# Tax Accounting: Definition, Types, vs. Financial Accounting

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## What Is Tax Accounting?

Tax accounting is a [method of accounting](https://www.investopedia.com/terms/a/accountingmethod.asp) used to prepare tax returns for individuals, corporations, and other entities. Governed by the [Internal Revenue Code](https://www.investopedia.com/terms/i/internal-revenue-code.asp), it tracks funds coming in as well as funds going out. Unlike financial accounting, it only focuses on transactions that affect taxes.  

### Key Takeaways

*   Tax accounting is the subsector of accounting that deals with the preparations of tax returns and tax payments.
*   Tax accounting is used by individuals, businesses, corporations and other entities.
*   Tax accounting for an individual focuses on income, qualifying deductions, donations, and any investment gains or losses.
*   For a business, tax accounting is more complex, with greater scrutiny regarding how funds are spent and what is or isn't taxable.

## Tax Accounting Principles vs. Financial Accounting (GAAP)

In the United States, there are two sets of accounting principles: tax accounting principles and financial accounting principles, or [generally accepted accounting principles (GAAP)](https://www.investopedia.com/terms/g/gaap.asp).

Under GAAP, companies must follow a common set of accounting principles, standards, and procedures when they compile their financial statements by accounting for any and all financial transactions. [Balance sheet](https://www.investopedia.com/terms/b/balancesheet.asp) items can be accounted for differently when preparing [financial statements](https://www.investopedia.com/terms/f/financial-statements.asp) and tax payables. For example, companies can prepare their financial statements implementing the first-in-first-out (FIFO) method to record their inventory for financial purposes, yet they can implement the last-in-first-out (LIFO) approach for tax purposes. The latter procedure reduces the current year's taxes payable.

While accounting encompasses all financial transactions to some degree, tax accounting focuses solely on those transactions that affect an entity's tax burden, and how those items relate to proper tax calculation and tax document preparation. Tax accounting is regulated by the [Internal Revenue Service (IRS)](https://www.investopedia.com/terms/i/irs.asp) to ensure that all associated tax laws are adhered to by tax accounting professionals and individual taxpayers. The IRS also requires the use of specific documents and forms to properly submit tax information as required by law.

> **Important**
>
> Hiring a professional tax accountant is optional for an individual, but often necessary for a corporation, as business taxes are more complicated than personal taxes.

## Tax Accounting for Individuals

For an individual taxpayer, tax accounting focuses solely on items such as income, qualifying [deductions](https://www.investopedia.com/terms/d/deduction.asp), investment [gains](https://www.investopedia.com/terms/g/gain.asp) or losses, and other transactions that affect the individual’s tax burden. This limits the amount of information that is necessary for an individual to manage an annual tax return, and while a tax [accountant](https://www.investopedia.com/terms/a/accountant.asp) can be used by an individual, it is not a legal requirement.

Meanwhile, general accounting would involve the tracking of all funds coming in and out of the persons' possession regardless of the purpose, including personal expenses that have no tax implications.

## Tax Accounting for Businesses

From a business perspective, more information must be analyzed as part of the tax accounting process. While the company’s earnings, or incoming funds, must be tracked just as they are for the individual, there is an additional level of complexity regarding any outgoing funds directed towards certain business obligations. This can include funds directed towards specific [business expenses](https://www.investopedia.com/terms/b/businessexpenses.asp) as well as funds directed towards [shareholders](https://www.investopedia.com/terms/s/shareholder.asp).

While it is also not required that a business use a tax accountant to perform these duties, it is fairly common in larger organizations due to the complexity of the records involved.

## Tax Accounting for Tax-Exempt Organizations

Even in instances where an organization is tax-exempt, tax accounting is necessary. This is due to the fact that most organizations must file [annual returns](https://www.investopedia.com/terms/a/annual-return.asp). They must provide information regarding any incoming funds, such as grants or donations, as well as how the funds are used during the organization’s operation. This helps ensure that the organization adheres to all laws and regulations governing the proper operation of a tax-exempt entity.

## What Is the Main Purpose of Tax Accounting?

Tax accounting is used to make the proper tax calculations and prepare tax documents in time for filing season.

## What Is the Difference Between a Tax Accountant and a Management Accountant?

A management accountant is an internal party who can't work with external clients, while a tax accountant is an external party who can work with other businesses and individuals. Management accountants assist their own companies with the financial implications of business decisions and provide strategic advice. Tax accountants help companies and individuals comply with taxation requirements.  

## How Can You Start a Career in Tax Accounting?

Tax accountants need a [Certified Public Accountant (CPA)](https://www.investopedia.com/terms/c/cpa.asp) licensure. This usually requires a bachelor's degree in an accounting-related field. And though it's not required, CPA candidates should consider completing a master's program in accounting. Tax accountants often must take continuing education (CE) courses to maintain their credentials. The CE requirements and length vary by state.

## The Bottom Line

Tax accounting is a set of methods for accounting and a useful tool that companies use to understand their tax liability and avoid penalties. Tax accounting is key not only for businesses but also for individuals to declare the correct income, pay appropriate taxes, and avoid penalties or IRS audits.

> **Article Sources**
>
> 1.  U.S. Securities and Exchange Commission. "[All About Auditors: What Investors Need to Know](https://www.sec.gov/reportspubs/investor-publications/investorpubsaboutauditorshtm.html)."
>     
> 2.  Tax Foundation. "[Understanding the Tax Treatment of Inventory: The Role of LIFO](https://taxfoundation.org/research/all/federal/lifo-tax-treatment-inventory/)."
>     
> 3.  Internal Revenue Service. "[The Agency, Its Mission, and Statutory Authority](https://www.irs.gov/about-irs/the-agency-its-mission-and-statutory-authority)."
>     
> 4.  Internal Revenue Service. "[Form 1040, U.S. Individual Income Tax Return](https://www.irs.gov/pub/irs-pdf/f1040.pdf)."
>     
> 5.  Internal Revenue Service. "[Form 1120, U.S. Corporation Income Tax Return](https://www.irs.gov/pub/irs-pdf/f1120.pdf)."
>     
> 6.  Internal Revenue Service. "[Charities and Nonprofits: Annual Filing and Forms](https://www.irs.gov/charities-non-profits/annual-filing-and-forms)."
>     
> 7.  Internal Revenue Service. "[Understanding Tax Return Preparer Credentials and Qualifications](https://www.irs.gov/tax-professionals/understanding-tax-return-preparer-credentials-and-qualifications)."
>     
> 8.  U.S. Bureau of Labor Statistics. "[How to Become an Accountant or Auditor](https://www.bls.gov/ooh/business-and-financial/accountants-and-auditors.htm#tab-4)."