 # Differed Taxes

Kehoe Construction reports tax expense of \$224,000 on its income statement. Included in pretax income was interest of \$40,000 from tax-free municipal bonds that the company owns. The company had a temporary difference of \$80,000 that will result in a future tax deduction. The company’s tax rate this year is 40%, but its tax rate in future years will be 30%. a. \$208,000 b. \$224,000 c. \$248,000 d. \$256,000 - Dinesh S

C??? Income tax expense

nice… Can’t get to the answer and would not hazzard a guess. This is what I know 40,000 is a permanent difference 80,000 * 30% = 24,000 is the increase in DTA IT expense = Tax payable + chg in DTL - Chg in DTA 224,000 = Tax Payable - 24,000 --> Tax payable = 248,000 just as docmash80 ^ Since, Municipial bonds are not taxed, we would probably have to make an adjustment for that. No clue what that should be. I would think we would need to decrease 248,000 by 40% * 40,000 (16,000). ???

delhirocks Wrote: ------------------------------------------------------- > Since, Municipial bonds are not taxed, we would > probably have to make an adjustment for that. No > clue what that should be. I would think we would > need to decrease 248,000 by 40% * 40,000 (16,000). > As you said, muni income is not taxed. So if it isn’t included in your calc of taxes for book purposes, and it isn’t put into your tax return as taxable income, why would you need to make an adjustment? Permanent differences do not give rise to deferred tax assets or liabilities

I am not worried about the deffered taxes being created. But the pretax income included that income, and thus IT payable does include the impact of tax free interest. “Included in pretax income was interest of \$40,000 from tax-free municipal bonds that the company owns” Wouldn’t we have to undo that?

Yup. It seems like you would have to. I would have done this: 224000/0.4 = 560000 Add back the 40K. Then 0.30*600K=180 K and go from there…

Maybe I’m just a little slow today, but what’s the question?

Wouldn’t we be accounting for the 40000 when calculating the effective tax rate only? Financial Statement says Tax Expense = 224000 Tax Payable : Tax Expense + Delta DTA = 224 + 80 * .3 = 248 So Taxable Income = 248 / .4 = 620,000 This contains the permanent difference of 40000 included. So Adjusted Pre-tax income = 620 - 40 = 580. On 580 your tax expense = 248 so effective tax rate = 224 / 580 = 38.6%

CPK…thx

made a mistake there… should’ve said on 580 tax expense = 224.

What is the question?

CPK,where did you get 224 from? Dinesh what is the ans?

Some of you guys are overcomplicating and overanalyzing this. This is how the income tax expense line is derived. You take pretax-income, subtracts out non-taxable income (like muni income), add back any non-deductible expenses (I think stuff like some excess political contributions), and mulitply that number by the statutory tax rate to get the credit to income tax payable, then add/subtract for any effect of announced future changes in tax rates on pre-existing temporary differences (which goes against deferred tax accounts). That is how income tax expense on the income statement is calculated. The expense line on the income statement is not just blind multiplication of reported pre-tax income and a rate. There is no adjustment to deferred taxes for permanent differences. It is one of the reasons that the effective tax rate that appears on the income statement is not the same as the statutory rate (along with the effect of catch-up adjustments for rate changes which are run thru the income tax expense line).

yeah i guess the permanent difference part confused me…

CPK, Won’t delta DTA for last year be [80 - (80/.4)*0.3] = 20 ? cpk123 Wrote: ------------------------------------------------------- > Wouldn’t we be accounting for the 40000 when > calculating the effective tax rate only? > > Financial Statement > says Tax Expense = 224000 > > Tax Payable : Tax Expense + Delta DTA = 224 + 80 * > .3 = 248 > > So Taxable Income = 248 / .4 = 620,000 > This contains the permanent difference of 40000 > included. > > So Adjusted Pre-tax income = 620 - 40 = 580. > > On 580 your tax expense = 248 > > so effective tax rate = 224 / 580 = 38.6%

nope… delta DTA will be 80 * .3 The company had a temporary difference of \$80,000 that will result in a future tax deduction. The company’s tax rate this year is 40%, but its tax rate in future years will be 30%. You had a temporary difference of 80 K for which 80 * .4 = 32K would have been the calculated DTA last year. This year - it will reset to 32 / .4 * .3 = 24 K (or easier … 80 * .3) The 80 K is the temporary difference, not the DTA itself. Hope this explains.

Yes it does. But then why isn’t Delta DTA = 32k-24k=8k ? That is the only change as result of tax change.

delta DTA is supposed to be paid in the future, not yet paid. So you have accounted for 32 k, which is not 32 k any more… It has reduced because of the new tax rate to 24K. So that’s all will show on the books. This would increase the Tax expense in the future. If the tax rate had increased e.g. to 50% – this Delta DTA would have increased from 32 K to 40K and would have further reduced the Tax Expense in the future period. This is because Tax Expense = Tax Payable + Delta DTL - Delta DTA Earlier Delta DTA was 32 K (reduction) Now it is a 24K reduction … so the reduction was smaller, so you have a bigger tax expense. When Delta DTA due to 50% tax rate – becomes 40K The reduction would become 40K – so you have a smaller Tax expense. Hope this clarifies for you. CP

cpk - **First off, the question at the start of the thread has obviously been trimmed abit, so all answers have to be taken with a grain of salt** You are mixing up your balance sheet and income statement. You start with a deferred tax asset (balance sheet) amount of \$32K (\$80K *40%) that relates to future years. Then (based on my assumption on missing info from the question) you are told that future tax rates drop to 30%. Your new required balance sheet amount will be \$24K (\$80K * 30%). You credit your DTA account by \$10K and debit tax expense by \$10K. The delta in DTA is the CHANGE (after all, thats what delta means) in the balance, not the NEW balance.

Dinesh, what’s the full question?