Permanent differences do not cause deferred tax liabilities or assets. These occur if a revenue or expense item:
Therefore, permanent differences result from revenues and expenses that are reportable on either tax returns or in financial statements but not both. Permanent differences arise because the tax code excludes certain revenues from taxation and limits the deductibility of certain expenses.
These differences are permanent because they will not reverse in future periods.
No deferred tax consequences are recognized for permanent differences; however, they result in a difference between the effective tax rate and the statutory tax rate that should be considered in the analysis of effective tax rates.
A company owns a $50,000 municipal bond with a 4% coupon and has an effective tax rate of 50% and a statutory tax rate of 40%. Calculate the deferred tax created by this bond.
The bond does not result in deferred tax, as the difference it causes is a permanent difference that will not reverse. As a result, no deferred tax is recognized.
Temporary differences result in deferred tax liabilities or assets. Different depreciation methods or estimates used in tax reporting and financial reporting are a common cause of temporary differences.
There are two categories of temporary differences.
Taxable Temporary Differences (TTD)
Items that give rise to taxable temporary differences are:
Deductible Temporary Differences (DTD)
Items that give rise to deductible temporary differences are:
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