Should a Business Tax Return Include a Balance Sheet?

March, 19 2025 by Carolyn Richardson, EA, MBA

As a small business owner, you may know that you should keep track of your income and expenses for your business, but you may not be that familiar with accounting. It's surprising how many business owners are unfamiliar with the most basic accounting concepts, including what should go on a balance sheet and an income statement. When you own a business, being an accurate bookkeeper is important. While most business owners know the basics of an income statement, where you calculate your total income and subtract your total expenses to see if you had a gain or loss, knowing how to prepare and interpret a balance sheet is also a critical skill for a small business owner. Preparing financial statements such as these will help you to assess your business's overall health.

 

Do I have to Prepare a Balance Sheet?

If your business is incorporated or operating as an entity other than a sole proprietorship, the tax return you submit to the IRS includes a balance sheet, which is Schedule L in all business entity returns. You may be preparing the balance sheet as part of the return for your business entity, but for a small business, you probably are not completing it. The IRS requires the balance sheet to be prepared only when certain income and asset limits are met. Most business entities, such as corporations, S corporations, partnerships, or limited liability companies, are not required to prepare the balance sheet with their return unless their total receipts are $250,000 or more and their total assets are $250,000 or more. Partnerships have an extra requirement, which is to provide Schedule K-1 to the partners on or before the due date of the return, including extensions. Remember that many liability companies are taxed as partnerships, so don't think this doesn't apply to your LLC.

Why would you want to prepare the balance sheet if it's not required? To some extent, that may depend on your type of business. Some businesses may be required to prepare a balance sheet for regulatory reasons, regardless of the IRS' requirements. A business that is largely providing services, such as a consulting business, probably does not have a large amount of assets in the business other than cash and accounts receivable. In a service-type business, most of the equity is invested in the owner of the business itself. If you're using accounting software to track your business income and expenses, the software can produce a balance sheet when you need one, but many small business owners do not know how to interpret a balance sheet.

 

I’m Not an Accountant – What’s a Balance Sheet?

What does the balance sheet represent in your tax return? A balance sheet is a financial statement that reports a company's assets, liabilities, and equity. The balance sheet is a snapshot of your business's assets and liabilities at a given point in time. The tax return, for example, will reflect those amounts on whatever date your tax year ends, typically December 31. In the classic accounting equation, the balance sheet represents assets on the left column, and liabilities plus equity on the right column. The total of these two sides should always equal each other, meaning they are in balance. Assets are anything of value that your company owns, such as tangible assets like equipment, cash or cash equivalents, prepaid expenses, accounts receivable, inventory, and other tangible or intangible assets, such as copyrights or patents. Liabilities are obligations that your company owes to others, such as loans, mortgages, accounts payable, or taxes. Finally, owner's equity (or shareholder's equity in a corporation) is the difference between your total assets and your total liabilities, and it typically increases when your company shows a profit or decreases when you incur a loss and is also reduced by owner's draws or distributions to the partners or shareholders. Equity is essentially the excess value created by the company and is a measure of its profitability. Because the total of the two columns must always be equal to each other, anything you do financially will impact both columns. For example, if cash increases, then either a liability or the equity must also increase. Likewise, if a liability decreases, then an asset must decrease, such as paying off a bill with money from the checking account. This is why it is called "double entry" accounting.

 

A Balance Sheet Will Tell You How Your Business is Performing

One of the things that a balance sheet can do for you is to help you understand your company's financial standing and its overall financial health. Because the balance sheet gives you a snapshot of the company's financial position at any given time, it will help you determine its financial health (and your own, if you are a sole proprietor). For example, if your liabilities are more than your assets, the company is likely not in a good financial position and may be unable to pay its obligations. On the other hand, if company assets are more than liabilities, this means you have the ability to pay your bills going forward and keep the business going. A balance sheet will also give you a benchmark from period to period so you can identify trends in your business, especially if you are doing them monthly or quarterly. Maybe your business is more seasonal than you think. You can also use the balance sheet to compare your company's profitability with similar businesses and your competitors.

Regularly preparing your balance sheet will help you determine whether or not the company is performing to your expectations. While many small business owners keep a mental tally of their overall income or loss in their heads, having it on paper can show if your mental calculations are good or flawed. You can compare balance sheets with each other to see whether or not your assets are increasing or decreasing. Most people can't do that kind of mental math comparison in their heads. Do you know whether your liabilities are increasing or decreasing? Have you accumulated more debt? It's easy to overlook important and pending obligations when trying to track financial performance informally.

While many small businesses think they are profitable, that's not always the reality. If a business costs you more money than it is making, why would you continue to operate it? Worse, the IRS may consider a business that consistently loses money to be an activity not engaged in for profit in an audit situation, and that can seriously impact your tax liability. Suppose the IRS determines that you have not been running the business with the necessary profit motive. In that case, they may invoke the "hobby loss" rules, especially if your business is typically recreational in nature, such as catering, being a DJ, photography, or many other activities. Under the hobby loss rules, losses are disallowed, and deductions are limited to the amount of income that you create in the business. To make matters worse, hobby losses are currently disallowed under the TCJA, but you still have to report any income you make from the activity.

 

Bringing in Investors or Outside Financing

And what do you do if you need more money to support or grow the business but can't provide that yourself? Both investors and bankers will want to see your balance sheet. The balance sheet is used to compute certain ratios that financial advisors and investors will use to determine whether or not to do business with you or invest in your company. For example, the debt-to-equity ratio is determined by dividing the total liabilities by the owner or shareholder's equity. This helps determine the company's financial leverage. Another common ratio used to determine the health of the business is called the quick ratio. The quick ratio is computed by adding cash, any cash equivalents, marketable securities, and accounts receivable and then dividing that total by the current liabilities. The quick ratio shows a banker or investor whether your liquid assets can pay for the bills you expect to incur in the next period.

What if you eventually want to retire and sell your business? An investor or potential buyer of your company will want to see the complete financial statements, including the balance sheet, so that they can determine whether or not to purchase your business and how much to pay for it. They will likely want to see this for several years. Comparing the owner's equity from one period to the next shows you how your company is doing. If the equity declines, you may need to determine what is causing that and make changes to your business plan. Maybe you need to pay off debts and reduce liabilities or invest more cash. If you need a loan, lenders will typically look at a financial statement when you're requesting financing or a loan for your business. If you're applying for a loan from the Small Business Administration of over $350,000, then a balance sheet will be required. And if you haven't been preparing a balance sheet regularly, suddenly needing to prepare one can throw your head into a tailspin. And trying to recreate a balance sheet from two years ago is difficult, even for accountants.

If your business is growing and you want to move your business outside of your home and into a rented office space, the landlord may require you to provide financial statements, including a balance sheet, to show that you can pay the rent. While it's not something you necessarily have to include with your tax return, you should keep track of these amounts in some sort of accounting software or even just on a spreadsheet.

 

Where to Start

If you have someone doing your bookkeeping or preparing your taxes, you can always discuss what your balance sheet should reflect. Most bookkeeping services have software that can generate a balance sheet at any time with just a few clicks, and your tax preparer can generally force their tax software to prepare the balance sheet in your tax return (providing it is a business entity and not a sole proprietorship) regardless of whether or not it is required. That can be done just for your reference and does not need to be submitted to the IRS. Either your bookkeeper or your tax preparer can explain to you any items on the balance sheet that you are unfamiliar with.

Whether your business is preparing a balance sheet or not, TaxAudit will always have your back if the tax return is questioned by the IRS or the state tax agency. All you need to do is sign up for membership and call us when you receive a notice.