Chapter 16 Discussions Flashcards
Describe the process of computing a corporation’s TI assuming the corporation must use GAAP to determine its book income.
To compute TI, start with BI before income tax expense and make book-to-tax adjustments which results in TI. (If a corporation is not required to use GAAP and utilize tax accounting methods to determine BI & TI then no book-to-tax differences would be recognized.)
How does a corporation determine the % for its DRD?
% is determined based on the actual ownership of the receiving corporation in the distributing corporation’s stock.
< 20% = DRD 50%
21-49% = DRD 65%
> 80% = DRD 100%
What is the difference between favorable and unfavorable book-tax difference?
Favorable differences are subtracted from BI (DTLs). Unfavorable differences are added to BI (DTAs).
Which limitations might restrict a corporation’s deduction for a cash charitable contribution? Explain how to determine the amount of the limitation.
Charitable Contributions are deductible to the extent they exceed 10% of TI before any charitable contribution, DRD, and net capital loss carrybacks.
An accrual-method corporation generally will not be allowed to deduct a charitable contribution it accrues in the current year if it does not pay actual contributions with 3.5 months after it’s tax year-end (2.5 months if EOY is 6/30).
What role do a corporation’s audited financial statements play in determining its taxable income?
It will generally start with income, after income tax expense, from its audited financial statements and then reconciles to TI by adjusting for book-tax difference.
Why is it important to be able to determine whether a particular book-tax difference is permanent or temporary?
The IRS requires large corporations ($10M assets or more) to disclose their permanent and temporary book-tax differences on Parts II and III of Schedule M-3 and attach the Schedule to their tax returns. Additionally, the distinction is useful for those responsible for computing and tracking book-tax differences for tax return purposes for keeping track of when temporary differences will reverse, and for calculating the income tax expense and effective tax rate to be reported in the financial statements.
What are the carryover and carryback periods for NOLs? Does a corporation have the option to choose the years to which it carries back a NOL?
Before 2018 - carryover 20 years, carryback 2 years.
2018-2020 - can forego carryback entirely and carry the loss forward, but if they do carryback it must carry the loss to the earliest year and then next earliest and so on. It is not allowed to pick and choose the years to which it will carry the loss back.
After 2017 - carryover is indefinite
Describe the relation between B/T differences associated with depreciation expense and the B/T differences associated with gain or loss on disposition of depreciable assets.
Tax Depreciation Methods generally provide for more accelerated depreciation so B/T differences associated with depreciation are usually favorable in the early year’s of an asset’s depreciable life. The difference reverses later on. However, when a corporation disposes an asset before it is fully depreciated, it is likely that the tax basis of the asset will be lower than the book basis. For tax purposes, the corporation will recognize more gain (or less loss) for TI than BI resulting in an unfavorable B/T difference (DTA). The B/T difference on the sale is a complete reversal of the cumulative B/T differences from prior year depreciation.
What are the common B/T differences relating to accounting for capital gains and losses? Do these differences create favorable or unfavorable B/T adjustments?
A corporation will deduct a net capital loss for book purposes but is not allowed to deduct for tax purposes. This generates an unfavorable temporary book difference if it is not carried back to a prior year. When the net capital loss is deducted for tax purposes as a carryover it generates a favorable B/T difference because the carryover is not deductible for book purposes.
Why does Congress provide the DRD for corporations receiving dividends?
The DRD mitigates the extent to which the earnings of a corporation may be subject to more than two levels of taxation (corporate income should “technically” only be subject to double taxation, first at the corporate level and then at the shareholder level).
A corporation owns stock in B Corporation, and A Corporation receives a dividend from B Corporation. Ignoring the DRD, what B/T difference will A report for the year relating to its investment in B?
The dividend could generate a B/T difference depending on the level of ownership in the distributing corporation.
If >20% owned there generally will be no B/T difference.
If 21-49% owned, the B/T difference generally will be the difference between the amount of the dividend and the amount of income the corporation recognizes on its books for its pro-rata share of the distributing corporation’s earnings.
If >50% owned, the dividend will be eliminated for book purposes in the consolidated income statement but only eliminated for tax purposes if the corporation owns 80% or more, but if not eliminated for tax purposes, there would be an unfavorable book-tax difference.
Unrelated: If A owns >20% of B, A will recognize any unrealized gain or loss in its B stock for book but not for tax which will create a temporary difference that is unfavorable if A has an unrealized loss in its B stock and favorable if A has unrealized gain.
For tax purposes, what happens to a corporation’s charitable contributions that are not deducted in the current year because of the taxable income limitation?
Charitable contributions that are restricted by the taxable income limitation are carried forward for 5 years. When the excess contribution is carried forward, it is treated as though it was a contribution in the subsequent year. However, if the contribution is limited in the subsequent years, the current year’s contributions are deducted before the carryover. Also, carryovers from different years are deducted in FIFO. If the carryover is not deducted within five years, it expires without providing any tax benefit.
Describe how goodwill with a zero basis for tax purposes but not for book purposes leads to a permanent B/T difference when the book goodwill is written off as impaired.
The impairment of goodwill that has a book, but not a tax, basis, creates a deduction on the Income Statement that is not replicated on the tax return. This book-only deduction results in an unfavorable permanent difference.
Compare and contrast the general rule for determining the amount of the charitable contribution if the corporation contributes capital gain property verses ordinary income property.
Generally, corporations are allowed to deduct the amount of money they contribute, the fair market value of capital gain property they donate and the adjusted basis of any ordinary income property they donate.
How do corporations accounts for capital gains and losses for tax purposes? How is this difference from the way individuals account for capital gains and losses?
For tax purposes, capitals gains are taxed at the corporation’s tax rate of 21%; individuals are taxed on net long-term capital gains at preferential rates. Corporations are not allowed to deduct net capital losses against ordinary income, but can carry back net capital losses 3 years (mandatory) and forward five years to offset net capital gains in those years. Individuals can deduct up to $3K of net capital loss against ordinary income in a year. They carry over the remainder indefinitely to offset against net capital gains in subsequent years and up to $3K for net capital losses against ordinary income each year.
