Income Taxes
What this domain tests
This domain tests current and deferred income taxes, temporary and permanent differences, valuation allowances, uncertain tax positions, and presentation under ASC 740 and IAS 12.
Core rules
Current tax expense equals taxable income times the enacted tax rate. Deferred tax assets and liabilities arise from temporary differences between financial statement carrying amounts and tax bases. A taxable temporary difference creates a deferred tax liability; a deductible temporary difference creates a deferred tax asset. Deferred taxes are measured using enacted rates expected to apply when the difference reverses and are not discounted.
A valuation allowance reduces deferred tax assets when it is more likely than not that some or all will not be realized. Permanent differences, such as municipal bond interest or nondeductible fines, affect the effective tax rate but do not create deferred taxes. Total tax expense is current tax expense plus deferred tax expense or benefit. Intraperiod allocation assigns tax to continuing operations, OCI, and equity. For uncertain tax positions, recognize a benefit only if the position is more likely than not to be sustained and measure it at the largest amount more likely than not to be realized.
Worked example
Pre-tax book income is $500,000. Tax depreciation exceeds book depreciation by $40,000. Warranty expense is $30,000 for book purposes, and $10,000 was tax-deductible this year, creating a $20,000 deductible temporary difference. The tax rate is 25%. Taxable income is $500,000 - $40,000 + $20,000 = $480,000; current tax is $120,000. The depreciation difference creates a $10,000 deferred tax liability, and the warranty difference creates a $5,000 deferred tax asset. Deferred tax expense is $5,000, total tax expense is $125,000, and the effective rate is 25%.
Traps
Creating deferred taxes for permanent differences; using anticipated rather than enacted rates; forgetting the valuation allowance; discounting deferred taxes; classifying all deferred taxes as current; and offsetting assets and liabilities from different tax authorities.