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AssignmentsAssignments

For Next Class:Read Chapter 3, pages 24-38

ChapterChapter33

The Corporate Income Tax The Corporate Income Tax

GAAP Tax Accounting andReconciliation from Book Income

to Taxable Income

GAAP Tax Accounting andReconciliation from Book Income

to Taxable Income

Book-Tax Differences

Contrasting principles of conservatismGAAP conservatism principle

Protect shareholders and creditorsCurb management tendencies to overstate revenues and

understate expenses for book purposes

Tax conservatism principle Protect government revenuesCurb taxpayer tendencies to understate income and overstate

deductions

Book-Tax Differences

Permanent differences = items included in book income that are never recognized for tax purposes or vice versa

Temporary differences = items that are included in book income and recognized for tax purposes but in different taxable years (the difference will “reverse” over time)

Book-Tax Differences – Permanent

Examples of permanent book-tax differences Tax-exempt state and local bond interest incomeNondeductible expenses incurred to generate state and

local bond interest incomeLife insurance proceeds (death benefits)Premiums on key-man life insurance50% of meals and entertainmentPolitical contributionsFines and penaltiesBribes, kickbacks and illegal paymentsDividends-received deduction

Book-Tax Differences – Temporary

Examples of temporary book-tax differences:Depreciation versus cost recovery (and gains/losses on

sales of property with different book/tax bases)Accrued liabilities not meeting the all events and/or

economic performance testsPrepaid incomeRelated party accrualsAccrued compensationBad debt expenseNet operating lossesCharitable contributions in excess of limitationCapital loss carryovers

GAAP Tax Expense

GAAP total tax expense (benefit) = current tax expense (benefit) plus deferred tax expense (benefit)

GAAP Tax Expense

GAAP current tax expense (benefit) = estimated tax payable (refund receivable) based on estimated taxable income for the current year Exception: Effects of stock options compensation and

“other comprehensive income” items are booked directly to retained earnings

GAAP Tax Expense

GAAP deferred tax expense (benefit) = estimated tax effects of temporary differences (those differences that will reverse in future years)Differences that make taxable income lower than book

income at origination create deferred tax liabilitiesDifferences that make taxable income higher than book

income at origination create deferred tax assets

GAAP Tax Expense

GAAP (SFAS109) uses the Balance Sheet approach to calculating deferred tax expenseCalculate deferred tax liability or asset on cumulative

temporary differences at the beginning of the year and again at the end of the year

Deferred tax liability increase (deferred tax asset decrease) => deferred tax expense

Deferred tax liability decrease (deferred tax asset increase) => deferred tax benefit

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Example 13: GAAP Tax ExpenseExample 13: GAAP Tax Expense

A corporation has book income before taxes of $1,000,000. It has only two book-tax differences as follows:The accumulated depreciation for book purposes was

$350,000 at the beginning of the year and current year depreciation expense is $50,000. The accumulated MACRS was $475,000 at the beginning of the year and current year MACRS deduction is $80,000.

The total meals deducted per books was $82,000.

What is the corporation’s tax expense (current and deferred) and net book income?

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Example 13: GAAP Tax ExpenseExample 13: GAAP Tax Expense

Net book income before taxes $1,000,000

Meals not deductible (50% x $82,000) 41,000

Book - tax depreciation difference(50,000 – 80,000)

(30,000)

Estimated taxable income $1,011,000

Current tax expense (1,011,000 x 34%) $343,740

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Example 13: GAAP Tax ExpenseExample 13: GAAP Tax Expense

Beg. of Year End of Year

Cumulative MACRS over book depreciation

$125,000 $155,000

Tax rate x 34% x 34%

Deferred liability $42,500 $52,700

Deferred tax expense $10,200

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Example 13: GAAP Tax ExpenseExample 13: GAAP Tax Expense

Income before taxes per books $1,000,000

Current tax expense $343,740

Deferred tax expense 10,200

Total tax expense 353,940

Net income per books $646,060

GAAP Tax Expense

In simple situations: Adjusted book income = pre-tax book income plus

or minus all permanent book-tax differencesTotal tax expense per books = (adjusted book

income X tax rate) minus tax creditsDeferred tax expense (benefit) = total tax expense

(benefit) less current tax expense (benefit) Gives the same number as that calculated under

SFAS 109 using the balance sheet approach if thetax rate does not change during the year

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Example 13: GAAP Tax ExpenseExample 13: GAAP Tax Expense

Income before taxes per books $1,000,000

Permanent differences 41,000

Adjusted book income $1,041,000

Tax rate x 34%

Total tax expense $353,940

Less: Current tax expense 343,740

Deferred tax expense $10,200

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Schedules M-1 and M-3Schedules M-1 and M-3

Corporations are required to provide, with their tax return, a reconciliation from their GAAP financial statement income to taxable incomeCorporations with total assets of $10 million or more

must use Schedule M-3 (requires breakdown of temporary and permanent differences)

Other corporations may use Schedule M-1 (requires breakdown by four categories)

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Example 13: GAAP Tax ExpenseExample 13: GAAP Tax Expense

Schedule M-1:

1. Net income per books $646,060

2. Federal income tax per books 353,940

5. Expenses per book not deducted

c. Travel and Entertainment41,000

8. Deductions per return not in books

a. Depreciation (30,000)

Taxable Income $1,011,000

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GAAP Tax ExpenseGAAP Tax Expense

Example 14

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ProblemsProblems

Chapter 3: C3-58, C3-59, and C3-61