Reconciling corporation book and tax net income, tax years 1996-1998 - Statistical Data Included

Statistics of Income Bulletin, Spring, 2002 by George A. Plesko

Figure A

Schedule M.1 Reconciliation of Income (Loss) per Books With
Income per Return, Tax Years 1996-1998

1 Net income (loss) per books (after-tax)
  Additions:

2 Federal income tax

3 Excess of capital losses over capital gains

4 Income subject to tax not recorded on books this year

5 Expenses recorded on books this year not deducted on this return:
       Depreciation
       Travel and entertainment
       Contributions carryover

6 Equals: Book income after additions

 Subtractions:

7 Income recorded on books this year not included on this return:
       Tax-exempt interest

8 Deductions on this return not charged against book income this year:
       Depreciation
       Contributions carryover

9 Equals: Total subtractions

10 Book income after additions and subtractions, equal to tax net
   income before net operating loss deduction
   and special deductions (line 6 less line 9)

NOTE: The schedule M-1 line numbers are included for reference.

The second source of differences in the measures of income is permanent, and arises when a particular item of income or expense is recognized under one system but not the other. An example is tax-exempt interest on municipal bonds, which is included in book income but not in the determination of tax net income.

Both temporary and permanent differences are reported in corporations' financial statements. Under FASB's Statement of Financial Accounting Standards Number 109, corporations report a total amount of tax liability based on current year financial reporting income, delineating the portion currently owed to the Government from that which is deferred due to differences in income and expense recognition between the two methods. If the deferred portion is positive a deferred tax liability is created, representing the amount of taxes not paid on financial statement income this period because of temporary differences reducing tax net income below book income. Such is usually the case in the short term with depreciation, as more deductions are taken for tax purposes during the early years of an asset's life than are recognized as expenses for book purposes. The deferred tax liability associated with the asset on a corporation's financial statements represents the amount of tax to be paid in the future relative to future book earnings when the tax depreciation deductions fall below the book depreciation expense. In contrast to deferred tax liabilities,' deferred tax assets are created when more taxes are paid than would be paid if financial reporting income were used to base tax liability, and represent a financial claim on the Government for taxes paid ahead of time relative to financial reporting.

Permanent differences, such as the effect of tax-exempt interest, never reverse and therefore do not create deferred tax assets or liabilities. Corporations account for permanent differences in a separate financial disclosure in the tax footnote of their financial statements. Figure B provides some examples of the types of transactions with different accounting treatments under each system.