Income Taxes Pt. 2

Question 1

What is a tax position?

Answer 1

it is a filing position that an enterprise has taken or expects to take on its tax return

there is a two-step approach

step 1: recognition of the tax benefit

the more-likely-than-not threshold must be met before a tax benefit can be recognized in the financial statements

the assessment is based on the expected outcome if the dispute with the taxing authority were taken to the court of last resort

the threshold is based on the technical merits of the position; presume that the relevant taxing authority will examine the tax position and has full knowledge of all relevant information; each tax position should be evaluated separately

the tax benefit is not recognized in the financial statements if it fails to meet the more-likely-than-not test and financial statement tax expense is increased

step 2: measurement of the tax benefit

recognize the largest amount of tax benefit that has a greater than 50% likelihood of being realized upon ultimate settlement with the taxing authority

if the tax position is based on clear and unambiguous tax law, recognize the full benefit in the financial statements

Question 2

What is the enacted tax rate?

Answer 2

measurement of deferred taxes is based on the applicable tax rate; this requires using the enacted tax rate expected to apply to taxable items (temporary differences) in the periods the taxable item is expected to be paid (liability) or realized (asset)

Question 3

Changes in tax laws or rates

Answer 3

the liability method requires that the deferred tax account balance (asset or liability) be adjusted when the tax rates change; thus if future tax rates have been enacted, not just proposed or estimated, the deferred tax liability and asset accounts will be calculated using the appropriate enacted future effective tax rate; changes in tax laws or rates are recognized in the period of change (enactment)

Question 4

Change in the valuation allowance

Answer 4

a change in circumstances that causes a change in judgment about the ability to realize the related deferred tax asset in future years should be recognized in income from continuing operations in the period of the change

Question 5

Balance sheet presentation

Answer 5

under U.S. GAAP, deferred tax liabilities and assets should be classified and reported as a non-current amount on the balance sheet; all deferred tax liabilities and assets must be offset (netted) and presented as one amount (a net non-current asset or a net noncurrent liability), unless the deferred tax liabilities and assets are attributable to different tax-paying components of the entity or to different tax jurisdictions

Question 6

Operating Losses

Answer 6

a net operating loss (NOL) arising in 2018, 2019, or 2020 tax years can be carried back five years (to the oldest year first) and carried forward indefinitely to offset taxable income in other years; NOLs utilized in the five-year carryback period or in 2018, 2019, or 2020 tax years are not subject to a taxable income limitation

NOLs carried forward to taxable years beginning in 2021 or later are limited to 80% of taxable income before the NOL deduction; taxpayers can elect not to carry back and just carry forward; NOLs arising in 2021 and beyond cannot be carried back but can be carried forward indefinitely; taxable income and financial accounting income will differ for the years in which the loss is incurred and carried back or forward

if operating losses are carried back to a year before 2018 when the federal corporate tax rate was 35%, tax receivables should be measured at the 35% rate applicable to the carryback year

if an operating loss is carried forward, the tax effects are recognized to the extent that the tax benefit is more likely than not to be realized; tax carryforwards should be recognized as deferred tax assets (because they represent future tax savings) in the period in which they occur

Question 7

Investee’s undistributed earnings

Answer 7

taxable income is the dividends received; under U.S. tax law, there is a dividends-received deduction (exclusion) based on the percentage of ownership in the stock of the other corporation

ownership 0-19% = 50% exclusion
ownership 20-80% = 65% exclusion
ownership over 80% = 100% exclusion

report percentage of investee’s income using the equity method for an investment between 20-50%