Income Taxes pg 516 Flashcards
Asset/Liability Approach
- Income Tax Exp for period reflects amt will ultimately be payable on yrs transaction
- Income Tax Pay, Deferred Tax Asset, Deferred Tax Liab report remaining tax receivables & obligations facing firm from transactions that have already occurred as of BS date
- Income Tax Exp amt derived from changes in tax-related assets & liabilities (no longer directly computed value)
Permanent Differences
- Amt appears on tax return or income statement but never both
- Fine/Penalty is never deductible but is treated as expense or loss for income statement. Permanent differences do not enter into process of interperiod tax allocation. They have no deferred tax consequences
Temporary Difference
- Item of revenue or expense that over total life will affect pretax accting income and taxable income in same total amt, but will be recognized in diff amts in any given yr for financial reporting & tax purposes
- Depreciation diff for any given yr for income and tax reporting but over life of asset total depreciation is same
Net Operating Loss
Carried back 2 yrs and forward 20 yrs to reduce taxable income for those yrs
Types of Permanent Differences
- Tax-Free Interest Income: Interest income earned on investment in state/municipal bond-included in pretax accting income but NOT taxable income
- Life Insurance Exp: Insurance premiums of life insurance for key employee where firm is beneficiary-included in taxable income but not in pretax accting income (exp)
- Proceeds on life Insurance: Event of death of key employee-proceeds from LI not taxable income, but are a gain in pretax acct income
- Dividends Received Deduction: 80% deduction received dividends deduction from taxable income but included in pretax accting income
- Fines/Penalties: not deducted for income tax but deduction (exp) from pretax accting income
- Depletion: GAAP Depletion Based on cost of natural resource used-Tax Depletion based on revenues of resource sold
- These are never reversed like temporary diff.. Income Tax Law is what ultimately determines whether item is considered for tax purposes
- Effect of Permanent Diff on INCOME TAX EXP is same as effect on INCOME TAX LIABILITY for the period
Examples of Temporary Differences
Taxable After Recognized for Books: Revenues/Gains taxable after recognized in financial income. (Ex Installment Sales Basis of Accting for income tax purposes & equity method to recognize income from investments)
- Deductible After Recognized for Books: Exp/Losses deductible after recognized in financial income (Recognition of Warranty Exp-recognition usually in yr related merchandise is sold and for TAX Exp recognized in yr defective product returned by customer)
- Taxable Before Recognized for Books: Rev/Gains taxable before recognized in financial income (Rent Rev)
- Deductible Before Recognized for Books: Exp/Losses deductible before recognized in financial income (Depreciation)
Originating Difference
Difference when item first causes temporary difference
Reversing Difference
Difference attributable to item in later yrs after causing temporary difference
Two Tax Categories for temporary differences
- Taxable Temporary Differences: Involves differences initially cause postponement in pmt of taxes
> In yr of origination, item causes taxable income to
decline relative to pretax accting income
> When item reverses, item causes future taxable
income to exceed pretax accting income. These
increase taxable income relative to pretax accting
income in future
> Future Taxable differences give rice to deferred tax
liabilities - Deductible Temporary Differences: Involves differences initially cause prepmt of taxes
> Yr of origination, itme causes taxable income to
increase relative to pretax accting income
> When item reverses, item causes future taxable
income to be less than pretax accting income. These
reduce taxable income relative to pretax accting
income in future
> Future deductible differences give rise to deferred
tax assets
Income Tax when yr’s full tax liability is paid early next yr
Only way to compute this is the sum of increase in deferred tax liability & income taxes payable
Effective Tax Rate
- IS NOT CURRENT TAX RATE
- IS ratio of income tax expense to pretax accting income
Tax Rate Considerations
When tax rate changed DURING yr new rate applied as of beginning of yr (estimate change) to recompute deferred tax balance. Results in immediate change to income tax expense.
Corporations taxed @ increasing rates as taxable income increases so average tax rate is used for computing changes in deferred tax accts
Future Temp diff expected to reverse @ diff rate than regular (like capital gains rate) specific rate applying to diff is used
Classification for BS Reporting on Deferred Tax Accounts
For external reporting current deferred tax accts are netted together to create one current deferred tax asset or liability and noncurrent deferred tax accts are netted together to create one noncurrent asset or liability
Valuation of Deferred Tax Assets
When not sufficient probability of realizing deferred tax asset, valuation allowance recorded to reduce deferred tax asset to amt expected to be realized
Things to Consider for realizing Deferred Tax Assets
- Expectation of future taxable income
- Taxable income in prior yrs w/in two yr carryback for net operating losses
- Future Taxable Diff
- Tax Planning Strategies
Uncertain Tax Positions
- Income Tax Exp is reduced ONLY if “more likely than not” that position will be sustained upon audit by IRS
- If “more likely than not” will be sustained probabilistic approach is used to determine amt
- if NOT “more likely than not” position will be sustained income tax expense will not reduce and add’l tax liability is recognized, no benefit recorded
Options for NOL firms
-Option chose is irrevocable for given NOL yr
1. Carryback/Carryforward Option: NOL first carried back
to 2 yrs before (earlier yr used 1st).
> based on tax rate in earlier yrs and can only absorb
taxes actually pd
> If NOL exceeds taxable income for 2 yrs remainder
then carried forward for 20 yrs
2. Carryforward Only Option: Firm chooses only to carry forward NOL not carryback 1st.
REMEMBER: First Compute Ending DTA from remaining NOL bc computing “used up” amt of NOL by current yrs taxable income using current yr rate will not work if tax rate changed.
Income Tax Disclosures
- Current/Deferred Portions of Income Tax Exp
- Any investment tax credits & other credits taken
- Benefits of operating tax loss carryforwards/remaining amts/expiration dates
- Gov’t grants to extent used to reduce income tax
- Adj to deferred tax accts (and valuation allowance) as result of change in enacted tax rates or tax status
- Total of all deferred tax liabilities
- Total of all deferred tax assets
- Total Valuation Allowance recognized for deferred tax asstes
- Net change in valuation allowance
- Approx tax effect of each type temp diff (and carryforward)
- Reconciliation reported income tax exp on income from continuing operations, w/ tax would have resulted from applying statutory tax rate to income from continuing operations
- Any change in tax status
