Question

How to create a book to tax reconciliation and how to know when to add/subtract the permanent and temporary differences?

Answer 1

A book-to-tax reconciliation is the act of reconciling the net income on the books to the income reported on the tax return by adding and subtracting the non-tax items.

Differences between book income and tax income is classified into two types they are :
1.Permanenet differences
2. Temporary differences.

Permanent differences occur only for the tax year in which they occur. Temporary differences occur over several years, ending when the differences reverse. Forms of income that lead to permanent differences include:

interest earned from tax-exempt bonds;
nontaxable life insurance proceeds on key employees;
dividends received from other corporations that qualify for the dividends received deduction.

Nondeductible items that lead to permanent differences between book and taxable income include:

*50% of business meals and entertainment.
*expenses related to tax exempt income.
*bribes, kickbacks, and other illegal payments.
*lobbying and other political expenses.
*premiums paid on life insurance policies for key people.

So if a corporation pays a $10,000 fine, then that must be recorded as an expense since it must be paid, but it is never deductible, so it leads to a permanent difference between book and taxable income.

A common temporary difference occurs for nonqualified deferred compensation for key employees. Some businesses set aside some compensation in a retirement plan for key employees that does not satisfy ERISA requirements. This compensation must be treated as an expense because the business is legally obligated to pay it, but IRC §§ 83(h) and 404(a)(5) only allow a deduction when the employee receives the compensation, which may be many years later.

Temporary differences also arise because, in financial accounting, income is not recognized until it is earned, whereas for taxes, income is recognized when it is received. So if a business receives $20,000 for an office rental from July 1, 2017 to June 30, 2018, then the business would record $10,000 of that income for 2017 and the remaining $10,000 for 2018. However, the business would have to include the entire $20,000 in its taxable income for 2017. Hence, taxable income would be $10,000 greater than book income in 2017. However, in 2018, the difference reverses, because book income will be $10,000 greater than taxable income since the taxes due on the $10,000 that was recorded for 2018 have already been paid.