Common Permanent Book-Tax Differences (chapter 9)

Description

Explanation

Interest Income from Municipal Bonds

Income included in book income,

excluded from taxable income

Favorable

Death benefit from Life Insurance on Key

Employees

Income included in book income,

Excluded from taxable income

Favorable

Interest expense on loans to acquire

investments generating tax-exempt
income

Deductible for books,

but expenses incurred to generate tax-exempt income are not
deductible for tax

Unfavorable

Life insurance premiums for which

corporation is beneficiary

Deductible for books, but expenses incurred to generate taxexempt income (life insurance death benefit) are not deductible for
tax

Unfavorable

Meals and Entertainments expenses

Fully deductible for books, but only 50% deductible for tax

Unfavorable

Fines and Penalties and Political

Contributions

Deductible for books, but not for Tax

Unfavorable

Domestic Production Activities Deduction

(DPAD)

Deduction for businesses involved in manufacturing activities in the

U.S. equal to the lesser of 9% of the companys qualified production
activities income (QPAI) or taxable income computed without DPAD
(i.e., the DPAD cannot create a NOL)

Difference

Favorable

Common Temporary Book-Tax Differences

Description

Explanation

Depreciation Expense
(chapter 10)

Difference between accelerated depreciation expense for tax

purposes and straight-line depreciation expense for book
purposes.

Gain or loss on disposition of depreciable

assets
(chapter 11)

Difference between gain or loss for tax and book purposes when
corporation sells or disposes of depreciable property. Difference
generally arises because depreciation expense and thus the
adjusted basis of the asset, is different for tax and book
purposes. The difference is essentially the reversal of the booktax difference for the depreciation expense on the asset sold or
disposed of.

Initial Difference *
Favorable

Unfavorable

Bad debt expense

(chapter 9)

Direct write-off method for tax purposes, allowance method for

book purposes

Unfavorable

Unearned rent revenue

(chapter 9)

Taxable on receipt but recognized earned for book purposes

Unfavorable

Deferred compensation
(chapter 9)

Deductible when accrued for book purposes, but deductible when

paid for tax purposes if accrued but not paid within 2.5 months
after year end. Also, accrued compensation to shareholders
owning more than 50% of the corporation is not deductible until
paid

Unfavorable

Organizational expenses and start-up

costs
(chapter 10)

Immediately deducted for book purposes but capitalized and

amortized for tax purposes (limited immediate expensing allowed
for tax).

Unfavorable

Warranty expense and other estimated

expenses
(chapter 9)

Estimated expenses deducted for book purposes, but actual

expenses deducted for tax purposes

Unfavorable

Certain expenditures deducted for book purposes, but capitalized

to inventory for tax purposes. Difference reverses when inventory
is sold.

Unfavorable

UNICAP (263A)
(chapter 9)

DESCRIPTION

EXPLANATION

DIFFERENCE

Interest income from Municipal Bonds

Death benefit from life insurance on Key Employees
Interest expense on loans to acquire investments
generating tax-exempt income
Life insurance premiums for which corporation is
beneficiary
Meals and Entertainment expenses
Fines and penalties and political contributions
Domestic production activities deduction (DPAD)

income included in book income excluded from taxable income

income included in book income, excluded from taxable income
deductible for books, but expenses incurred to generate tax-expenpt
income are not deductible for tax
deductible for books, but expenses incurred to generate tax-exempt
income (life insurance death benefit) are not deductible for tax
50% deductible for tax
deductible for books, but not for tax
deduction for businesses involved in manufacturing activities in the
U.S. equal to the lesser of 9% of the companys qualified production
activities income (QPAI) or taxable income computed without the
DPAD (i.e., the DPAD cannot create a NOL)

Favorable
Favorable
Unfavorable
Unfavorable
Unfavorable
Unfavorable
Favorable

Chapter 16 Corporate Operations

ACCOUNTING PERIODS & METHODS
Corporations

Accrual overall method of accounting

Avg recipts of $5million < 3yrs Cash Method
not in existence for at least 3yrs
compute avg. gross recpts to determine if
allowed to use the Cash Method

Goodwill acquired
in an asset acquisition

COMPUTING CORPORATE REGULAR TAXABLE INCOME

Start

with Book (financial reporting income)

make adjustments for book-tax
differences to reconcile to the tax
numbers

Book-Tax Differences

Income and expense are accounted for

differently for book and tax purposes

Unfavorable
book-tax difference

any book-tax difference that requires

an add back to book income to
compute taxable income
(it requires an adjustment that
increases taxable income relative to
book income)

Favorable
book-tax difference

requires corporations to subtract the

difference from book income in
computing taxable income
(because it decreases taxable income
and taxes payable-relative to book income)

Permanent
book-tax differences

do not reverse over time

Temporary
book-tax differences

that reverse over time such that over the

long-term, corporations recognize the
same amount of income or deductions
for the items

Federal Income tax expense Book

Tax

Dividends

Tax amortize purchased goodwill on a

straight-line basis over 15 years.
Book amt. recognized same or different
as for tax purposes.
recover the cost of goodwill for
book purposes only when and
only to the extent goodwill is
impaired
Temporary

Tax Amortization exceeds the book impairment expense

favorable / Permanent
Book impairment expense exceeds the goodwill tax amortization
unfavorable / Temporary

Corporate-Specific Deductions and Associated Book-Tax

Differences
Stock Options
Exercise Price

is usually the stock price on the day the options are

issued to the employee

Incentive Stock
Options (ISO)

less common, more administrative qualification to

qualify
Never deduct any compensation expense
associated with the options for tax purposes

Nonqualified
Stock Options
(NQO)

more common, options that dont qualify as ISOs

deduct the difference between the fair market value
of the stock and the exercise price of the option
(bargain element) as compensation expense in the
year which employees exercise the stock options

income deduct
do not deduct
Permanent

There is no book-tax difference for incentive stock option granted

before 2006

received
Book own <20% of stock
include dividends in income
NO book-tax difference

They report favorable, Permanent book-tax difference for the

bargain element of nonqualified stock options granted before 2006
(when the options are exercised)

own 20% but 50%

includes pro rata portion of
distributing corp. earnings in
income
does not include dividend in
income
Temporary
for difference between the
pro rata share of income and
the amount of the dividend.
own > 50% (beyond scope of text
Tax include in gross income

Nonqualified

Temporary unfavorable book-tax differences.

for the value of options that vest during the year but
are not exercised during that year.
completely reverses when employees actually
exercise the stock options