Studied by 7 people
Exam 1
______________ is often the starting point for computing taxable income?
Financial income
Treatment for: Unfavorable differences
Add-back to book income to compute taxable income
Treatment for: Favorable differences
Subtract from book income to compute taxable income
What type of differences reverse over time?
Temporary differences
Describe the book-tax difference:
50% of meals expense for meals not purchased from restaurants in 2021 and 2022
Unfavorable, permanent
Describe the book-tax difference:
Bad debt expense
Temporary
Describe the book-tax difference:
Interest income from municipal bonds
Favorable, permanent
Describe the book-tax difference:
Death benefit from life insurance on key employees
Favorable, permanent
Describe the book-tax difference:
Organizational expenditures or start-up cost
Temporary
Describe the book-tax difference:
Life insurance premiums
Unfavorable, permanent
Describe the book-tax difference:
Entertainment expenses
Unfavorable, permanent
Describe the book-tax difference:
Unearned rent revenue
Temporary
Describe the book-tax difference:
Fines, penalties, and political contributions
Unfavorable, permanent
Describe the book-tax difference:
Federal income taxes
Unfavorable, permanent
What type of differences never reverse?
Permanent differences
Describe the book-tax difference:
Dividends-received deduction
Favorable, permanent
Describe the book-tax difference:
Interest expense
Temporary
Describe the book-tax difference:
ISO and NONQUAL: Stock option expense from stock options during vesting period
Unfavorable, permanent
Describe the book-tax difference:
Depreciation
Temporary
Describe the book-tax difference:
Gain/loss on sale of depreciable asset
Temporary
Describe the book-tax difference:
§263A uniform inventory capitalization costs
Temporary
Describe the book-tax difference:
Like-kind exchange
Temporary
Describe the book-tax difference:
Equity income
Temporary
Describe the book-tax difference:
Deferred compensation
Temporary
What is the rule for carrying Net capital loss to other years
Carry back three years and forward 5
Explain how book-tax differences could occur from dividends:
Ownership is <20%
dividend income is included in gross income for tax purposes if received from domestic corporation
Ownership <20%, dividend income is included in book income.
Unrealized G/L is realized in book income but not in tax (temporary)
Explain how book-tax differences could occur from dividends:
Ownership is >20% but <50%
dividend income is included in gross income for tax purposes if received from domestic corporation
Ownership more than 20% but less than 50%, the equity method is used. The corporation does not include the dividend in book income (permanent)
Explain how book-tax differences could occur from dividends:
Ownership is >50%
dividend income is included in gross income for tax purposes if received from domestic corporation
Ownership >50%, the corporation uses consolidated financial reporting. Dividends are eliminated for book purposes (permanent)
Explain how book-tax differences could occur from dividends:
Ownership is <80%
If ownership is >80%, consolidated tax reporting. Intercompany dividends from members of the consolidated group are eliminated for tax purposes
Ownership >50%, the corporation uses consolidated financial reporting. Dividends are eliminated for book purposes
(no difference)
What is ATI
Adjusted taxable income: taxable income before interest income or deductions
does not include interest income, interest expense, or depreciation and amortization
What is the limitation on Net Interest Expense?
these deductions are limited to 30% of taxable income before interest income or deductions, plus interest income
deductions disallowed are carried forward indefinitely
In what case does the limitation on Net Interest Expense NOT apply?
If the taxpayers annual average gross receipts is less than $27 million for the prior 3 years
What is AGR
Average Gross Receipts
What is an ISO
Incentive stock option
What is the treatment for ISO
Book: initial estimated FV of stock options/requisite service period
Tax: no deduction
Unfavorable, permanent difference
What is a NONQUAL
Nonqualified Stock Option
What is the treatment for a NONQUAL
Book: initial estimated FV of stock options/requisite service period
Tax: non deduction until exercise
Unfavorable, temporary difference
What is the treatment for a NONQUAL in the year of exercise
Book: initial estimated FV of stock options/requisite service period
Tax: bargain element
Favorable, temporary (reversing unfavorable difference in PY)
What is a Bargain element?
The difference between the FMV of the stock and the exercise price on the date the employee exercises the stock options
What is NCL
Net Capital Losses
What is the treatment for Net Capital losses
There are no current deductions for net capital losses (NCL in excess of capital gains). In tax, carry back NCL three years and forward 5 (on FIFO basis).
What is NOL
Net operating Loss
What is the treatment for Net Operating Loss
No current tax benefit from current-year loss.
NOLs from years beginning after 12/31/17 can be carried forward indefinitely, limited to 80% of taxable income before the NOL deduction. Can offset up to 100% of taxable income before the NOL deduction
NOLs from pre-2018 tax years can be carried back 2 years and forward 20 years
No deductions for: NOL carrybacks or carryovers from other years. Capital loss carrybacks (carryovers are allowed)
After 2020, carryback is not allowed. can offset up to 80% of TI after deducting NOL carryovers from NOLs originating in tax years beginning before 2018
What is the treatment for Charitable Contributions?
