Tax Law and Accounting

Submitted by Alice.

There is an old saying that says, “There are only two things that are certain in life: death and taxes.” While some people may think of this as simply an old saying to not take so seriously (while others still may think of it merely as a catchy quote from “Meet Joe Black” starring Brad Pitt), the fact is that almost everywhere you are in the world taxes play a key role in our lives. Despite their large role, however, many people do not fully understand how they do actually affect us. This paper will hopefully shed some light into this mystery by focusing on three primary aspects: the objectives of modern income tax statues, how Generally Accepted Accounting Principles (GAAP) and tax accounting are different, and the difference between tax avoidance and tax evasion.

The first step to understanding taxes is, for many, to first understand why we have taxes in the first place. As citizens many people take for granted what benefits we gain from the government developing the country around us. The various infrastructures, public systems, education, and the very safety of the citizens in a country are all affected by government funds. People generally are unable to pay for these services directly out of their own pockets, so the government provides for the care of its citizens out of its own funds. Every day there are numerous activities going on throughout the country and, as the US Department of the Treasury states on its website, “taxes, and especially the paying of taxes, yield citizens a personal sense of the total price of those activities” (Taxes and Society, 2008).

So how does this pay into the objectives of modern income taxes? As most people know, the United States tax system is special in that citizens generally can pay taxes to a variety of levels: federal, state, and even city taxes depending on where you live. Regardless of whom you pay taxes to, or if you live in the United States or in some other country around the world, the objective of income taxes still remains the same. Just as was mentioned in the previous paragraph, taxes are used to fund various government activities that affect the citizens of a country throughout their everyday life. Income taxes provide a way to ensure that the government is able to collect revenue from its citizens efforts at a variety of governmental levels to provide proper care and service for its people and keep the country running.

After understand why taxes are important, another important aspect to understand is how tax accounting differs from Generally Accepted Accounting Principles (GAAP) that most businesses in the United States use for their financial reporting. The primary cause of the difference between the two is the usage of the Matching Principle that is required by GAAP. Under the Matching Principle all revenue and losses need to be recorded when they are officially received or expended by the company while the tax code recognizes them automatically, such as the case where fees are collected in advance and GAAP would recognize the revenue when it is earned over time while tax code considers the rent taxable income automatically (Accounting for Income Taxes, 2003). This difference could cause a variety of differences, such as in depreciation consideration as well where GAAP may allow for the use of a depreciation method such as straight-line depreciation where the tax code may require accelerated depreciation methods. The resulting differences often cause differed tax assets or liabilities that individuals may transfer from one accounting period to another depending on the financial situation of the organization in question.

Finally, one last important issue to understand is the difference between two very different things that may not seem so different from each other at first glance—tax avoidance and tax evasion. To put it tax avoidance simply, “The courts recognize the fact that no taxpayer is obliged to arrange his/her affairs so as to maximize the tax the government receives. Individuals and businesses are entitled to take all lawful steps to minimize their taxes” (Tax Evasion and Tax Avoidance, 2008). That means that if anyone follows proper tax reporting procedures and follows all lawful steps to minimize the amount of taxable income possible during a tax period this is not an illegal action. This can be done through a variety of means, both on at a personal and a corporate level. This is, however, much different than intentionally falsifying tax information that is provided to the government.

Tax evasion, a very serious issue for many people, occurs when people may intentionally falsify financial information in order to pay fewer taxes than are due to the government for any financial period in time. This is usually done by not reporting actual income accordingly or by reporting incorrect deductions to the government for a period of time. This is a crime that is one of the duties of the Internal Revenue Service (IRS) to detect and ensure doesn’t occur regularly, punishing offenders accordingly. Tax evasion can easily be confused with tax avoidance for many people in consideration of how taxes can be paid or have payment differed over a period of time. For example, reinvesting capital gains from the sale of real estate into new real estate in order to differ the capital gains tax that needs to be paid is tax avoidance rather than evasion as it is a legal means of “putting off” paying the tax until a later date through deferment, rather than evading it entirely. In essence, tax avoidance means using acceptable means to pay less taxes legally, while tax evasion means falsifying records to pay less taxes illegally.

In short, taxes are an aspect of life that are constantly changing in minor details, but almost always there no matter where you live. While understand the objectives of modern income tax statues, how Generally Accepted Accounting Principles (GAAP) and tax accounting are different, and the difference between tax avoidance and tax evasion may help clear some of the fog that may revolve around tax issues the best guarantee for understanding the issues in an ever changing world is to keep up on legal news. There may be many things that come and go with time but, as the old saying goes, there will always be taxes.

References

Accounting for Income Taxes (2003). MIT. Retrieved March 9, 2008, from http://ocw.mit.edu/NR/rdonlyres/Sloan-School-of-Management/15-514Financial-and-Managerial-AccountingSummer2003/3E30FF40-96C8-42B8-857B-9EC7F7407A5C/0/lec11notes.pdf

Taxes and Society (2008). United Stated Department of the Treasury. Retrieved March 8, 2008, from http://www.ustreas.gov/education/faq/taxes/taxes-society.shtml

Tax Evasion and Tax Avoidance (2008). FreeAdvice, Tax Law. Retrieved March 9, 2008, from http://law.freeadvice.com/tax_law/income_tax_law/tax_evasion.htm

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