FISHER NEWS
Book-tax income profit disparity to receive closer
review by IRS, says Fisher tax expert

The Internal Revenue Service’s computer system upgrade and a new corporate tax form will mean closer scrutiny for publicly traded companies in 2007, said William Raabe, a tax expert and a member of Fisher’s accounting faculty. The IRS will pay closer attention to the differences between how financial accounting income is reported to the Securities and Exchange Commission and taxable income is reported to the IRS.

Public companies that look successful and profitable to shareholders and the stock market, at the same time can appear to have low or negative income when it comes time to pay taxes, Raabe said.

According to the IRS, the approximate 4,200 publicly traded companies showed taxable income that was at least $160 billion less than financial accounting income for the 2004 year. This means that book income—what companies reported to Wall Street—was almost 40 percent higher than taxable income for that period, Raabe said.

“The IRS computer system is finally waking up,” Raabe said, adding that the agency now has more capacity to process a larger amount of data. Subsequently, the IRS is now requiring public companies to disclose new and more detailed information on book income.

Some of that new data will come from a new corporate tax form, Schedule M-3, introduced in 2004. It will become mandatory for the 2007 filing season. Raabe is a co-author of a new text, "Schedule M-3:Book-Tax Differences," that will be a primer to public companies and accounting firms preparing the new forms.

The M-3 will require comprehensive, itemized data on interest income from bonds, government grants, overseas transactions, stock options and depreciation and other data attributed to the profit gap, he said.

“Public companies will have a lot of new spreadsheets that they have never had to do before,” Raabe said. “They are going from a 10-line form to a 110-line form with four columns.”

An example of disparities between corporate tax disclosures and SEC filings that will change with the Schedule M-3 is how depreciation is reported. Traditionally, capital depreciation has helped lower taxable income for companies.

“A company can take a deduction for constructing a new building or buying a new piece of equipment. For book purposes, public companies want depreciation to be very slow because for shareholders you don’t want earnings per share to evaporate. For tax purposes, you want it to be fast, accelerated depreciation,” Raabe said.

Government grants and interest on state and local bonds are all items reported as income to the SEC, but previous IRS regulations did not require companies to report it as income, he said. Overseas business transactions that have favorable tax advantages to companies will have to be reported next year.

“The SEC already has this information in the footnotes to financial statements. There are two or three tax-oriented footnotes that have a lot of information, which the IRS does not read,” Raabe said.
However next year, the IRS is moving into a new era of scrutiny of public companies, according to Raabe.

“In the last five years you have had Enron and WorldCom, so now people are watching more closely,” he said, adding that the new computer system will enable the IRS to do much better audits.
“Many public companies are accustomed to routine audits and some may even have IRS auditors onsite,” Raabe said. “Companies won’t face more audits, just broader and more targeted ones; and the IRS will probably even say more efficient.”