Ch 16 tax
On its year 1 financial statements, Seatax Corporation, an accrual-method taxpayer, reported federal income tax expense of $570,000. On its year 1 tax return, it reported a tax liability of $650,000. During year 1, Seatax made estimated tax payments of $700,000. What book-tax difference, if any, associated with its federal income tax expense should Seatax have reported when computing its year 1 taxable income? Is the difference favorable or unfavorable? Is it temporary or permanent?
Corporations reconcile from book income to taxable income by making adjustments for book-tax differences. In this case, Seatax deducted $570,000 of federal income tax expense to determine its book income (note that it did not deduct its actual tax liability). Because corporations are not allowed to deduct any federal tax expense on their tax returns, Seatax will make a permanent $570,000 unfavorable book-tax difference when computing its year 1 taxable income.
bargain element
FMV - exercise price
What is the difference between favorable and unfavorable book-tax differences?
Favorable" book-tax differences are subtractions from book income when reconciling to taxable income. In contrast, unfavorable book-tax differences are additions to book income when reconciling to taxable income. Relative to book income, favorable book-tax differences decrease taxable income (that is, they reduce taxable income and taxes payable so they are favorable), and unfavorable book-tax differences increase taxable income (that is, they increase taxable income and taxes payable so they are unfavorable).
How do corporations account for capital gains and losses for tax purposes? How is this different from the way individuals account for capital gains and losses?
For tax purposes, capital gains are taxed at the corporation's ordinary tax rate of 21%, and individuals are taxed on net long-term capital gains at preferential rates (lower than ordinary rates). Corporations are not allowed to deduct net capital losses against ordinary income. They carry back net capital losses three years and forward five years to offset capital gain net income in those years. Individual taxpayers can deduct up to $3,000 of net capital loss against ordinary income in a year. They carry over the remainder indefinitely to offset against capital gains in subsequent years and up to $3,000 of net capital loss against ordinary income each year.
Describe the book-tax differences that arise from non-qualified stock options granted after ASC 718 became effective.
Nonqualified options generate permanent and temporary book-tax differences. Corporations initially recognize temporary book-tax differences associated with stock options for the value of options that vest during the year but are not exercised during that year. This initial temporary difference is always unfavorable because the corporation deducts the value of the unexercised options that vest during the year for book purposes but not for tax purposes. This initial unfavorable temporary book-tax difference completely reverses when employees actually exercise the stock options.The amount of the permanent difference is the difference between the estimated value of the stock options exercised (the amount associated with these stock options deducted for book purposes) minus the bargain element of the stock options exercised during the year (the amount that is deducted for tax purposes). If the estimated value of stock options exercised exceeds the bargain element of the stock options exercised, the permanent book-tax difference is unfavorable, otherwise it is favorable. The permanent book-tax difference is recognized in the year the options are exercised. The tax benefits related to the excess tax deductions over the estimated book amounts are recorded as a reduction in the company's income tax provision (prior to 2018, such excess benefits were recorded as an increase in additional paid-in capital).
What is the difference between permanent and temporary book-tax differences?
Permanent book-tax differences arise from income items or deductions reported during the year for either book purposes or for tax purposes but not both. Permanent differences do not reverse over time, so over the long-term the total amount of income or deductions for the items is different for book and tax purposes. In contrast, temporary book-tax differences reverse over time such that over the long-term, corporations recognize the same amount of income or deductions for the items on their financial statements as they recognize on their tax returns. Temporary book-tax differences arise because the income or deduction items are included in financial accounting income in one year and in taxable income in a different year
In general terms, identify the similarities and differences between the corporate taxable income formula and the individual taxable income formula.
Similarities: Both formulas start with gross income (income after exclusions) for the taxable year. Both formulas reduce gross income by deductions to determine taxable income and apply tax rates to taxable income to determine the tax liability. Finally, both formulas reduce the tax liability by credits and tax payments to determine taxes due or the refund. Both formulas allow taxpayers to take deductions for business expenses to compute taxable income.Differences: Individuals distinguish deductions between for and from AGI deductions, and they report adjusted gross income. Corporations do not distinguish between deduction types and do not report adjusted gross income. Corporations do not itemize deductions, nor do they deduct standard deductions..
What are the common book-tax differences relating to accounting for capital gains and losses? Do these differences create favorable or unfavorable book-to-tax adjustments?
The first common difference arises when a corporation has a net capital loss in a year. The corporation deducts the net loss for book purposes but is not allowed to deduct it for tax purposes. As a result, the net capital loss generates an unfavorable temporary book-tax difference. When the net capital loss is deducted for tax purposes as a carryover it generates a favorable book-tax difference because the carryover is not deductible for book purposes.
Briefly describe the process of computing a corporation's taxable income assuming the corporation must use GAAP to determine its book income. How might the process differ for corporations not required to use GAAP for book purposes?
To compute taxable income a corporation starts with book income before income taxes and makes book-to-tax adjustments for items that are accounted for differently for book and tax purposes. The end result is taxable income. A corporation that is not required to (and chooses not to) use GAAP for tax purposes could use tax accounting methods to determine book and taxable income. In these situations, the corporation would not report any book-tax differences.
If bargain price is higher than original estimate FMV then
it is favorable
If bargain price is lower than original estimate FMV then
it is unfavorable
What are the carryback and carryover periods for a net operating loss? Does it depend on the size of the corporation? Explain.
or taxable years beginning after December 31, 2017, net operating losses can be carried forward indefinitely and offset up to 80% of taxable income in the carryover year. For taxable years beginning before December 31, 2017, net operating losses were carried back two years and any remaining loss was carried forward for up to 20 years to offset up to 100% of taxable income. Pre-2018 net operating loss carryovers retain their 20 year carryover limitation and can offset 100% of taxable income in the carryover period (carryovers are used on a first-in first-out basis). The tax treatment of net operating losses does not depend on the size of the corporation.
Describe the book-tax differences that arise from incentive stock options granted after ASC 718 became effective.
under ASC 718, incentive stock options give rise to permanent, unfavorable book-tax differences. Corporations are not allowed to deduct any compensation expense associated with incentive stock options for tax purposes, but for financial accounting purposes, corporations are required to deduct the initial estimated value of the stock options times the percentage of the options that vest during that particular year.
Incentive stock
unfavorable permanent
