Ch8. Tax Accounting Deep Dive — Corporate Tax, Individual Income Tax, and Sales Tax

Corporate Income Tax — Book-Tax Differences

Taxable income calculation:
Book income (GAAP net income)
± Book-tax adjustments (M-1 / Schedule M-3)
= Taxable income (Form 1120, Line 28)

Permanent differences (no deferred tax):
Items included in book income but never in taxable income
  (or vice versa), AND vice versa — never reverse
Examples:
  + Tax-exempt interest on municipal bonds (book income; not taxable)
  + Dividends Received Deduction (taxable income deduction;
    reduces book tax expense but is a permanent benefit)
  − Meals and entertainment (50% disallowed permanently under TCJA)
  − Life insurance proceeds on key-person policies (book income; tax-exempt)
  − Fines and penalties (book expense; not tax-deductible)

Temporary differences (create deferred taxes; reverse over time):
Examples of taxable temporary differences (→ DTL):
  Accelerated MACRS depreciation > straight-line book depreciation
  Installment sales recognized ratably for book; deferred for tax

Examples of deductible temporary differences (→ DTA):
  Warranty expense accrued for book; deductible when paid for tax
  Allowance for credit losses (CECL for book; specific charge-off for tax)
  Net operating loss (NOL) carryforward: §172 deduction

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Individual Income Tax Structure

Federal Individual Income Tax (Form 1040):

Gross Income (§61 — all income from whatever source)
− Above-the-line deductions (adjustments to income):
    Student loan interest, HSA contributions,
    self-employment tax deduction, alimony (pre-2019)
= Adjusted Gross Income (AGI)
− Greater of Standard Deduction or Itemized Deductions:
    Standard deduction (2024): $14,600 single / $29,200 MFJ
    Itemized (Schedule A): SALT cap $10,000; mortgage interest;
    charitable contributions; medical expenses >7.5% of AGI
− QBI Deduction (§199A): up to 20% of qualified business income
  for pass-through owners (subject to income limits / W-2 wage tests)
= Taxable Income

Tax Rates (2024 Married Filing Jointly):
10%: $0 – $23,200
12%: $23,201 – $94,300
22%: $94,301 – $201,050
24%: $201,051 – $383,900
32%: $383,901 – $487,450
35%: $487,451 – $731,200
37%: over $731,200

Preferential rates (Net Long-Term Capital Gains / Qualified Dividends):
  0% / 15% / 20% depending on taxable income bracket

Retirement income:
  Traditional IRA / 401(k): pretax contributions; ordinary income on distributions
  Roth IRA / Roth 401(k): after-tax contributions; qualified distributions tax-free

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US Sales and Use Tax

Sales Tax:
Consumption tax; imposed at the state and local level
(no federal sales tax in the US)

Taxable events:
Sale of tangible personal property
Selected services (varies by state)
Digital goods (increasingly taxable; varies by state)

Tax rates:
State rates: 0% (Oregon, Montana, New Hampshire, Delaware, Alaska)
  to 7.25% (California)
Combined state + local: up to ~10%+ in some jurisdictions

Exemptions (common across states):
Groceries and prescription drugs
Resale purchases (for resale → buyer provides resale certificate)
Manufacturing equipment (in many states)
Services (B2B services often exempt; varies widely)

Economic Nexus (South Dakota v. Wayfair, 2018):
Remote sellers with >$100,000 in sales OR >200 transactions
in a state must collect and remit that state's sales tax
Prior physical presence standard (Quill) overruled

Reporting:
Sellers file periodic sales tax returns (monthly/quarterly/annual)
  based on state requirements
Streamlined Sales and Use Tax Agreement (SSUTA):
  voluntary simplification framework adopted by 24 states

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Key Concept Cards

Book-Tax Differences: Permanent vs. Temporary ★★★★★ : Permanent differences (fines, tax-exempt income) → never reverse → no deferred tax. Temporary differences → reverse → create DTA or DTL. Memory hook: permanent = no deferred tax; temporary = deferred tax

Sales Tax = No Federal Component ★★★★★ : The US has NO federal sales tax. Sales and use tax is exclusively state/local. Post-Wayfair: economic nexus means remote sellers must collect where they have significant sales activity. Memory hook: sales tax = state only; Wayfair = economic nexus

Individual Income Tax Rate Range ★★★★☆ : Seven brackets, 10%–37% marginal rates (ordinary income). Long-term capital gains taxed at preferential 0%/15%/20% rates. Memory hook: 7 brackets, 10–37%; LTCG = 0/15/20

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Practice Quiz

Q. A corporation pays a $50,000 fine to the EPA. How is this treated for tax purposes?

Fines and penalties paid to a government agency are permanently non-deductible under IRC §162(f). The $50,000 book expense is added back on Schedule M-1 / M-3, increasing taxable income relative to book income. Because this is a permanent difference, there is no deferred tax consequence — only a higher current tax expense than what the GAAP effective tax rate would otherwise reflect.

Q. What is the difference between sales tax zero-rating and a sales tax exemption?

In the US sales tax context: an exemption means no tax is collected on the transaction, and the seller incurs no sales tax (e.g., resale, certain groceries). A concept analogous to VAT “zero-rating” does not technically exist in US sales tax, but the comparable concept is “exempt with credit” — effectively, in states with a manufacturing exemption, the seller pays no tax on inputs and does not charge tax on exempt sales, but also does not receive a direct refund mechanism (unlike VAT). Note: This contrasts with the VAT zero-rate / exemption distinction (IFRS context) covered in international tax courses.