Tax
Tax Basis vs Book Basis: Differences With Examples
By SimplyCPA · 11 October 2026
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- Different rulebooks: Book income follows US GAAP to inform investors; taxable income follows the Internal Revenue Code to raise revenue.
- Temporary differences: Timing only — depreciation, bad debts, warranty accruals, prepaid income, goodwill amortisation.
- Permanent differences: Never reverse — municipal bond interest, fines and penalties, the non-deductible half of business meals, federal income tax expense.
- Reconciliation: Corporations reconcile book to taxable income on Schedule M-1, or the more detailed Schedule M-3 if total assets are $10 million or more.
- Why it matters: The same differences drive deferred tax assets and liabilities in FAR.
Common book–tax differences
| Item | Book (US GAAP) | Tax (IRC) | Type |
|---|---|---|---|
| Depreciation | Straight-line over useful life | MACRS; 100% bonus depreciation for qualified property acquired after January 19, 2025; Section 179 expensing (limit $2,560,000 for 2026) | Temporary |
| Bad debts | Allowance (expected credit losses) | Direct write-off when the debt becomes worthless | Temporary |
| Warranty costs | Accrued when sales are made | Deducted when paid | Temporary |
| Prepaid (advance) income | Deferred until earned | Generally taxed when received, with a limited one-year deferral for accrual-method taxpayers | Temporary |
| Goodwill (acquired in an asset purchase) | Not amortised (public companies); tested for impairment | Amortised over 15 years (Section 197) | Temporary |
| Domestic research and experimental costs | Expensed | Deductible currently for tax years beginning after December 31, 2024 (Section 174A), or amortised if elected | Largely aligned again |
| Municipal bond interest | Income | Excluded | Permanent |
| Fines and penalties paid to a government | Expense | Not deductible | Permanent |
| Business meals | Expense | Generally 50% deductible | Permanent |
| Federal income tax expense | Expense | Not deductible | Permanent |
| Life insurance premiums where the company is beneficiary | Expense | Not deductible (proceeds also excluded) | Permanent |
| Dividends received deduction | None | 50%, 65% or 100% of dividends from domestic corporations | Permanent |
| Capital losses (corporation) | Expense | Deductible only against capital gains; carry back 3 years and forward 5 | Temporary |
| Charitable contributions (corporation) | Expense | Limited to 10% of taxable income; excess carried forward 5 years | Temporary |
Worked example: Schedule M-1
| Net income per books | $800,000 |
| + Federal income tax expense | 210,000 |
| + Fines and penalties | 15,000 |
| + 50% of business meals | 10,000 |
| + Excess of book bad debt expense over write-offs | 25,000 |
| − Municipal bond interest | (30,000) |
| − Excess of tax depreciation over book depreciation | (120,000) |
| Taxable income before special deductions | $910,000 |
Schedule M-1 vs M-3
- Schedule M-1 — the simpler reconciliation on Form 1120.
- Schedule M-3 — required for corporations with total assets of $10 million or more. It separates temporary and permanent differences line by line and starts from financial statement income of the consolidated group.
- Schedule M-2 reconciles unappropriated retained earnings.
Book basis vs tax basis of an asset
The same idea applies to balance sheet items. A machine costing $100,000 with $20,000 of book depreciation has a book basis of $80,000; after $100,000 of bonus depreciation its tax basis is $0. The $80,000 difference is a taxable temporary difference — a deferred tax liability in FAR, and the amount that becomes ordinary income (Section 1245 recapture) if the machine is sold for its book value.
See deferred tax assets and liabilities and C corporation taxation.