Question

(EXPLAIN COMPUTATION OF DEFERRED TAX LIABILITY FOR MULTIPLE TAX RATES)

At December 31, 2017, Higley Corporation has one temporary difference which will reverse and cause taxable amounts in 2018. In 2017, a new tax act set taxes equal to 45% for 2017, 40% for 2018, and 34% for 2019 and years thereafter.

INSTRUCTIONS:

Explain what circumstances would call for Higley to compute its deferred tax liability at the end of 2017 by multiplying the cumulative temporary difference by:

(A) 45%

(B) 40%

(C) 34%

Answer 1

A temporary difference is a difference between the tax basis of an asset / liability and its amount in the financial statements will result in taxable amounts or deductible amounts in the future years; at the time when either the reported amount of the asset is recovered or when the reported amount of the liability is settled.

(a) The 45% tax rate shall be used in computing the deferred tax liability at December 31, 2017, if a net operating loss or NOL is expected in the year 2018 that is to be carried back to the year 2017; as the enacted tax rate is 45% in the year 2017.

(b) The 40% tax rate shall be used in computing the deferred tax liability at December 31, 2017, if the taxable income is expected in the year 2018 ; since the tax rate enacted for the year 2018 is 40% and 2018 is the year in which the future taxable amount is expected to occu.

(c) The 34% tax rate shall be used in computing the deferred tax liability at December 31, 2017, if a net operating loss or NOL is expected in the year 2018 which is to be carried forward to the year 2019 and the tax rate enacted for the year 2019 is 34%.

Explaination / Discussion:

In order to determine the future tax consequences of temporary differences, it is helpful that we prepare a schedule. The schedule will show in which future years the existing temporary differences will result in taxable or deductible amounts. The appropriate enacted tax rate is applied to these future taxable and deductible amounts. In order to determine the appropriate tax rate, we must first make assumptions that whether the entity will report taxable income or losses in the various future years, expected to be affected by the reversal of existing temporary differences. Thus, we calculate the taxes payable or tax refundable in the future due to the existing temporary differences. To make these calculations, we need to apply the provisions of the tax laws and enacted tax rates for the relevant periods.

For future taxable amounts:

A future taxable amount is going to increase the taxable income relative to pretax financial income in future periods due to the temporary differences, existing at the balance sheet date.

1. If the taxable income is expected in the year that a future taxable amount is scheduled, we need to use the enacted rate for that future year in order to calculate the related deferred tax liability.

2. If Net Operating Loss is expected in the year that a future taxable amount is scheduled, we need to use the enacted rate of what would be the prior year the net operating loss would be carried back to or the enacted rate of the future year to which the carry-forward would apply, in order to calculate the related deferred tax liability.

For future deductible amounts:

A future deductible amount is going to decrease the taxable income relative to pretax financial income in future periods due to the existing temporary differences.

1. If the taxable income is expected in the year where a future deductible amount is scheduled, we need to use the enacted rate for that future year in order to calculate the related deferred tax asset.

2. If a net operating loss is expected in the year where a future deductible amount is scheduled, we need to use the enacted rate of what would be the prior year the net operating loss would be carried back to or the enacted rate of the future year to which the carry-forward would apply, in order to calculate the related deferred tax asset.