Accounting for Income Taxes Sid Glandon, DBA, CPA Assistant Professor of Accounting The University of Texas at El Paso

Fundamentals Pretax financial income Determined in accordance with GAAP Accrual accounting Taxable income Determined in accordance with IRC Modified cash basis

Deferred Taxes Income tax expense differs from income tax liability Temporary differences Tax vs. book depreciation Reverse over time Permanent differences Municipal bond interest Does not reverse over time

Deferred Tax Liability Represents the increase in taxes payable in future years as a result of temporary taxable differences existing at the end of the current year

Deferred Tax Asset Represents the decrease in taxes payable in future years as a result of temporary taxable differences existing at the end of the current year

Temporary Differences Deferred Tax Assets Revenue and gains Recognized for income tax purposes Deferred in financial statements Expenses and losses Recognized in financial statements Deferred for income tax purposes Deferred Tax Liabilities Revenue and gains Recognized in financial statements Deferred for income tax purposes Expenses and losses Recognized for income tax purposes Deferred in financial statements

Temporary Differences

Permanent Differences Items recognized for financial accounting purposes but not tax Interest income on tax exempt securities Fines and expenses resulting from violations of law Items recognized for tax purposes but not financial accounting Dividends received deduction Percentage depletion on natural resources

Deferred Taxes Deferred tax asset Arises due to net deductible amounts in the future Deferred tax liability Arises due to net taxable amounts in the future

A Deferred Tax Liability

Deferred Tax Asset

Temporary Differences: Originating and Reversing

Sequence of Analysis Identify book to tax difference Analyze temporary differences Deferred tax assets Deferred tax liabilities Calculation of income tax payable Calculation of income tax expense Prepare journal entry

Deferred Tax Asset Valuation Allowance Account Based on all available evidence More likely than not that some portion or all of the deferred tax asset will not be realized A valuation allowance is established to recognize the reduction in the carrying amount of the deferred tax asset account

Valuation Allowance

Income Statement Presentation

Tax Rate Considerations Apply the enacted tax rate for the year in question Use the average of the enacted tax rate Revision of future tax rates The effect is reported as an adjustment to income tax expense in the period of change State and foreign income taxes

Net Operating Loss Tax terminology Tax deductions exceed taxable income NOL for each year is computed Carry back 2 years (election-carry back option) Carry forward 20 years (carry forward only)

Net Loss (Operating Loss) Financial accounting terminology NOL can be derived from net loss Any tax refunds are reported in the year of the original net operating loss

NOL Carryback

NOL CARRYBACK RULES

Balance Sheet Presentation Deferred tax classification relates to underlying asset or liability Current Noncurrent Sum all current tax assets and liabilities Sum all noncurrent tax assets and liabilities

Income Statement Presentation Income tax expense allocated to: Continuing operations Discontinued operations Extraordinary items Cumulative effect of accounting change Prior period adjustments Current tax expense Deferred tax expense/benefit