Differences Between Book and Tax

Question 1

What is a temporary difference?

Answer 1

Items of income or expense that are recognized in one period for book but in a different period for tax. These cause timing differences between the two incomes, but end up having no difference in the long run (ex. depreciation –> straight-line for book and accelerated for tax)

Question 2

What is a permanent difference?

Answer 2

Items of income or expense that are recognized for book but never recognized for tax (or vice versa). These cause permanent differences between the two incomes (ex. municipal bond interest income –> recognized as income on the books but never taxed)

Question 3

What are Schedules M-1 and M-3?

Answer 3

They reconcile the book/tax differences (this is required by the IRS)

Schedule M-1 does not distinguish between temporary and permanent differences

If the total assets of the company are $10m or more, the company is required to use Schedule M-3 (which breaks out items in more detail and distinguishes between temporary and permanent differences)

Question 4

When calculating taxable income, what are some common items to add/subtract?

Answer 4

Add: fines/penalties, rent income in excess of book, political expenses, federal taxes, term life insurance premiums, excess capital losses over capital gains, interest incurred on indebtedness used to carry municipal bonds

Subtract: depreciation in excess of book, municipal bond interest income, excess of tax amortization over book impairment of goodwill

**keep in mind the rules for amortization (goodwill/intangibles), organization/start-up costs, charitable contributions, DRD, bad debt expense (amount written off), meals expense, warranty expense (cost incurred in meeting warranty obligations)