1. Accounting for Income Taxes
Interperiod, Intraperiod, operating loss carryback/carryforward

2. Interperiod Tax allocation Accrue taxes each period
2. Intraperiod Tax Allocation Accrued tax on current period’s earnings/loss for different categories of income -- continuing operations, discontinued operations, extraordinary item, net income taxes follow the income
Interperiod Tax allocation
Accrue taxes each period
Impacted by financial accounting book income on income statement (US GAAP) being different than IRS taxable income (tax return) Ignores permanent differences between financial accounting book income (book NI) and IRS taxable income (tax NI) when creating deferred tax asset/liability Uses timing differences that reverse over time between book NI and tax NI to create deferred tax asset/liability
Carryback & Carryforward of operating loss
Seeking refund on previous taxes paid if sustain current operating loss (carry back)
Seeking reduction in future taxes to be paid if sustain current operating loss (carry forward)

3. Comparison of records U.S. GAAP Income Statement Tax return Tax return
Taxable revenues XX
Deductible expenses
(XX)
Taxable income
Times current tax rate %
Tax payable
Income Statement 1/1-12/31/XX
Revenues
Sales revenue
 XX
Interest revenue
Service revenue
total XX
Expenses
Depreciation expense
 (XX)
Rent expense
Insurance expense
Warranty expense
Total
Income before tax
Less: tax expense
(XX)
Net Income

4. Interperiod tax allocation journal entry results in:
An increase to tax expense (debit) or tax credit (credit) as the “plug” figure of the journal entry and impacting the Income Statement
Deferred tax asset (current or long-term asset- depending on when it reverses) or deferred tax liability (current or long-term liability – depending on when it reverses) Also, need to know enacted future tax rates (if known) when item reverses. Impacts the balance sheet.
Tax payable – based on IRS rules and the taxable income on the tax return and current tax rates.
The entry can look like one of the journals below or a combination of the two: :
Income tax expense XX
Deferred tax liability
Income tax payable
Income tax expense XX
Deferred tax asset
Income tax payable

5. Interperiod tax –differences in tax and book
Permanent differences-
Taxable income not changed by income statement revenue or expense, or taxable income changed by revenue or expense not reported on the income statement
Affects either reported pretax income statement profits or taxable income on tax return but never both
Never triggers deferred tax asset or liability, never reverses
Ignored for Interperiod tax allocation
Temporary differences-
Taxable income changed by income statement revenue or expense, but not in the same time period
Triggers deferred tax asset or liability, reverses
Difference between US GAAP balance sheet assets/ liabilities versus IRS tax basis assets/liabilities
Affects both pretax income statement profits and taxable income on tax return

6. Reversing of deferred tax items
Example –Accrue taxes for 3 years, assuming depreciation is the only timing difference. New equipment $9000, 3 year life, no salvage depreciated using double declining balance for taxes and straight-line for books, assume pretax financial income is $10,000 every year, 20% tax rate. STL=(cost-salvage)/useful life, DDB=(cost-accumulated depreciation) X 2/useful life). STL = 9000/3=3000 annually, DDB= year 1 (9000-0)*2/3=6000, year 2 ( )*2/3=2000, year 3 ( )*2/3 adjust to  Notice the ending balance of the general ledger account “deferred tax payable” becomes zero by the end of the 3rd year (and thus reversing liability balance earlier) Deferred tax payable
Yr. 1
Tax expense
2000
Deferred tax payable
600
Tax payable
1400
(deferred tax payable is ( ) * .20=600, tax payable (10000-( )) *.20=1400, tax expense =plug figure or 10000* .20)
Yr. 2
200
2200
(deferred tax payable = ( ) * .20, tax payable ( ( ) *.20=2200, tax expense plug or 10000*.20=2000
Yr. 3
400
2400
(deferred tax payable = ( )*.20=400, tax payable ( ( )) *.20=2400, tax expense plug or 10000*.20=2000

7. Future taxable amounts create deferred tax payable (in future, more taxable revenues or fewer tax deductions, raising future taxable income)
Tax rules, more on cash basis (taxable income increases when businesses taxed on cash collected from customers and taxable income decreases for tax deductibles when cash paid for
Book rules, accrual basis (revenue recognized when earned, serving customers, etc., expensed when incurred (assets used up, service received)
Results in deferred tax liability now (credited) and higher tax payable (versus book tax expense) in the future
Often elect tax rules currently that lower taxable income now by taking the largest tax deduction right away. Eventually they catch up to you!
Examples of lower taxable income on tax return now compared to book pretax financial income this year (to reverse in future)
Installment sales gross profit “point of sale” currently recognized completely in this period’s income statement, while taxed in the next several years as cash is collected.
Revenues/expenses reported on US GAAP income statement using % of completion method for long-term projects, reported with completed contract method on IRS tax return (profits taxed in future when project complete –versus some profits recognized each period as work is done on each income statement)
Equity method --US GAAP income statement shows ownership % share of investment times company profits versus taxable income only increased for dividends collected from investment.
Unrealized gains from holding trading securities immediately impact profits on income statement but only affect tax return when they are sold later for a realized gain.
Accelerated tax depreciation versus non-accelerated book depreciation method (such as straight-line)
Interest expense capitalization currently on self-constructed assets for books (take away expense and add to asset—expensed through depreciation in future) versus interest expense deducted from taxable income on tax return
Prepaid expenses deducted for tax purposes when paid are only expensed for books when expired/used

