Chapter 13: INCOME TAX REPORTING

Book income vs. taxable income

1) Temporary differences
2) Permanent differences

Examples of temporary differences include

 Depreciation
 Bad debt expense
 Prepaid expenses
 Installment sales

E13-1, 13-3, 13-6, 13-8

Examples of permanent differences include

 Goodwill impairments
 Interest on state and municipal bonds
 Fees/penalties for breaking the law
 Key-man life insurance premiums and proceeds

Temporary differences will reverse

Permanent will NOT

Temporary differences that result in deferred tax

liabilities (DTLs) are called future taxable amounts
because future taxable income will be greater than future
book income

E13-2
Temporary differences that result in deferred tax assets
(DTAs) are called future deductible amounts because
future taxable income will be less than book income.

TAX RATE CHANGES: In the year that current or

future tax rates are changed, income tax expense gets hit
with the full effect and the relationship between financial
statement income and income tax expense is destroyed.
This is called the “liability approach.”

So there will be adjustments to earnings (through income

tax expense) that are NOT sustainable.

Effect on net income will depend on whether:

1) Tax rates are increasing or decreasing
2) The firm has a net DTA or net DTL position and
3) The amount of the deferred taxes

E13-8 amended

DTA Valuation Allowances:

If the probability of future taxable income is greater than
50%, no need for valuation allowance

BUT, if “more likely than not” that some of the DTA will
not be realized then must set up a valuation allowance.

E13-14
!!!#@%_________*!@#
EARNINGS MANAGEMENT OPPORTUNITY
*!@#___________!!!#@%
Net operating losses (NOLs):
Used to be able to take back two years (called a
“carryback”), then take forward twenty years if any left
(called a “carryforward”). OR could choose to carry it all
forward. E 13-11

NOW, because of the 2017 “Tax Cuts and Jobs Act”

NOLs can only be carried forward. Carrybacks
eliminated.
Deduction for NOLs is limited to 80% of taxpayer’s
eligible income (reduced from 100%)

May need valuation allowance

E13-11 REVISED

Uncertain tax positions:

Step 1 – is it more likely than not (more than 50%
likelihood) that the tax return position will be upheld? If
so, then go to Step 2

Step 2 – measure the tax benefit. It is the largest amount

that is cumulatively greater than 50% likely to be realized.

Have to use a “tax contingency reserve” NOT a

“valuation allowance”

E13-18
Effective for fiscal years after 12/15/16, all DTAs and
DTLs are noncurrent.

Reported in single net noncurrent DTA or DTL on the

balance sheet.

C 13-3

Other changes of note in 2017 Tax Cuts and Jobs Act:

 Flat corporate tax rate of 21%
 Dividends received deduction lowered from
80%/70% to 65%/50%
 Deduction for “business entertainment” eliminated
 New rules were effective 12/22/17