Q: Are most business tax returns reported on an accrual basis? I don’t see the basis on the returns.
A: The basis on which a business tax return is prepared is listed on Schedule B. There are three options – “Cash”, “Accrual”, and “Other”. “Other” is usually a hybrid of “Cash” and “Accrual”.
In a fundamental sense, accrual financial statements are the basis for all business tax returns unless, in extremely rare instances, a company keeps its books only on a cash basis. If it does so, it means there is no amount due the company and no amount the company owes other parties – such as a lender – reported on the financial statements.
A company may prepare its business tax returns on a cash basis even though it keeps its books on an accrual basis. It may do so if it meets specific IRS guidelines, such as average revenues of less than $25 million over the past three years. The decision to use cash or accrual as the reporting method in preparing business tax returns depends on which option minimizes the company’s taxable income.
With respect to which of the of the three reporting options is the most popular, it is hard to say since such information is not readily available and will vary by industry and company size.
Q: Aren’t owners of all entity types liable for debt obligations if the lender requires them to sign as guarantors?
A: Yes. If owners sign a continuing guarantee, they are liable for the debt they guarantee regardless of how a business is organized.
Q: Is passive income on Schedule E used to pay taxes and non-passive income is used like a distribution? What’s the difference?
A: Passive income is a taxpayer’s share of income in a business operation in which he or she plays no role. Non-passive income is a taxpayer’s share of income in a business operation in which he or she plays an active role. In both cases, the amount of income reported in Part II on Schedule E represents taxable income to the taxpayer in question.
With respect to payment of taxes on these taxable income streams, the taxpayer uses distributions or loans from his or her business to meet the personal income tax obligations on the taxable business income he or she must report on the personal income tax returns.
Please note that these issues are addressed in Sessions 2, 3, and 4, especially.
Course overview: Business Income Tax Returns