8. Future deductible amounts- create deferred tax assets (in future, less taxable revenues or more tax deductions, lowering future taxable income)
Tax rules, more on cash basis (taxable income increases when businesses taxed on cash collected from customers and taxable income decreases for tax deductibles when cash paid for
Book rules, accrual basis (revenue recognized when earned, serving customers, etc., expensed when incurred (assets used up, service received)
Though often elect tax rules currently that lower taxable income now, sometimes this is not possible based on cash versus accrual accounting
Results in deferred tax asset now (debited) and lower tax payable (versus book tax expense) in the future
Examples of higher taxable income on tax return now compared to book pretax financial income this year (to reverse in future)
Cash from unearned revenue taxed when collected versus unearned revenue earned and recognized as revenue on the income statement
Accrued expenses (interest, warranties, etc.) are deducted on US GAAP income statement when incurred as expenses and deducted for taxes when cash is paid.
Assets not generating cash as planned (bad debt, losses on inventory, etc.) are deducted on US GAAP income statement as expenses right away and deducted for taxes when cancelled or sold.
Compensatory stock option plans are expensed as incurred on the income statement but not deducted for taxes until options are exercised.
Contingent loss may be expensed on income statement (if material, probable, estimateable) but not deducted for taxes until cash is paid.
Unrealized loss from holding trading securities immediately impact profits on income statement but only affect tax return when they are sold later for a realized loss.

9. Permanent federal income tax differences-- examples
Those that affect US GAAP income statement but not taxable income on tax return:
Interest earned on an investment in municipal bonds—generally not taxed though reported as revenue on income statement
Life insurance cash proceeds paid to company from death of insured employee – generally not taxed (just as insurance premiums paid by company can not be used as a tax deduction from taxable income on the income tax return). US GAAP income statement can show cash proceeds as a gain and insurance premiums paid as an expense.

10. Tax payable Current liability often accrued monthly
Taxable income times current tax rate = income tax owed
Follows IRS tax code – use tax rates for current period
taxable income = taxable revenues less tax deductions (expenses)

11. Valuation allowance may be needed if deferred tax assets created (but not with deferred tax payable)
Deferred tax asset benefit only if sufficient future taxable income to allow tax benefit from deferred tax asset to be used to lower taxable income.
A valuation allowance is a contra asset to reduce deferred tax asset to estimated realizable value.
If future income uncertain, then required to do an adjusting entry as follows:
Income tax expense (or income tax benefit from operating loss carryforward) XX
Allowance to reduce deferred tax asset to realizable value

12. Intraperiod Income Tax Allocation
Splitting up tax obligations (tax expense) between different categories of income (tax follows the income- continuing operations, discontinued operations, extraordinary items, net income)
Needed for Earnings per share for different categories of income
Accrue taxes example – 10% tax rate, before tax --continuing operations $200,000, discontinued operations – ($50,000), extraordinary loss ($10000). Assume no Interperiod tax allocation.
Income tax expense – continuing operations
20000
Income tax credit – discontinued operations
5000
Income tax credit – extraordinary
1000
Income tax payable
14000
Income statement
Income from continuing operations before tax
200,000
Less: tax expense
(20,000)
Income from continuing operations after tax
180,000
Earnings per share –
continuing operations
Discontinued operations (net of $5000 tax credit)
(45000)
discontinued operations
Extraordinary loss (net of $1000 tax credit)
(9000)
extraordinary loss
Net income
126000
EPS –net income

13. Operating loss impact on taxes
Operating loss carrybacks
Business reports operating loss
Tax code allows refund of previous tax payments, so can offset loss against previous taxed earnings (or can wait until future earnings to offset)
If future tax rates higher and future earnings likely, may just elect carry forward
Operating loss carryforwards
Business reports operating loss
Tax code allows current operating loss to be offset against future earnings (or can offset against previous earnings)
Results in deferred tax asset
If future earnings are not likely, better to carryback first