USCPA (FAR) – (28) Income Taxes

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General Journal entry of Income taxes

(DR) Income Tax Expense 30 (CR) Change in DTL 10

(DR) Change in DTA 20 (CR) Income tax Payable 40

Income tax to specific required items on income statement

• Income from continuing operations: Allocation of income tax to revenue generated from normal business activities.
• Changes in accounting principles: Allocation of income tax to reflect the impact of accounting standard changes that are applied retrospectively.
• Discontinued operations: Allocation of income tax to revenue and expenses related to business segments that have been decided to be sold or discontinued.

Asset and Liability Approach

• GAAP Approach: Under GAAP, the asset and liability approach (also known as the balance sheet approach) is used to calculate income tax expense.
• Explanation of the Asset and Liability Approach: This approach involves first determining the amounts of deferred tax assets and deferred tax liabilities. Deferred tax assets and deferred tax liabilities reflect the future tax effects of temporary differences, representing the taxes that the company will pay or receive in the future. Income tax expense-deferred is calculated based on the cumulative temporary difference at the current enacted tax rate.
• Calculation of Income Tax Expense: After determining the amounts of deferred tax assets and deferred tax liabilities, the income tax expense is calculated based on these amounts. Specifically, the net increase or decrease in deferred tax assets and liabilities at the end of the period is considered, and the tax rate is applied to the pre-tax income for the period to calculate the income tax expense.
• Deferred tax expense is PL account.

Effective tax rate

• Income tax expense / Pretax income.
• In tax effect accounting, the tax rate applied is the one that will be in effect in the year the temporary difference is realized.

Applied tax rate

• the latest tax rate for the periods, the temporary difference is expected to reverse should be used.

Allowance for doubtful accounts

• For GAAP purposes, the accounts for bad debts using the allowance method and has an allowance for doubtful accounts. For tax purposes, the direct write-off method is used and no allowance is recorded.

Permanent difference

• Meals and entertainment expenses
• the premium on an officer’s life insurance 
• Dividends Received Deduction (DRD) : Ownership of at least but less than 20%: 50% deduction Ownership of 20% or more but less than 80%: 65% deduction Ownership of 80% or more: 100% deduction

Accumulated depreciation, excess of tax over GAAP

• A temporary difference exists because the company is using the straight-line method for GAAP purposes and accelerated methods for tax purposes. Because tax depreciation exceeds GAAP depreciation, this temporary difference results in a deferred tax liability.

Valuation allowance

• A change in circumstances that results in a change in judgment concerning the potential realization of a deferred tax asset should be recognized in income from continuing operations in the period of the change.
• A valuation allowance is needed whenever it is more likely than not that part or all of a deferred tax asset will not be realized.
• the estimation method for tax-related items under U.S. GAAP. This explanation is based on the “more-likely-than-not” threshold principle for recognizing tax benefits. According to this principle, a tax benefit must be probable to occur, which is quantitatively defined as more than a 50% likelihood. In the example given, a $100,000 outcome has only a 20% chance of occurring, thus failing to meet this threshold. However, a $30,000 result has a 35% chance of occurring, and cumulatively, there is a 55% chance of realizing at least $30,000 as a tax benefit.
• Accounting recognition is not given to offers to sell assets because a completed transaction has not occurred.
• Unless evidence is provided to the contrary, it is generally assumed that an NOL in the current period means that there is a greater than 50 percent chance that there will be NOLs in future periods. Therefore, a “valuation allowance” should reduce the deferred asset to zero, and result in no increase in net income.
• In a carryforward, the tax benefit equals the carryforward times the appropriate tax rate.

Presentation of DTA and DTL

• Under U.S. GAAP, deferred tax assets and deferred tax liabilities are classified as non-current. All deferred tax liabilities and assets must be offset (netted) and presented as one amount (a net non-current asset or a net non-current liability), unless the deferred tax liabilities and assets are attributable to different tax-paying components of the entity or to different tax jurisdictions.
• In accounting, permanent differences do not affect future taxes, so there is no need to disclose the items or amounts related to them. On the other hand, temporary differences, net operating losses, and tax credit carryforwards do affect future taxes, so their nature, types, and amounts need to be disclosed in the financial statements.

Taxation is required at the time of cash receipt

• Unearned Revenue: When a company receives cash before providing goods or services, it is classified as unearned revenue. Under financial accounting (US GAAP), this is recorded as a liability until the revenue is actually earned. However, for tax accounting purposes, it is often taxed at the time the cash is received. This is because the IRS requires that the cash received be recognized as taxable income at that time.
• Taxpayers using the Cash Basis: Some small businesses and individual proprietors adopt the cash basis of accounting. Under the cash basis, income is recognized when cash is actually received, and expenses are recognized when cash is actually paid. Therefore, cash received is recognized as taxable income in the year it is received.
• In these cases, the IRS requires that the cash received be recognized as taxable income at the time of receipt, which results in a difference between the timing of revenue recognition for tax purposes and financial accounting purposes.”

NOL limitation

• The tax law change that limits the carryforward of NOLs to 80% of taxable income for tax years beginning in 2021 or later. Due to this change, NOLs cannot be fully deducted immediately and are limited to a portion (80%) of taxable income, thus capping the amount of deduction that can be utilized.
• In a carryforward, the tax benefit equals the carryforward times the appropriate tax rate.
•  A carryback results in a claim for refund of past taxes, which is shown on the balance sheet as a tax refund receivable, an item separate from deferred taxes.
• When applying a carryback to a Net Operating Loss (NOL), the journal entry involves reducing the Deferred Tax Asset (DTA) and decreasing the income tax payable.

An uncertain tax position

• An uncertain tax position exists when a company has a level of uncertainty about the sustainability of a particular tax position. U.S. GAAP requires a more-likely-than-not level of confidence before the impact is recorded in the financial statements. In this case, the company expects the $10,000 deduction will be disallowed. This seems to indicate a more-likely-than-not scenario. If the deduction is disallowed, reported taxable income will be higher and the tax liability will be greater. As a result, considering the tax rate of 40 percent, a $4,000 ($10,000 × 40% tax rate) tax liability for an unrecognized tax benefit is recorded because it represents the entity’s potential future obligation to the tax authority for a tax position that was not recognized. This also causes an increase in income tax expense.