The Impact of Income Tax Liability on Your Balance Sheet (2024)

We’ve got the rundown on these questions, including what you need to know about a balance sheet and how it could impact your income tax liability.

What is a balance sheet?

You can think of the balance sheet as a snapshot of your businesses finances at a point in time. It shows you what you own (assets), what you owe (liabilities), and what has been invested in the company (equity).

A balance sheet is one of three main financial statements businesses use to understand their financial health, the others being an income statement and cash flow statement.

You would use an income statement and cash flow statement to understand the revenue and expenses of your business. Then, abalance sheet shows you the end result (including bank and credit card balances) of that activity.

What is income tax liability?

Your income tax liability is the taxes you owe based on what you earned. You most likely need to pay income taxes on both the federal and state level with the taxes from each going towards programs like building infrastructure or funding education.

Income tax liability and the balance sheet

Generally speaking, your balance sheet does not provide any information on your income tax liability. Since your taxable income is calculated using revenue and expenses, you need to use a financial statement that holds that information: an income statement.

This doesn’t mean your balance sheet has no impact on your tax filing process. In some cases, you’ll be required to provide a balance sheet as part of the state or federal tax filing process.

How a balance sheet affects income tax liability

Sole Proprietorship or LLC filing taxes as a sole proprietor

When you file as a sole proprietorship, you’re essentially saying that you and your business are the same entity. Instead of filing a separate tax form, you submit a “schedule”—an additional document you attach to your tax return. In the case of your federal tax return, you submit a Schedule C which reports information about your incomes and expenses which are found on your income statement.

While the information on your balance sheet may be helpful as part of the tax filing process, the information on it will not affect your income tax liability.

Partnerships, LLC filing taxes as a partnership, S-Corporation or C-Corporations

Federal taxes

For businesses that file as separate entities, there are specific tax forms depending on what you’re filing as.

Partnerships file Form 1065 which summarizes its net income broken up into the income and tax deductions found on your income statement. These earnings and deductions then “pass-through” to the partners who report that income on their personal tax returns. This means the information on your balance sheet does not affect your income tax liability. However, you must fill out Schedule L to report all the items on your balance sheet.

C corporations and S corporations file Form 1120 and Form 1120-S respectively. Like other forms mentioned, they report your income and tax deductions to calculate your final tax bill. Both forms require a Schedule L that reports everything on your balance sheet, but it doesn’t affect your tax liability.

Why does the IRS require a balance sheet if it doesn’t affect your income tax liability? It’s being used as an additional step of verifying the income and tax deductions you present. For example, if you have a mortgage on your balance sheet but no interest expenses, the IRS might treat that as a red flag that the reporting is inconsistent and trigger an audit.

State taxes

A balance sheet may affect your tax liability at the state level. In particular, this can affect franchise taxes in certain states. Remember, franchise taxes are not an income tax, rather they’re a separate tax paid to the state for the privilege of doing business there.

While there are different methods to calculate franchise taxes by state, some opt for taxing based on the business’s net worth or total assets. The net worth of the business is found by looking at the assets it owns as reported on the balance sheet.

An example of this is the state of Delaware. Delaware has two methods of calculating franchise taxes and the assumed par value capital method uses total assets in the first step of the calculation. The total assets number you use must match the total assets as reported on Schedule L of Form 1120.

Not every state charges a franchise tax. Of the 18 states that charge a franchise tax, only the following 10 states require you to report your assets with implications on your liability:

Arkansas: If your assets are under $100,000,000, the franchise tax is $300, otherwise it is $400.
Delaware: If you use the assumed par value capital method, you report your total assets in the first step of the calculation.
Georgia: You must pay a net worth tax that is based on the assets you hold in Georgia or a proportion of assets like cash, accumulated depreciation, and accounts receivable based on the percentage of business conducted in Georgia.
Illinois: The franchise tax is based on what percentage of your assets are based in Illinois. The money value of your assets does not affect your taxes, rather how much of that money value is in the state.
Mississippi: You pay a dollar amount per $1,000 of the value of the capital used in the state, or assessed property value in the state (whichever is bigger).
Missouri: The franchise tax you pay is based on your total assets or issued stock (whichever is bigger), but you do not need to pay franchise taxes if your total assets in Missouri is less than $1,000,000.
New York: The business must pay the highest of three tax calculations. The tax is either a flat rate, a percentage of business income collected in the state, or a percentage of assets used in the state.
North Carolina: While it differs by entity type, for corporations the tax amount is based on the company’s net worth as based on the assets held.
Oklahoma: The franchise tax is based on the total capital held within the state.
Tennessee: The franchise tax is based on the net worth or total property held by the business within the state.

