FAR 3D - Income Taxes Flashcards
(38 cards)
What is a Tax Position?
A position in a previously filed return or one expected to be taken in a future return, used in measuring current or deferred income tax assets/liabilities.
It can result in:
✅ Permanent reduction of taxes payable
⏳ Deferral of taxes to future years
🔁 Change in expected realizability of deferred tax assets
Examples of Tax Positions (ASC 740)
🚫 Decision not to file a tax return
🌍 Allocation/shift of income between jurisdictions
❌ Exclusion or recharacterization of taxable income
🏛️ Claiming tax-exempt treatment for an item or entity
🧾 Entity status (e.g., pass-through, NFP)
What must you keep in mind when calculating deferred income taxes on the balance sheet?
✅ Focus only on temporary differences
🔹 Ignore permanent differences (e.g., tax-exempt interest)
📊 Classify:
Deductible in future → Deferred Tax Asset
Taxable in future → Deferred Tax Liability
🧮 Apply the enacted future tax rate
➗ Net DTA and DTL into a single balance
📅 Reflects future tax effects of today’s differences
What are common permanent differences that do not create deferred taxes?
These affect book income but never affect taxable income, so they are excluded from deferred tax calculations:
🏛️ Tax-exempt interest (e.g., municipal bonds)
🎓 Fines and penalties
🎁 Life insurance premiums (on key employees, if company is beneficiary)
⚰️ Proceeds from life insurance (if tax-exempt)
💰 Dividends received deduction (DRD) for corporations (partial exclusion)
🧾 Nondeductible meals and entertainment (e.g., 50% limit or full exclusion)
What are common temporary differences that do create deferred taxes?
These cause timing differences between book income and taxable income and will reverse in future periods:
🏗️ Depreciation (tax depreciation > book depreciation → DTL)
🎓 Warranty expense (booked now, deductible later → DTA)
💸 Bad debt expense (estimated for books, deducted when written off → DTA)
⚖️ Litigation accruals (booked now, deductible when paid → DTA)
🏦 Prepaid expenses (deducted now for tax, expensed later for books → DTL)
📦 Installment sales (revenue recognized now for books, taxed when collected → DTL)
🧠 Key: These differences reverse over time and impact deferred tax accounting.
How are uncertain tax positions recognized and measured under ASC 740?
✅ Recognition Threshold:
A tax position is recognized only if it is more likely than not (>50%) to be sustained based on its technical merits under tax law.
📏 Measurement:
If recognized, the amount recorded is the largest amount of benefit that is greater than 50% likely to be realized upon settlement.
🧾 Example:
Claimed $100 deduction
$60 is the largest amount with >50% likelihood of being upheld
→ Recognize $60, not $100
🧠 Applies to both current and deferred taxes
What are the key concepts to remember for income tax accounting under ASC 740?
🔁 Temporary Differences
➤ Cause timing gaps between book and tax income
➤ Create Deferred Tax Assets (DTA) or Deferred Tax Liabilities (DTL)
🚫 Permanent Differences
➤ Affect book income only
➤ Do not create deferred taxes
📅 Use Enacted Future Tax Rate
➤ Apply the enacted rate expected to apply when the difference reverses
⚖️ Uncertain Tax Positions
➤ Recognize only if more likely than not
➤ Measure by the largest amount >50% likely to be upheld
🧾 Net DTA and DTL on the balance sheet
➤ Shown as a single noncurrent amount
How do you know if a temporary difference creates a Deferred Tax Asset (DTA) or Deferred Tax Liability (DTL)?
- Expense on books before tax
Book income < Taxable income → Future deduction → ✅ DTA - Income on tax return first
Taxable income > Book income → Future deduction → ✅ DTA - Expense on tax before books
Book income > Taxable income → Future tax due → ❌ DTL - Income on books before tax
Book income > Taxable income → Future tax due → ❌ DTL
How do you determine if a temporary difference creates a Deferred Tax Asset (DTA) or Liability (DTL)?
📊 Answer: Compare Tax Expense vs. Taxes Payable
🧮 Tax Expense = Based on book income
💵 Taxes Payable = Based on taxable income
Comparison Interpretation Result
Tax Expense > Taxes Payable Paying too little tax now ❌ DTL
Tax Expense < Taxes Payable Paying too much tax now ✅ DTA
Why is income tax expense based on book income instead of actual tax payments?
Tax Expense (GAAP) reflects the tax effect of income earned under accounting rules, not what is paid.
It ensures matching of income and tax cost in the same period.
🧮 Key Difference:
Concept, Based On, Purpose
Tax Expense 📘, Book Income, Shows economic reality (GAAP)
Taxes Payable 💵, Taxable Income, Follows tax law (IRS/legal obligation)
How does the matching principle explain deferred income taxes?
GAAP requires expenses to be matched with the revenues they help generate, regardless of when cash is paid.
Tax expense must reflect the economic income earned, not just taxes paid.
