Question

Mays Industries was established in 1992. Since its inception, the company has generated the following levels of earnings before taxes (EBT) (losses are shown in parentheses):

                    Year         EBT

                    1992      $ 50,000

                    1993        40,000

                    1994        30,000

                    1995        20,000

                    1996      (100,000)

                    1997        60,000

Assume that each year the company has faced a 40 percent income tax rate. What is the company's tax liability for 1997? (Hint: Tax law allows losses to be applied to taxable income from the prior three years and then carried forward up to 15 years in calculating a firm’s current tax liability. Said differently, a firm can receive a tax refund in years in which a loss is incurred if the firm has taxable income in the prior three years. The amount of the refund a firm is eligible for is limited to the amount of taxes paid in the prior three years. If taxes paid in the prior three years are less than the tax rate times the loss, then the difference can offset tax liabilities in the next 15 years until the difference is consumed.)

a. $20,000

b. $21,000

c. $22,000

d. $24,000

e. $26,000

Answer 1

Answer is option (a) $20,000
	Amount in $	Amount in $
Loss Incurred in year 1996		-1,00,000
Loss Eligible for refund of Tax
Income of previous Three years
Income of 1995	20,000
Income of 1994	30000
Income of 1993	40,000	90,000
Loss Carried Forword to 1997		-10,000
Computation of tax liability for the year 1997
Income Earned		60,000
Less: Loss carried forword		-10,000
Taxable Income		50,000
Tax Liabiltiy =$50,000*40% =$20,000