Question

Diff Corp has the following items during the year. Indicate whether each is a temporary (T) or a permanent (P) difference and whether it is favorable (F) or unfavorable (U).

Interest income municipal bonds

Death benefits from life insurance on key employee’s

Meals and entertainment expense

Dividends received deduction

Gain on sale in year 3 of a 7-year life asset where book and tax depreciation were different (tax depreciation was higher)

A $100 charitable contribution deduction carryforward that is used in the current year.

Diff has total short-term capital gains of $100 and long-term capital losses of $70 for the current year.

Answer 1

a. Interest Income from municipal bonds - Interest income on municipal bonds is taxable in the year in which the same are available i.e they are received. Therefore, there is temporary difference if it is booked on accrual basis by company. This will be a favorable temporary difference.

b. Death benefits from life insurance - Death benefits from life insurance are not taxable and therefore it is a permanent difference.

c. Meals & entertainment expense - only 50% of the meals & entertainment expense are deductible for taxation purpose and therefore the remaning unallowed 50% is permanent difference. 50% alllowed expense are neither permanent difference nor temporary.

d. Dividends received deduction - This is the reduction of dividends from total income of the company receiving such dividends from another company and therefore, this is a permanent difference as book profits will be more than the taxable profits.

e. Gain on sale in year 3 of a 7-year life asset where book and tax depreciation were different (tax depreciation was higher) - This is temporary difference as the gain will be higher as per tax depreciation since it was charging higher depreciation. It is a favorable difference

f. A $100 charitable contribution deduction carryforward that is used in the current year - Charitable contribution was made in previous year and the same was carryforward in current year for use. Last year, there was permanent difference of $100 x tax rate which was favorable difference. This year the same is allowed for tax purposes and therefore there will be reversal of favorable difference in form of unfavorable difference.