2022 is an enhanced residential energy tax credit that can be used to mitigate the costs of qualifying improvements.

Who’s eligible for the tax credit

By making eligible energy-efficient improvements to your home on or after January 1, 2023, you might qualify for a tax credit of up to $3,000, and you can claim this credit for any eligible improvements through 2032.

This tax credit equals 30% of specific qualified expenses for energy improvements to a home located in the United States, including:

  • Qualified energy-efficient improvements installed during the year
  • Residential “energy property” expenses
  • Home energy audits

Of course, there are limits on the allowable yearly credit and the amount of credit for specific expenses.

The maximum claimable credit available each year is:

  • $1,200 for energy property costs and specific energy-efficient home improvements, with limits on doors ($250 per door and $500 total), windows ($600 total), and home energy audits ($150)
  • $2,000 per year for qualified heat pumps, biomass stoves or biomass boilers

In addition to the credit for windows and doors, other energy property includes central air conditioners and hot water heaters.

Prior to the 2022 law, there was a lifetime credit limit of $500. Today, this credit has no lifetime dollar limit. You’re allowed to claim the maximum annual amount every year that you make qualifying improvements until 2033.

For instance, you can make a few improvements this year and take a $1,200 credit for 2023, and then make additional improvements the next year to claim a $1,200 credit for 2024.

It’s important to note that the credit is claimed in the year in which the installation is completed.

Additional limits and rules

Generally speaking, the credit is available for your primary residence, although some improvements on secondary residences may qualify. 

If a property is used exclusively for business, you’re not allowed to claim this credit. 

If your home is partially used for business, the amount of credit you can receive will vary. For business use maxing out at 20%, you can claim the full credit, but anything over 20% will get you a partial credit.

While the credit is available for specific water heating equipment, you can’t claim it for anything that’s used to heat a swimming pool or hot tub.

This credit is nonrefundable, which means you can’t get back more on the credit than you owe in taxes. Additionally, you can’t apply any excess credit to future tax years. However, there’s no phaseout based on your income level, so even high-income taxpayers can benefit from this credit.

Have questions? Smolin can help

If you have questions about making energy-efficient improvements or purchasing energy-saving property for your home, contact the knowledgeable professionals at Smolin. We’ll show you how to make the Inflation Reduction Act and other tax breaks work for you.

2023 Q3 Tax Calendar: Key Deadlines for Businesses and Other Employers
2023 Q3 Tax Calendar: Key Deadlines for Businesses and Other Employers 1275 750 smolinlupinco

For business owners and other employers, it’s essential to keep up with important tax deadlines, even in the summer months. The following is a list of key tax-related deadlines for the third quarter of 2023. 

Deadlines

July 31st 

  • Report income tax withholdings and FICA taxes for the second quarter of 2023 using Form 941, and pay any taxes owed. (Refer to the exception below, under “August 10th.”)
  • Submit a 2022 calendar-year retirement plan report using Form 5500 or Form 5500-EZ, or request an extension.

August 10th 

  • Declare income tax withholdings and FICA taxes for the second quarter of 2023 using Form 941, if you deposited on time and in full all of the associated taxes owed.

September 15th

  • If a calendar-year C corporation, pay the third installment of your 2023 estimated income taxes.
  • If a calendar-year S corporation or partnership that filed an automatic six-month extension:
    • Submit a 2022 income tax return using Form 1120-S, Form 1065, or Form 1065-B, then pay any tax, interest, and penalties due.
    • Make contributions for 2022 to specific employer-sponsored retirement plans.

It’s important to note that this list isn’t all-inclusive, so there might be some additional deadlines that apply to your business. You’ll need to look into specific requirements to make sure you have everything you need.

Have questions? Smolin can help.

If you’re unsure about what third-quarter taxes your business needs to pay this summer, or you need some assistance filing with the IRS, contact the team of professionals at Smolin and we’ll work to ensure you’re meeting all the deadlines that apply to your business.

Understanding Deferred Taxes
Understanding Deferred Taxes 1275 750 smolinlupinco

Navigating deferred taxes can be a confusing process, and the accounting rules for reporting deferred taxes can sometimes seem arbitrary and nonsensical when viewed through the lens of real-world economics. Here’s a brief article to help simplify this complex subject.

What are deferred taxes?

Companies are required to pay income tax on taxable income as defined by the IRS. On their Generally Accepted Accounting Principles (GAAP) financial statements, however, companies record income tax expense based on accounting “pretax net income.” 

In any particular year, your taxable income (for federal income tax purposes) and pretax income (as reported on a GAAP income statement) may differ substantially. Depreciation expense is typically the reason for this temporary difference.

The IRS allows companies to use accelerated depreciation methods to lower taxes that are paid in the early years of an asset’s useful life. Many companies may also choose to claim Section 179 deductions and bonus depreciation for the year an asset is put into service. 

An alternative route that many companies take for GAAP reporting purposes is to use straight-line depreciation. At the beginning of an asset’s useful life, this typically causes taxable income to be dramatically lower than GAAP pretax income. That said, as the asset gets older, this temporary depreciation expense is reversed. 

Understanding differing depreciation methods

Using differing depreciation methods for tax and accounting purposes causes a company to report deferred tax liabilities. In simple terms, this means that by claiming higher depreciation expense for tax purposes than for accounting purposes, the company has momentarily reduced its tax bill but must make up the difference in later tax years. 

Deferred tax assets can come from other sources like operation loss carryforwards, tax credit carryforwards, and capital loss carryforwards.

How should deferred taxes be reported on financials?

When a company’s pretax and taxable incomes differ, it is required to record deferred taxes on its balance sheet. 

This can go one of two ways. If a company pays the IRS more tax than an income statement reflects, it records a deferred tax asset for the future benefit the company is entitled to receive. If the opposite occurs and the company pays less tax, it must record a deferred tax for the additional amount it will owe in the future.

Like other liabilities and assets, deferred taxes are classified as either current or long-term. 

No matter their classification, though, deferred taxes are recorded at their cash value (that is, with no consideration of the time value of money). Deferred taxes are also based on current income tax rates. The company can revise its balance sheet, in which case change flows through to the income statement if tax rates change.

Unlike deferred tax liabilities which are recorded at their full amount, deferred tax assets are offset by a valuation allowance that reflects the potential of an asset expiring before the company can utilize it. Determining the amount of deferred tax valuation allowance to log is at the discretion of management is highly subjective. It’s important to note that all changes to this allowance will flow through to the company’s income statement.

Today, or later on down the line?

For financial statement users, it’s critical not to lose sight of deferred taxes. A company with significant deferred tax assets may be able to reduce its tax bill in the future and save much-needed cash on hand by claiming deferred tax breaks. 

On the other hand, a company with considerable deferred tax liabilities will have already taken advantage of tax breaks and may need additional cash on hand to pay the IRS in future tax years.

Questions? Smolin can help 

Still unsure of how deferred taxes might affect your business? If you would like to discuss any of these issues or gain a better understanding of tax rules for businesses, our CPAs can help. Contact us to get started. 

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