📅 So when book income ≠ taxable income:
A timing difference arises
GAAP records the difference as a Deferred Tax Asset (DTA) or Liability (DTL)
➡️ This ensures income tax expense is aligned with the period’s book income, fulfilling the matching principle.
What’s the difference between current, deferred, and total income tax expense?
- Current Tax Expense
📗 Based on: Taxable income
💰 Purpose: Taxes owed now (cash-based)
🧮 Formula: Taxable Income × Tax Rate - Deferred Tax Expense
📘 Based on: Temporary differences
⏳ Purpose: Taxes owed or relieved later
🧮 Formula: Change in DTA/DTL - Total Tax Expense
📘 Based on: Book income
🎯 Purpose: Matches tax to book income (GAAP)
🧮 Formula: Current + Deferred
What must public entities disclose about Deferred Tax Assets and Liabilities (DTAs/DTLs)?
💼 Total DTAs and DTLs, by major category (e.g., NOLs, depreciation)
➗ Net deferred tax position: current vs. noncurrent
🚨 Valuation allowance:
- Amount recognized
- Explanation for changes in the allowance
📊 Rate reconciliation: Effective tax rate vs. statutory, with explanations
What are the disclosure requirements for Unrecognized Tax Benefits (UTBs)?
📈 Tabular reconciliation from beginning to end of period:
- 🔼 Increases for current and prior period positions
- 🔽 Decreases from settlements, reversals, statute expirations
💰 Portion of UTBs that would affect the ETR if recognized
📆 Expected significant changes to UTBs in next 12 months
What other tax-related disclosures must public entities include under ASC 740?
🧾 Tax years open for examination by jurisdiction
🏛️ Policy for interest and penalties (and where reported — e.g., income tax expense)
📉 Tax expense breakdown:
- Current vs. deferred
- Federal, state, foreign components
When should a deferred tax asset (DTA) for a net operating loss carryforward be recognized under ASC 740?
Only if it is more likely than not that sufficient future taxable income will exist to utilize the loss.
If that threshold is:
Met → Recognize the DTA
Not met → Recognize a valuation allowance to offset all or part of the DTA
🧠 Key factors to evaluate:
Future income projections
Carry forward periods
Taxable income in carryback years
History of losses or earnings
Unused tax planning strategies
When is a valuation allowance required for a deferred tax asset (DTA)?
More likely than not that the DTA will not be realized
Recent cumulative losses
History of unused carryforwards
Uncertain future taxable income
Weak or speculative tax planning strategies
Not needed if positive evidence outweighs negative evidence
When should a valuation allowance for a deferred tax asset (DTA) be reversed?
✅ Strong positive evidence arises
✅ Future taxable income becomes likely
✅ Reliable tax planning strategies emerge
✅ Loss history is overcome by sustained profitability
❌ Do not reverse based only on vague or speculative projections
❌ Do not reverse if significant uncertainty remains
How do you use book vs. tax basis of an asset (liability reversed) to determine DTA or DTL?
- Book basis > Tax basis (asset) → ❌ DTL
- Book basis < Tax basis (asset) → ✅ DTA
- Book basis > Tax basis (liability) → ✅ DTA
- Book basis < Tax basis (liability) → ❌ DTL
- Higher taxable income when reversed → ❌ DTL
- Lower taxable income when reversed → ✅ DTA
How are deferred tax assets or liabilities classified when related to noncurrent assets, even if they reverse soon?
- Classification is based on the underlying asset or liability
- Related to noncurrent asset → ❌ Noncurrent
- Related to current asset or liability → ✅ Current
- Timing of reversal does not affect classification
- Deferred taxes are not split between current and noncurrent on the balance sheet
What are the balance sheet presentation and disclosure rules for deferred tax assets and liabilities under ASC 740?
❌ All deferred tax assets and liabilities are classified as noncurrent
✅ This applies regardless of whether they relate to current or noncurrent items
✅ Netting is permitted only within the same tax jurisdiction
✅ The balance sheet presents a single net amount per jurisdiction
✅ Footnotes must disclose gross DTA and DTL amounts before netting
❌ Netting across jurisdictions is not allowed
When DTA or DTL accounts change, do you apply the tax rate to the change again?
- ❌ No, do not apply the tax rate again
- ✅ DTA and DTL balances are already tax-effected
- ✅ Any change in DTA or DTL is already in tax dollars
- ✅ Add increases in DTL to tax expense
- ✅ Add decreases in DTA to tax expense
- ❌ Do not multiply changes by the tax rate again
What assumptions must be made when evaluating a tax position under ASC 740?
✅ Assume the taxing authority will examine the position
✅ Assume the authority has full knowledge of all relevant facts
❌ Do not assume audit risk is low
✅ Evaluation must be based on technical merits of the position
✅ Technical merits include statutes, regulations, rulings, case law, and widely understood administrative practices
How must each tax position be evaluated under ASC 740?
✅ Each tax position must be evaluated independently
❌ Do not aggregate multiple positions to improve recognition
❌ Do not offset a weak position with a strong one
✅ Apply the more-likely-than-not test to each specific position on its own
