Temporary differences form the foundation for the deferred tax provision. The total tax provision is comprised of:
  • The current tax provision – an estimate of taxes payable or refundable on the tax return for the current year
  • The deferred tax provision – the change in the estimated future tax effects of temporary differences and carryforwards
Deferred tax assets and liabilities represent the future effects on income taxes that result from temporary differences and carryforwards that exist at the balance sheet date and are measured using enacted rates and provisions of the tax law. Deferred tax assets (DTAs) are recognized for deductible temporary differences (i.e., future tax-deductible amounts) as well as tax attributes (e.g., net operating loss and credit carryforwards). Deferred tax liabilities (DTLs) are recognized for taxable temporary differences (i.e., future taxable amounts).
The recognition principle in ASC 740-10-25-5 and measurement principle of ASC 740-10-30-7 apply in computing the tax bases of assets and liabilities. A temporary difference exists when the tax basis of an asset or a liability differs from its reported amount in the financial statements and that difference, referred to as a basis difference, will result in taxable income or a tax deduction upon reversal. Reversal occurs when the reported amount of an asset or liability in the financial statements is recovered or settled, respectively. There are temporary differences that have balances only on the income tax balance sheet and are not identified with an asset or liability in the financial statements. For some of these differences, reversal occurs upon recognition in the tax return (e.g., tax credits). If a basis difference will not affect future taxable income, it is not a temporary difference. A presumption under ASC 740 is that assets will be recovered, and liabilities will be settled at their financial statement carrying amounts. Future changes in carrying amounts are not anticipated in determining temporary differences at the balance sheet date.
Because the definition of a temporary difference hinges on the difference between the GAAP basis and tax basis of an item, the comparison of a GAAP-compliant balance sheet with a balance sheet that is prepared on a tax basis is often the best way to identify temporary differences. In many instances, there will be both a book and a tax basis (e.g., in the case of fixed assets). In other instances, there will be a book basis and no tax basis, as in the case of expense accruals that are not tax deductible until they are paid. In yet other instances, there may be a tax basis but no GAAP basis, as in the case of organizational costs expensed for GAAP purposes but capitalized and amortized for tax purposes.
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