Taxes Flashcards
Key Summary for Taxes
- Taxable Income is amount subject to tax per IRS and creates the TAX LIABILITY (Payable).
- Pretax Accounting Income is reported (GAAP) income BEFORE Taxes (Income before IT).
- Income Tax Expense is a derived amount based on transactions for the year (I/S and B/S) to achieve matching. Equals the Income Tax Payable PLUS the net Change in Deferred Tax Accounts (DTL and DTA).
- Temp Difference: Causes the DTA or DTL based on timing (reported accrued revenue that is not taxable yet, but WILL have to pay tax eventually, so reflected in DTL and Income Tax Expense)
- Permanent Differences: Amount that occurs on Tax Return or Income Statement, but not BOTH like a Fine that is on I//S (lowers income) that is not deductible so Taxable Income higher.
Example: Fine would show as permanent difference through income tax expense that would appear to be higher than it needs to be vs. reported acctg income. Would cause ETR to be higher by the say 30% x $200 fine that have to pay taxes on, but that is NOT in reported income, but is in Taxable income (Dr Income Tax Expense and Cr Income Tax Payable)
Income Tax Liability
This IS the current Income Taxes due for the year (Current Income Tax Provision).
Amount firm must pay on Taxable Income for a year.
Creates Tax Payable or Credit to Cash if paid before setting up payable.
Deferred Income Tax
Amount of Income Tax Expense NOT currently Due.
Not in the Income Tax Liability, but represented in Income Tax Expense through the DTL as example.
Interperiod Tax Allocation
The process of measuring and recognizing the total income tax consequences of transactions in the year.
Deferred Income tax provision
The amount of income tax expense that is not currently due;
Equals the net sum of the change in the deferred tax accounts.
Income Tax Expense
The account reported in the income statement that measures the income tax cost for the year’s transactions. It is the net sum of the income tax liability, net change in the deferred tax accounts.
Common Permanent Differences
Tax-Free Interest Income;
Life Insurance Expense Premiums on key employee;
Proceeds from life insurance on key employee;
Dividends Received Deduction;
Fines and penalties.
DTL vs DTA
JET NOTE: think of whether will have to pay that tax later (DTL) or paid it already (DTA). Have to pay later if future TAXABLE INCOME will be HIGHER (because Taxable INCOME is LOWER now)
- Due to say Pre-paid insurance (Pay now and Expense for Taxes NOW so FUTURE Taxable Income will be HIGHER than Pre-Tax Income in FUTURE)
- DTL: TI >PT in FUTURE from less expense or more revenue (on taxable basis).
DTL: Revenue earlier and expenses later per BOOKS (Accelerated Depr for tax means Book Depr lower now, but higher later).
Expense is reflected NOT whether current or deferred from the transaction; if more than liability then will pay that portion in future so DTL). Taxable Income LESS>
DTA: Revenue later or expenses earlier per BOOKS (when Tax Depr lower than Book means recognizing more Depr on books now). Taxable Income MORE.
Formula for Calculating Liability and Expense
A. Pre-Tax adjusted for PERMANENT differences x Tax Rate = Income Tax Expense (per Books)
B. Above adjusted for TEMP x Tax Rate = Expense
Deferred amount is delta of Above.
Rates to use in Taxes
NEEDS REVIEW
When to use current Rates vs. Future Rates
Use Current for Income Tax Liability (Current) and Future for Deferred (DTA and DTL) as that is when they will be settled.
Adjustments to Pre-Tax for PERMANENT
- Add back to Pre-Tax if an INCREASE to Taxable Income. (Expense that is NOT Deductible)
- Take out if decreases Taxable Income vs Book (Income that is exempt from taxes).
Calculating Tax Liability from Pre-Tax
If Increases Taxable Income (say Advance RentP) then add it back and take it out if decreases taxable income (Muni Bond Income or accel depr).
DTL and DTA Examples
I. An increase in pre-paid insurance implies that future accounting insurance expense will exceed future tax insurance expense. Therefore, future taxable income will increase relative to future pre-tax accounting income. This increases the deferred tax liability.
II. An increase in rent receivable implies that future tax-rent revenue will exceed future accounting-rent revenue. A rent receivable is recorded when accounting-rent revenue is recognized before cash is received. Cash will be received in the future, which will be recognized as rent revenue for tax, but no revenue will be recognized for accounting. Therefore, again, future taxable income will increase relative to future pre-tax accounting income.
III. An increase in warranty obligations implies that future tax-warranty expense will exceed future accounting-warranty expense. Accounting has recognized the warranty expense in the year of sale, whereas tax-warranty expense is recognized in the year the repairs are made. This time, future taxable income will decrease relative to future pre-tax accounting income. This increases the deferred tax asset, rather than the deferred tax liability.
Current Income Tax Expense vs. Income Tax Expense
BE CAREFUL if asks for Current Only (does not include impact of Deferred).
Effective Tax Rate
The effective tax rate is the ratio of income tax expense to pre-tax accounting income. income tax expense equals income tax liability in this case, because there are no temporary differences. Both the interest revenue and life-insurance premiums are permanent differences. The income tax liability is the product of the income tax rate and taxable income.
DTL
The deferred tax liability is the future enacted tax rate, multiplied by the future taxable temporary difference.
DTL and Dividends from Equity Method Dividends
- Start with Future Dividends to Come and Adjust for Ownership % (Total Earnings less Dividends then times Ownership %)
Deferred Accounts
The deferred portion of 2005 income taxes is the net change in the deferred tax accounts during the year. There were no beginning balances in the deferred tax accounts. Therefore, the net change in the deferred tax accounts equals the difference between the ending deferred tax liability and asset.
The deferred tax accounts are measured using the future enacted tax rates in the years that the temporary differences reverse. The depreciation difference gives rise to a taxable difference (deferred tax liability) and the warranty difference gives rise to a deductible difference (deferred tax asset).
