Sch C - Deferred Income Taxes

[Snaggletooth]

The client has a proprietorship, nonetheless he has financial statements prepared. His financials showed a profit and he
issued these financials to the bank who has financed a line-of-credit for him. Bank is allowed to ask for 1)financial statements
and 2)tax return.

Now comes time to prepare his taxes. In order to reduce his taxes, he wants to take s. 179 on his new equipment. If he does
this, he reports a loss for tax purposes.

This is done routinely for corporations, who have two depreciation schedules (actually three including the AMT). The difference
in taxes is expensed and accrued into a liability called "Deferred Income Taxes." The corporation is allowed to do this under
GAAP and pays the lesser income tax.

My question: Can "deferred income taxes" be recognized in the financial statements of a proprietorship? If so, at what rate,
since the proprietorship pays no tax by itself?

[taxxcpa]

A proprietorship pays no tax as an entity, but the accounting is not much different than accounting for a corporation, other than some of the terminology, such as Owner Equity in a proprietorship vs Retained Earnings for a Corporation.

So I see no reason why you could not show deferred taxes if accounting is on the accrual basis.

[Traveling EA]

Deferred taxes

Who prepared the financials for the bank? You or someone else? Deferred taxes can either be an asset or liability on the balance sheet.

[Roland Slugg]

Can "deferred income taxes" be recognized in the financial statements of a proprietorship? If so, at what rate, since the proprietorship pays no tax by itself?

No, for the reason you already stated. If a balance sheet is prepared for a proprietorship, it should not include any income tax expense, liability, accrual or deferral.

What the lender probably really wants, though, is a balance sheet for the proprietor, and on that balance sheet taxes can and should be recognized. On the owner's balance sheet there may be both accrued current income taxes and deferred income taxes. The accrual for the current year taxes should match the actual or estimated current year's income tax returns ... federal and state, if applicable ... net of prepayments (i.e. estimated taxes paid), and the accrual for deferred taxes should be based on the tax rates and tax brackets expected to be in effect for the future years in which the deferred taxes will become current taxes.

What you might want to suggest to your client ... and to the lender, if you meet with it ... is the submission of a separate balance sheet and income statement for the proprietorship alone in addition to the financial statements for the owner. The "proprietorship only" statements should be prepared following GAAP, and submitted along with a transmittal letter stating that they were prepared to reflect the reversing out of the §179 deduction. A financial statement for a proprietorship should also contain a footnote pointing out that they reflect no income tax liability or expense. As an alternative it may be permissable to include that disclosure in the transmittal letter. However, since the transmittal may become separated from the financials, I would put all important disclosures in footnotes. GAAP or other rules regarding financial statements may even have rules that address this very thing.