Capital gain property (generally at FMV)
Ordinary income property (generally adjusted basis)
Under an accrual-method corporation:
deduct when accrued if: approved by BOD before YE, paid within 3 1/2 months after EOY (2 1/2 if June 30 YE)
What is the rule for charitable contributions in 2022?
deduction is limited to 10% of taxable income before deducting:
any charitable contributions
dividends-received deduction
net capital loss carrybacks
carry forward excess contributions for 5 years
What is DRD
Dividends-received deduction
What was the % limitation on charitable donations deductions in 2020 and 2021?
25% of taxable income before noted deductions
What is the rule for Dividends-Received Deduction?
Deduction to mitigate more than 2 levels of tax.
Own less than 20%: 50% DRD
Own at least 20% but less than 80%: 65% DRD
Own 80% or more: 100% DRD
Creates a favorable, permanent difference
How do you calculate DRD?
Dividend * DRD% (or)
DRD modified taxable income * DRD%
How do you calculate Modified taxable income?
Modified taxable income = taxable income before DRD, and NOL, and capital loss carrybacks.
(NOL rule: if full DRD increases or creates an NOL, this limit does not apply)
What is the rate for Corporate income tax Liability
21%, it is a flat rate applied to all C corporation taxable income
What Form and schedule do small corporations report taxable income?
Form 1120, schedule M-1
What Form and Schedule do large corporations report taxable income?
Form 1120, Schedule M-3
What are book-tax differences referred to as?
M adjustments
When are corporate returns due?
3 1/2 months after the close of the tax year, if YE is June 30th, 2 1/2. Automatic 6 month extension for filing
How are corporations supposed to pay their estimated income tax?
Evenly in quarterly installments (25% Q1, 25% Q2, 25% Q3, 25% Q4)
What is the required annual payment?
100% of tax liability on PY return (does not apply f no liability in PY)
100% of current-year tax liability
100% of estimated current-year tax liability using annualized method
What are the payment rules for large corporations?
$1,000,000 of taxable income in prior 3 years
may use prior-year liability for first quarter payment only
DTA
Deferred tax asset
DTL
Deferred tax liability
Tax Provision
The “income tax expense” that appears on the IS
What is included in the Current Provision
“everything but the kitchen sink”
Includes:
pre-tax book income
all permanent differences
current year effect of temporary differences
What is included in the Deferred tax
Temporary differences (the reversal)
What is included in the Income tax provision?
Current-year provision and any changes to future (deferred) income taxes.
What does ASC 740 apply to?
Income taxes levied by the federal government (does not include any other type of tax), US state and local governments, Non-US governments
How does FASB define income tax?
Tax based on income, which excludes property taxes, excise taxes, sales taxes, and value-added taxes (sometimes referred to as “indirect taxes
What are TWO objectives of ASC 740?
Recognize the amount of income taxes payable or refundable in the current year
Recognize deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an enterprise/s financial statements or tax returns
What is the objective of accounting for income taxes and income tax provision processes?
Both of the objectives of ASC 740 is to report a company’s income tax amounts on the balance sheet, not the income statement.
What is the ASC 740 approach to computing the tax provision often referred to as?
The “asset and liability approach” or the “balance sheet approach”
What is the purpose of accounting or income taxes and the income tax provision like this?
The timing of when income and deductions are reported on the two statements may differ (prepayments)
Different entities may appear on the two statements (book consolidates at 50%, tax consolidates at 80%)
How does a company compute the deferred tax liability or asset?
They calculate the future tax effects attributable to temporary differences and tax carryforwards.
What is considered “best practice” for accounting for DTAs and DTLs?
To keep both a book and tax balance sheet and compute the change in temporary differences using the comparative balance sheets rather than a “roll forward approach”
What are the steps in determining the income tax provision?
identify all permanent and temporary differences and carryforwards
calculate the current income tax expense or benefit
recognize DTA or DTL
calculate the deferred income tax expense or benefit and the total income tax expense or benefit
evaluate the need for a valuation allowance for DTA
evaluate the need for an uncertain tax position reserve
What is UTP
Uncertain tax position
What is the formula for computing the total income tax provision
Total income tax provision = current income tax expense (benefit) +/- deferred income tax expense (benefit)
What is ETR
Effective tax rate
What is TTD
Taxable temporary difference, a difference that is initially favorable.
When do TTDs generally arise?
When the financial reporting basis of an asset exceeds its corresponding tax basis, or the financial reporting basis of a liability is less than its corresponding tax basis. Revenues or gains are taxable after they are recognized in net income. expenses or losses are deductible on the tax return before they reduce net income.