The Bottom Line

A balance sheet is an integral financial report for businesses of all sizes. In some cases, they’re a required document as part of your tax filing process. But beyond that, it’s an easy way to see what your business owns and owes without jumping from account to account to figure it out.

With Bench, you get an intuitive dashboard and interactive reports that don’t just keep you tax compliant, but helps you better understand your financial health. Start a free trial today to see how our platform gives you the insights you need to make better financial choices confidently.

FAQs

The Impact of Income Tax Liability on Your Balance Sheet? ›

The taxes payable within a year are reflected on the balance sheet as current income tax liabilities. Taxes due in future years are listed as deferred income tax liabilities. If the corporation also owes state, local, or foreign income taxes, its balance sheet will reflect those liabilities as well.

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How do liabilities affect balance sheet? ›

The balance sheet (also referred to as the statement of financial position) discloses what an entity owns (assets) and what it owes (liabilities) at a specific point in time. Equity is the owners' residual interest in the assets of a company, net of its liabilities.

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How does income affect balance sheet? ›

The net income can help you understand how much cash flows onto the balance sheet. For example, when a company sees a net profit, the balance sheet will see adjustments in multiple accounts depending on how that net profit is allocated.

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How does deferred tax liability affect balance sheet? ›

A deferred tax liability is a listing on a company's balance sheet that records taxes that are owed but are not due to be paid until a future date. The liability is deferred due to a difference in timing between when the tax was accrued and when it is due to be paid.

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How do I record income tax liability? ›

This is recorded in the Income Statement. This is an estimate of the tax liability for the accounting period. Record Income Tax Expense: The Income Tax Expense is then recorded as a debit (increase) to the Income Tax Expense account and a credit (increase) to the Income Tax Payable account.

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What causes a balance sheet to be out of balance? ›

An increase in assets leads to an increase in equity and vice versa. The balance sheet will not be balanced if the equity does not show the difference between assets and liabilities. Therefore, errors in calculating equity can be another reason why your balance sheet has not tallied.

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What impacts the balance sheet? ›

Assets for the balance sheet include cash, inventory, accounts receivable and prepaid accounts. Buildings, land and equipment owned by the company are categorized as assets on the balance sheet. Assets represent the equity in the business. As the value of the assets increases, the equity in the business increases.

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How does deferred income affect the balance sheet? ›

Since deferred revenues are not considered revenue until they are earned, they are not reported on the income statement. Instead they are reported on the balance sheet as a liability. As the income is earned, the liability is decreased and recognized as income.

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Does deferred tax liability affect cash flow? ›

For example, deferred tax assets and liabilities can have a strong impact on cash flow. An increase in deferred tax liabilities or a decrease in deferred tax assets is a source of cash. Likewise, a decrease in the DTL or an increase in the DTA is a use of cash.

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Is a deferred tax liability a debt-like item? ›

Deferred Tax Liabilities and M&A Transactions

The liability will in essence be treated like a “debt” - but with nuances.

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How does income tax affect the balance sheet? ›

Balance sheets report the actual amount of taxes owed to the IRS, categorized either as current tax liabilities (income tax payable) or deferred income tax liabilities (noncurrent, longer-term liabilities). However, income tax expense is reported on an organization's income statements.

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What should I put for tax liability? ›

Your tax liability is the total amount of tax on your income minus any non-refundable credits, such as the Child Tax Credit, saver's credit, or dependent care credit, to name a few.

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How do you solve tax liability? ›

How to calculate tax liability from taxable income. Your taxable income minus your tax deductions equals your gross tax liability. Gross tax liability minus any tax credits you're eligible for equals your total income tax liability.

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What happens if liabilities increase? ›

When liabilities increase, it means that a company has incurred more debt or financial obligations. When this happens, the assets of the company will be affected in one of two ways: The assets of the company may decrease: When a company incurs more debt, it may need to sell assets to generate cash to pay off the debt.

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Why are current liabilities important on a balance sheet? ›

Examples of current liabilities include accounts payable, short-term debt, dividends, and notes payable as well as income taxes owed. The analysis of current liabilities is important to investors and creditors. This can give a picture of a company's financial solvency and management of its current liabilities.

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Why are liabilities negative on balance sheet? ›

If the liability account is Negative, there are 2 situations: - We overpaid the loan, or we paid much more than the loan amount. - Or: there is no opening balance, all loan payments were recorded as debit, and make the balance is negative.

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What happens when liabilities are more than assets in balance sheet? ›

If a company's assets are worth more than its liabilities, the result is positive net equity. If liabilities are larger than total net assets, then shareholders' equity will be negative.