(Explain Computation of Deferred Tax Liability for Multiple Tax Rates) At December 31, 2010, Higley Corporation has one temporary difference which will reverse and cause taxable amounts in 2011. In 2010 a new tax act set taxes equal to 45% for 2010, 40% for 2011, and 34% for 2012 and years thereafter.
Explain what circumstances would call for Higley to compute its deferred tax liability at the end of 2010 by multiplying the cumulative temporary difference by:
(a) 45%.
(b) 40%.
(c) 34%.
SOLUTION
(a) The 45% tax rate would be used in computing the deferred tax liability at December 31, 2010, if a net operating loss (an NOL) is expected in 2011 that is to be carried back to 2010 (the enacted tax rate is 45% in 2010). (See discussion below.)
(b) The 40% tax rate would be used in computing the deferred tax liability at December 31, 2010, if taxable income is expected in 2011 (the tax rate enacted for 2011 is 40% and 2011 is the year in which the future taxable amount is expected to occur). (See discussion below.)
(c) The 34% tax rate would be used in computing the deferred tax liability at December 31, 2010, if a net operating loss (an NOL) is expected in 2011 that is to be carried forward to 2012 (the tax rate enacted for 2012 is 34%). (See discussion below)
Discussion:
In determining the future tax consequences of temporary differences, it is helpful to prepare a schedule which shows in which future years existing temporary differences will result in taxable or deductible amounts. The appropriate enacted tax rate is applied to these future taxable and deductible amounts. In determining the appropriate tax rate, you must make assumptions about whether the entity will report taxable income or losses in the various future years expected to be affected by the reversal of existing temporary differences. Thus, you calculate the taxes payable or refundable in the future due to existing temporary differences. In making these calculations, you apply the provisions of the tax laws and enacted tax rates for the relevant periods.
For future taxable amounts:
1. If taxable income is expected in the year that a future taxable amount is scheduled, use the enacted rate for that future year to calculate the related deferred tax liability.
2. If an NOL is expected in the year that a future taxable amount is scheduled, use the enacted rate of what would be the prior year the NOL would be carried back to or the enacted rate of the future year to which the carry forward would apply, whichever is appropriate, to calculate the related deferred tax liability.
For future deductible amounts:
1. If taxable income is expected in the year that a future deductible amount is scheduled, use the enacted rate for that future year to calculate the related deferred tax asset.
2. If an NOL is expected in the year that a future deductible amount is scheduled, use the enacted rate of what would be the prior year the NOL would be carried back to or the enacted rate of the future year to which the carry forward would apply, whichever is appropriate, to calculate the related deferred tax asset.