Taxation
Core concepts
Taxation questions focus on the differences between accounting income and taxable income, deferred taxes, and the mechanics of the current tax provision. Understand permanent differences (e.g., certain fines, tax-exempt interest) versus temporary differences (e.g., depreciation timing, warranty accruals). Temporary differences create deferred tax assets or liabilities measured at enacted future tax rates. Know the valuation allowance for deferred tax assets that may not be realized, and the treatment of net operating loss carryforwards. Basic familiarity with progressive brackets and marginal versus average rates helps.
Traps
A common error is applying the current-year tax rate to a deferred item when a different enacted future rate applies. Another is treating a permanent difference as if it reverses-permanent differences never reverse and do not create deferred taxes. Watch for questions that confuse the effective tax rate (tax expense ÷ pretax income) with the statutory rate. Also be careful: a deferred tax asset arises when book expense exceeds tax deduction (e.g., warranty accrual), not the reverse.
Worked example
Pretax book income $100,000; tax depreciation exceeds book depreciation by $10,000, creating a taxable temporary difference. Taxable income = $90,000. At a 25% rate, current tax = $22,500. The $10,000 difference × 25% = $2,500 deferred tax liability. Rule of thumb: taxable temporary differences create DTLs; deductible temporary differences create DTAs.