Tax accounting follows the same rules as cash accounting in that income is recorded as taxable when it is received, and costs are not recognized as deductible until they are paid. Furthermore, some types of income, such as interest collected on municipal bonds or dividends received by companies, are not recognized for tax reasons and are known as book income. Furthermore, other expenses, including fines or political lobbying, are not deductible at all. Nonetheless, in order to accurately reflect a company's true financial situation, it must record all forms of income, whether taxable or not, and deduct all expenses, whether deductible or not. The financial income of a firm before taxes is referred to as book income. It is the amount that a firm discloses to its investors or shareholders, and it provides an indication of how well a company performed during a specific time period.
Tax income, on the other hand, refers to the amount of taxable income that a business declares on its tax return.
There are various temporary differences in taxable income and book income; Certain transactions will eventually appear in both a company's book and tax income; however, if they use different accounting systems for each set of records, those transactions may appear at various times. If a business receives advance payment for a service, for example, it must disclose it as taxable income on its tax return. However, that advance payment will not be recognized as revenue until the day the money is due, or "earned," according to their bookkeeping. The temporary disparity in book and tax income that resulted from this transaction will be reversed once this happens. When the clients utilize bonus depreciation and Section179, there is a frequent transitory mismatch between book income and tax income that may come into notice. The entity is speeding the tax deduction before the real expense has happened in such circumstances. This overstates deductions on the tax return during the asset's early years of useful life and understates deductions later. Certain discrepancies between book and tax income will never be made up.
The following are some examples of lasting differences:
Penalties and fines:-
These can be subtracted from gross income, but they are not tax-deductible.
Meals and Entertainment:-
Meals and entertainment expenses can be totally expensed for bookkeeping purposes. A business can only deduct 50% of meals and 0% of entertainment expenses for tax purposes.
Municipal bond interest is considered net income for bookkeeping purposes, however, it is not taxable income.
Permanent differences, unlike temporary differences, affect just the period in which they occur and do not result in deferred tax assets or liabilities.
In conclusion, Disparities between booking income and taxable income develop as a result of the differences between financial accounting and tax accounting. Some of these distinctions are long-term, while others are very transient. Permanent differences are only applicable to the tax year in which they arise. Temporary changes arise over a period of several years and then reverse.