Question

1. Create a numerical example of a permanent tax difference and how it is treated on the Company’s books and the tax (IRS) books?

Answer 1

A permanent difference is a business transaction that is reported differently for financial and tax reporting purposes, and for which the difference will never be eliminated. i.e the difference is permanent and will not reverse in the subsequent years.

A permanent difference that results in the complete elimination of a tax liability is highly desirable, since it permanently reduces a firm’s tax liability. Consequently, it is a key goal of tax planning. The following transaction types represent permanent differences when accounted for within the United States:

• Meals and entertainment. These expenses are only partially recognized for tax reporting purposes.

• Municipal bond interest. This is income for financial reporting purposes, but is not recognized as taxable income.

• Penalties and fines. These expenses are recorded for financial reporting purposes, but are not allowable expenses for tax reporting purposes.

There are also permanent differences related to the purchase of life insurance on employees, as well as the income derived from such insurance.

Numerical example

Accounting books

Permanent differences	USD in million
Pretax accounting income	80.00
Less: exempt income (municipal bond interest)	(4.00)
Add: non-deductible expenses (fines)	1.00
Accounting income for tax purposes	77.00
Corporate tax rate	40%
Accrual income tax expense (38.5 X 40%)	30.80
Effective tax rate	38.50%

Journal entry

Current tax Dr. 15.4 $m

income tax payable Cr. 15.4 $m

Tax books

Part II and III of Schedule M-3

Column (c). Permanent book-to-tax differences.

In column (c) report any book-to-tax difference not expected to reverse in a future year, and that also does not constitute a reversal of a prior year difference. The determination as to whether a difference is temporary or permanent should be based on the facts available at the time the foreign corporation files its U.S. tax return. If the foreign corporation is unable to determine whether a difference between column (a) and column (e) for an item will reverse in a future tax year or reverses a prior year book-to-tax difference, report the difference for that item in column (c).