CPA Regulation (REG) : Book/Tax Differences
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Example Questions
Example Question #1 : Special Issues In Taxation Of Organizations
Vital Corp. is an accrual-basis, calendar-year C corporation. Its year 2 reported book income before federal income taxes was $500,000. Included in that amount were the following items:
- Year 1 state franchise tax refund: $50,000
- Municipal bond interest income: 7,500
What should be the amount of Vital's year 2 taxable income as reconciled on Vital's Schedule M-1 of Form 1120, U.S. Corporation Income Tax Return?
$492,500
$442,500
$500,000
$450,000
$492,500
Municipal bond interest income is not taxable, and so must be deducted from book income to determine taxable income. The state tax refund, however, is treated the same for book and tax purposes. As a result, to arrive at tax income, only the bond interest must be removed: $500,000 - $7,500 = $492,500.
Example Question #2 : Book/Tax Differences
Which of the following items should be included on Schedule M-1, Reconciliation of Income (Loss) per Books with Income per Return, of Form 1120, U.S. Corporation Income Tax Return, to reconcile book income to taxable income?
Ending balance of retained earnings
Premiums paid on key-person life insurance policy
Cash distributions to shareholders
Corporate bond interest
Premiums paid on key-person life insurance policy
Life insurance expenses paid on key individuals in the corporation are not treated as expenses for tax purposes, and as a result must be included on Schedule M-1. The rest of the options are all either treated the same for book and tax purposes or are non-taxable transactions.
Example Question #1 : Book/Tax Differences
Taxi Co. reported book income of $140,000. Included in that amount was $50,000 for meal expenses and $40,000 for federal income tax expense. In Taxi’s Schedule M-1 of Form 1120, which reconciles book income and taxable income, what amount should be reported as taxable income?
$150,000
$205,000
$190,000
$140,000
$205,000
To calculate taxable income from book income, income tax expense must be added back before reconciling. Additionally, meal expenses are 50% deductible for tax purposes, meaning half of the expense must be removed to arrive at tax income. So, to calculate taxable income:
$140,000 + $40,000 + ($50,000 * 50%) = $205,000
Example Question #4 : Book/Tax Differences
Of the following items, which should be included on Schedule M1 of form 1120 to reconcile book income to taxable income?
Corporate bond interest
Cash distributions to shareholders
Premiums paid on key person life insurance policy
Ending balance of retained earnings
Premiums paid on key person life insurance policy
Of the following items, only premiums paid on key person’s life insurance policy is a difference between book and tax.
Example Question #5 : Book/Tax Differences
A C Corp had a beginning credit balance in its warranty reserve account of $120,000. During the year, it accrued estimated warranty expense of $16,000. At the end of the year, the Corp’s warranty reserve had a $90,000 credit balance. What amount of warranty expense should the C Corp deduct?
$16,000
$14,000
$46,000
$30,000
$46,000
Companies may only deduct the actual amount of cost incurred in meeting their warranty obligations. The actual cost incurred by the Corp in meeting its warranty obligation is calculated as $120,000 + $16,000 - $90,000 = $46,000.
Example Question #6 : Book/Tax Differences
Of the following items, which would result in a permanent book to tax difference as compared to a temporary?
Municipal bonds
Depreciation
Organizational cost deductions
LIFO accounting
Municipal bonds
Muni bonds are local government bonds which are tax-deductible for federal purposes. This income will never be taxed at the federal level, thus creating a permanent difference.
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