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Tax Basis of a Liability

Assets are expected to generate economic benefits for the firm when they are sold or used. The tax basis of an asset is the amount related to the asset that the Internal Revenue Code allows to be deducted from any revenues generated by the sale or use of the asset for income tax purposes. As a result, the tax basis reduces taxable income when the carrying amount of the asset is recovered.

On the other hand, liabilities typically reflect expenses that have already been accrued by the firm and have not yet been paid or revenues that have been received but not yet earned. A firm is expected to discharge its liabilities by giving up some economic benefit, usually firm assets. The tax basis of a liability is the related amount that increases taxable income when the carrying amount of the asset is discharged (or, more accurately, reduces the expense that is expected to be deducted from taxable income). This is the opposite of the tax basis for assets.

The tax basis of an accrued expense liability is equal to the carrying amount of the liability less any amounts related to the liability that will be deducted from income for tax purposes in the future. For example, if a phone bill received today is $500, but will not be paid until January, it’s carrying amount will be $500 for accounting purposes, $500 will be deductible for tax purposes in the future, and its tax basis is therefore $0.

The tax basis of an unearned revenue liability is equal to its carrying amount less any amount that will not be taxable in future periods.  For example, $1,000 installment payment is received on December 1st for delivery of goods in the next period. For tax purposes the entire $1,000 would be included in income in the current period. It’s carrying amount of the liability ($1,000) would be reduced by the amount that would not be taxable in the future period ($1,000) and its tax basis is therefore $0.

The tax basis for loans payable is equal to the carrying amount of the loan. This is because when a loan is paid back, no expense will be charged against income for tax purposes. 

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