Financial accounting and tax reporting serve different purposes and follow different rules. The same transaction may therefore be recognized at a different time, in a different amount, or with different treatment.
Accounting income measures a company’s financial performance under applicable accounting standards. Taxable income is calculated under tax law to determine the amount subject to tax.
What Types of Differences Arise?
Temporary Differences — Differences in Timing
Temporary differences reverse in future periods.
For example, tax depreciation may exceed book depreciation in the current year, reducing taxable income. This generally leaves fewer tax depreciation deductions available in later years.
Certain accrued expenses and allowances may also be recognized for accounting purposes before they become deductible. Deductibility depends on the applicable tax requirements, not simply on whether payment has occurred. Reference: IRS, Examination Techniques
Permanent Differences — Differences in Treatment
Permanent differences do not reverse in future periods.
Examples include federal income tax expense and certain fines or penalties paid to governments for legal violations. Exceptions apply to some payments, so their nature must be reviewed. References: IRS, Form 1120 Instructions, Internal Revenue Code Section 162
A Simple Example
| Item | Amount |
|---|---|
| Pretax accounting income | $100,000 |
| Add: Nondeductible expenses | +$5,000 |
| Subtract: Tax depreciation exceeding book depreciation | −$20,000 |
| Taxable income after these adjustments | $85,000 |
Accounting income is $100,000, while taxable income after these adjustments is $85,000.
This simplified example excludes loss carryforwards, other deductions, state adjustments, and additional items.
U.S. corporate returns reconcile book and tax income using Schedule M-1 or Schedule M-3, as applicable. Reference: IRS, Form 1120 Instructions
How Does This Relate to Deferred Tax Accounting?
Temporary differences may create deferred tax assets or liabilities, subject to applicable recognition requirements. Permanent differences generally do not.
Identifying whether a difference will reverse is therefore an essential part of the income tax provision process. Reference: FASB, Income Taxes — Topic 740 disclosure examples
How We Can Help
Threefold Hara CPA assists with book-to-tax reconciliations, identifying temporary and permanent differences, tax adjustments, and income tax provision calculations.
This article provides general information. Treatment depends on applicable accounting standards, tax laws, and the specific transaction.
Information reviewed: October 15, 2026
