Taxable Differences

Thus, a taxable difference means that the taxable income is lower than the financial income in the current period (Taxable Income < Financial Income). Higher than the financial income in the future.

A taxable difference occurs when a company's taxable income in the current period is lower than financial income. Because the item causing the difference is taxable in the future, the company's taxable income will be higher in the future

Company A: Income Statement
Item	2004	2005
Revenues	$50,000	$50,000
-Expenses other than depreciation	30,000	30,000
-Depreciation	8,000	8,000
=Income before taxes	12,000	12,000
Taxable Differences	8,000

 

Tax Return
Item	2004	2005
Revenues	$50,000	$50,000
-Expenses other than depreciation	30,000	30,000
-Depreciation	16,000	0
Taxable Income	4,000	20,000

The reported financial income before taxes is the same in both years. Now assume that the tax code permits the company to depreciate the full $16,000 in the first year instead of $8,000 each year. The taxable income will be $4,000 ($50,000 - $30,000 - $16,000) in the year 2004. Thus, taxable income is lower than the financial statement income for 2004. However, since the entire $16,000 was depreciated in 2004, there is no depreciation for 2005. The taxable income in 2005 will be higher: $20,000 ($50,000 - $30,000 - 0). This example considers an expense (depreciation). Other situations might involve revenues and taxable differences.

Assume that Company had completed 40% of a long term contract worth $200,000 as of the end of 2004. The company can recognize $80,000 of revenue for financial reporting in 2004 using the percentage of completion method. However, Company uses the completed contract method for tax reporting. In this instance, it does not record any revenue for tax purposes and postpones revenue recognition to the future. In this example, by postponing the recognition of revenue for tax purposes, Company reduces its current period taxable income but increases its taxable income in the future.

Thus, a taxable difference means that the taxable income is lower than the financial income in the current period. Higher than the financial income in the future.