CPA Regulation (REG) : Book/Tax Differences

Study concepts, example questions & explanations for CPA Regulation (REG)

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Example Questions

Example Question #7 : Special Issues In Taxation Of Organizations

Vital Corp. is an accrual-basis, calendar-year C corporation. Its year 2 reported book income before federal income taxes was $500,000. Included in that amount were the following items:

  • Year 1 state franchise tax refund: $50,000
  • Municipal bond interest income: 7,500

What should be the amount of Vital's year 2 taxable income as reconciled on Vital's Schedule M-1 of Form 1120, U.S. Corporation Income Tax Return?

Possible Answers:

$450,000

$492,500

$442,500

$500,000

Correct answer:

$492,500

Explanation:

Municipal bond interest income is not taxable, and so must be deducted from book income to determine taxable income. The state tax refund, however, is treated the same for book and tax purposes. As a result, to arrive at tax income, only the bond interest must be removed: $500,000 - $7,500 = $492,500.

Example Question #8 : Special Issues In Taxation Of Organizations

Which of the following items should be included on Schedule M-1, Reconciliation of Income (Loss) per Books with Income per Return, of Form 1120, U.S. Corporation Income Tax Return, to reconcile book income to taxable income?

Possible Answers:

Cash distributions to shareholders

Corporate bond interest

Premiums paid on key-person life insurance policy

Ending balance of retained earnings

Correct answer:

Premiums paid on key-person life insurance policy

Explanation:

Life insurance expenses paid on key individuals in the corporation are not treated as expenses for tax purposes, and as a result must be included on Schedule M-1. The rest of the options are all either treated the same for book and tax purposes or are non-taxable transactions.

Example Question #9 : Special Issues In Taxation Of Organizations

Taxi Co. reported book income of $140,000. Included in that amount was $50,000 for meal expenses and $40,000 for federal income tax expense. In Taxi’s Schedule M-1 of Form 1120, which reconciles book income and taxable income, what amount should be reported as taxable income?

Possible Answers:

$140,000

$205,000

$150,000

$190,000

Correct answer:

$205,000

Explanation:

To calculate taxable income from book income, income tax expense must be added back before reconciling. Additionally, meal expenses are 50% deductible for tax purposes, meaning half of the expense must be removed to arrive at tax income. So, to calculate taxable income:

$140,000 + $40,000 + ($50,000 * 50%) = $205,000

Example Question #10 : Special Issues In Taxation Of Organizations

Of the following items, which should be included on Schedule M1 of form 1120 to reconcile book income to taxable income?

Possible Answers:

Corporate bond interest

Ending balance of retained earnings

Cash distributions to shareholders

Premiums paid on key person life insurance policy

Correct answer:

Premiums paid on key person life insurance policy

Explanation:

Of the following items, only premiums paid on key person’s life insurance policy is a difference between book and tax.

Example Question #1 : Book/Tax Differences

A C Corp had a beginning credit balance in its warranty reserve account of $120,000. During the year, it accrued estimated warranty expense of $16,000. At the end of the year, the Corp’s warranty reserve had a $90,000 credit balance. What amount of warranty expense should the C Corp deduct?

Possible Answers:

$16,000

$46,000

$30,000

$14,000

Correct answer:

$46,000

Explanation:

Companies may only deduct the actual amount of cost incurred in meeting their warranty obligations. The actual cost incurred by the Corp in meeting its warranty obligation is calculated as $120,000 + $16,000 - $90,000 = $46,000.

Example Question #2 : Book/Tax Differences

Of the following items, which would result in a permanent book to tax difference as compared to a temporary?

Possible Answers:

LIFO accounting

Organizational cost deductions

Municipal bonds

Depreciation

Correct answer:

Municipal bonds

Explanation:

Muni bonds are local government bonds which are tax-deductible for federal purposes. This income will never be taxed at the federal level, thus creating a permanent difference.

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