Question

Explain the difference between the statutory and effective tax rates. What are permanent and temporary differences? What are the four primary TYPES of temporary differences identified by the text (explain each of the four briefly in your own words)?

Answer 1

The statutory tax rate is the rate imposed by law on taxable income that falls within a given tax bracket. The effective tax rate isthe percentage of income actually paid by an individual or a company after taking into account tax breaks (including loopholes, deductions, exemptions, credits and preferential rates).

A permanent difference will cause adifference between the statutory tax rateand the effective tax rate. Also, because the permanent difference will never be eliminated, this tax difference does not generate deferred taxes, as in the case with temporary differences.

Temporary differences occur whenever there is adifference between the tax base and the carrying amount of assets and liabilities on the balance sheet. Permanent differences are differences between the tax and financial reporting of revenue or expense items which will not be reversed in thefuture.

As with temporary differences, quite a few accounting events lead to a permanent difference. Five common permanent differences are penalties and fines, meals and entertainment, life insurance proceeds, interest on municipal bonds, and the special dividends received deduction. Penalties and fines.