What is DTD
Deductible temporary difference
When do DTDs generally arise?
When the financial reporting basis of an asset is less than its corresponding tax basis, or the financial reporting basis of a liability exceeds its corresponding tax basis. When Revenues or gains are taxable before they are recognized in net income or when expenses or losses are deductible on the tax return after they reduce net income.
The future tax benefit associated with a deductible temporary difference is recorded on the balance sheet as a _______
Deferred tax asset (DTA)
The future tax cost associated with a taxable temporary difference is recorded on the balance sheet as a __________
Deferred tax liability (DTL)
What does the deferred tax account provide investors (and other interested parties)?
A measure of a company’s expected future income-tax-related cash inflows (outflows) resulting from book-tax differences that are temporary in nature or from tax carryovers
How does ASC 740 calculate the Deferred income tax expense or benefit?
By assessing the change in the cumulative differences between the financial accounting adjusted basis of an asset or liability and its corresponding tax basis from the beginning of the year to the end of the year.
When is a valuation allow for gross deferred tax assets needed?
When it is more likely than not that some or all of the deferred tax asset will not be realized in the future.
What are the 2 objective sources, according to ASC 740, for determining whether a valuation allowance is needed for DTAs?
Future reversals of existing taxable temporary differences
if reversing TTD provides sufficient future taxable income to absorb the reversing deductible differences, the company does not record a valuation allowance against the deferred tax asset
Taxable income in prior carryback years
if the tax benefit from the realization of a DTA can be carried back to a prior year that has sufficient taxable income to absorb the realized tax benefit then a company does not record a valuation allowance.
What are the 2 subjective sources, according to ASC 740, for determining whether a valuation allowance is needed for DTAs?
Expected future taxable income exclusive of reversing temporary differences and carryforwards.
a company might support its predictions of future table income with evidence of existing contracts or a sales backlog that will produce enough taxable income to realize the deferred tax asset when it reverses.
Tax planning strategies:
sale and lease back of operating assets, changing inventory accounting methods, refraining from making voluntary contributions to the company pension plan, sale of noncore assets…etc.
What does ASC 740 require that companies consider when determining whether it is more likely than not that a deferred tax asset will be realized in the future?
Both negative as well as positive evidence.
What are examples of negative evidence?
cumulative (book) losses in recent years (36 quarters)
a history of net operating (capital) losses and credits expiring unused
an expectation of losses in the near future
unsettled circumstances that, if resolved unfavorably, will result in losses from continuing operations in future years
What is the objective of FIN 48
to provide a uniform approach to recording and disclosing tax benefits resulting from tax positions that are considered to be uncertain.
What is the two-step process to evaluating UTPs (ASC 740)
Recognition process
determine if it is more likely than not that its tax position on a particular account will be sustained on IRS examination based on its technical merits
company then determines the amount it expects to be able to recognize.
Measurement process
make a cumulative probability assessment of all likely outcomes of the audit and litigation process
company recognizes the amount that has a greater than 50% probability of being sustained on examination and subsequent litigation
amount not recognized is recorded as a liability on the BS (UTB)
What does UTB mean?
Unrecognized tax benefit
What should a disclosure of a UTP include?
gross amounts of increases and decreases in liabilities related to uncertain tax positions as a result of tax positions taken during a prior period
amounts of decreases in liabilities related to uncertain tax positions relating to settlements with taxing authorities
reductions in liabilities related to uncertain tax positions as a result of a lapse of the applicable statute of limitations
How are DTAs and DTLs classified on the balance sheet
According to ASC 740, they must be classified as noncurrent. It is not permitted to net the DTA and DTLs that are attributable to different tax jurisdictions.
What does ASC 740 mandate about DTAs and DTLs in relation to income tax footnote disclosures?
They must disclose: components of the net deferred tax assets and liabilities reported on its balance sheet and total valuation allowance recognized for deferred tax assets.
What does does ASC 740 require publicly traded companies to disclose?
current tax expense or benefit
deferred tax expense or benefit
benefits of operating loss carryforwards
adjustments of a deferred tax liability or asset for enacted changes in tax laws or rates
adjustments to the beginning-of-the-year balance of a valuation allowance
What does ASC 740 require companies to reconcile?
Reported income tax provision attributable to continuing operations with the amount of income tax expense that would result from applying its US statutory tax rate (21%) to its pretax net income or loss from continuing operations.
What is the importance of the GAAP ETR?
it serves as a benchmark of a corporation’s tax position relative to the company’s industry peer group
What is the Cash Tax Rate?
cash taxes paid/pretax book income
How is the Cash Tax Rate used?
Analysts use it to compute a company’s tax status excluding deferred taxes
Note 
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