Advanced Income Tax

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______________ is often the starting point for computing taxable income?

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______________ is often the starting point for computing taxable income?

Financial income

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Treatment for: Unfavorable differences

Add-back to book income to compute taxable income

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Treatment for: Favorable differences

Subtract from book income to compute taxable income

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What type of differences reverse over time?

Temporary differences

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Describe the book-tax difference:

50% of meals expense for meals not purchased from restaurants in 2021 and 2022

Unfavorable, permanent

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Describe the book-tax difference:

Bad debt expense

Temporary

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Describe the book-tax difference:

Interest income from municipal bonds

Favorable, permanent

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Describe the book-tax difference:

Death benefit from life insurance on key employees

Favorable, permanent

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Describe the book-tax difference:

Organizational expenditures or start-up cost

Temporary

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Describe the book-tax difference:

Life insurance premiums

Unfavorable, permanent

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Describe the book-tax difference:

Entertainment expenses

Unfavorable, permanent

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Describe the book-tax difference:

Unearned rent revenue

Temporary

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Describe the book-tax difference:

Fines, penalties, and political contributions

Unfavorable, permanent

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Describe the book-tax difference:

Federal income taxes

Unfavorable, permanent

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What type of differences never reverse?

Permanent differences

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Describe the book-tax difference:

Dividends-received deduction

Favorable, permanent

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Describe the book-tax difference:

Interest expense

Temporary

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Describe the book-tax difference:

ISO and NONQUAL: Stock option expense from stock options during vesting period

Unfavorable, permanent

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Describe the book-tax difference:

Depreciation

Temporary

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Describe the book-tax difference:

Gain/loss on sale of depreciable asset

Temporary

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Describe the book-tax difference:

§263A uniform inventory capitalization costs

Temporary

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Describe the book-tax difference:

Like-kind exchange

Temporary

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Describe the book-tax difference:

Equity income

Temporary

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Describe the book-tax difference:

Deferred compensation

Temporary

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What is the rule for carrying Net capital loss to other years

Carry back three years and forward 5

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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)

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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)

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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)

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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)

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What is ATI

Adjusted taxable income: taxable income before interest income or deductions

  • does not include interest income, interest expense, or depreciation and amortization

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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

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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

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What is AGR

Average Gross Receipts

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What is an ISO

Incentive stock option

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What is the treatment for ISO

  • Book: initial estimated FV of stock options/requisite service period

  • Tax: no deduction

    • Unfavorable, permanent difference

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What is a NONQUAL

Nonqualified Stock Option

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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

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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)

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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

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What is NCL

Net Capital Losses

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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).

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What is NOL

Net operating Loss

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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

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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)

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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

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What is DRD

Dividends-received deduction

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What was the % limitation on charitable donations deductions in 2020 and 2021?

25% of taxable income before noted deductions

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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

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How do you calculate DRD?

  • Dividend * DRD% (or)

  • DRD modified taxable income * DRD%

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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)

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What is the rate for Corporate income tax Liability

21%, it is a flat rate applied to all C corporation taxable income

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What Form and schedule do small corporations report taxable income?

Form 1120, schedule M-1

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What Form and Schedule do large corporations report taxable income?

Form 1120, Schedule M-3

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What are book-tax differences referred to as?

M adjustments

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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

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How are corporations supposed to pay their estimated income tax?

Evenly in quarterly installments (25% Q1, 25% Q2, 25% Q3, 25% Q4)

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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

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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

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DTA

Deferred tax asset

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DTL

Deferred tax liability

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Tax Provision

The “income tax expense” that appears on the IS

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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

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What is included in the Deferred tax

Temporary differences (the reversal)

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What is included in the Income tax provision?

Current-year provision and any changes to future (deferred) income taxes.

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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

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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

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What are TWO objectives of ASC 740?

  1. Recognize the amount of income taxes payable or refundable in the current year

  2. 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

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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.

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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”

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What is the purpose of accounting or income taxes and the income tax provision like this?

  1. The timing of when income and deductions are reported on the two statements may differ (prepayments)

  2. Different entities may appear on the two statements (book consolidates at 50%, tax consolidates at 80%)

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How does a company compute the deferred tax liability or asset?

They calculate the future tax effects attributable to temporary differences and tax carryforwards.

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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”

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What are the steps in determining the income tax provision?

  1. identify all permanent and temporary differences and carryforwards

  2. calculate the current income tax expense or benefit

  3. recognize DTA or DTL

  4. calculate the deferred income tax expense or benefit and the total income tax expense or benefit

  5. evaluate the need for a valuation allowance for DTA

  6. evaluate the need for an uncertain tax position reserve

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What is UTP

Uncertain tax position

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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)

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What is ETR

Effective tax rate

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What is TTD

Taxable temporary difference, a difference that is initially favorable.

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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.

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What is DTD

Deductible temporary difference

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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.

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The future tax benefit associated with a deductible temporary difference is recorded on the balance sheet as a _______

Deferred tax asset (DTA)

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The future tax cost associated with a taxable temporary difference is recorded on the balance sheet as a __________

Deferred tax liability (DTL)

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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

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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.

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