Changes in the Income Tax Rate

Changes in the income tax rate can influence the measurement of income tax expense, the deferred tax asset and liability carrying amount in the year the change is enforced.

When the income tax rate changes, deferred tax assets, and liabilities are adjusted to the new tax rate. An increase in the income tax rate will trigger increments of deferred tax assets and liabilities. conversely, if the income tax rate decreases, deferred tax assets and liabilities will decrease. A decrease in deferred tax assets will reduce the extent to which they can offset future tax payments. A decrease in deferred tax liabilities, on the other hand, reduces future tax payments to the tax authorities.

Calculating the Effect of Income Tax Rate Changes

Consider the following information presented for a company.

Computer equipment value for accounting purposes (carrying amount): USD 11,000

Computer equipment value for tax purposes (tax base): USD 9,500

Difference: USD 1,500

If the income tax rate is 30%, the deferred tax liability in 2016 is calculated as: (USD 11,000 – USD 9,500) × 30% = USD 450.

If the tax authorities change the income tax rate to 35%, then the deferred tax liability is: (11,000 – 9,500) × 35% = USD 525. Despite the similar temporary difference (USD 1,500), the change in the income tax rate has resulted in a change of the deferred tax liability.

The provision for income tax expense will also be affected by the change in the income tax rate since taxable income for the year will be taxed at a rate of 35%, instead of the previous 30%. The increase in income tax expense which is attributable to the change in tax rate is, therefore:

(35% – 30%) × USD 1,500 = USD 75.

Example: Income Tax Expense

At the beginning of this year, XYZ Company reported a carrying amount of $18,000 and a tax base of $16,000 for its machinery. During the year, the company made a profit and reported payable taxes of $750. At the end of the year, the company reported a carrying value of $16,500 and a tax base of $15,000 for the same asset. What should be the company’s tax expense?

First, we calculate the deferred tax liability at the beginning of the year.

DTL = $18,000 – $16,000 = $2,000

Then, at the end of the year the liability became $16,500 – $15,000 = $1,500

To get the income tax expense, we aggregate the change in the income tax liability and the taxes payable. A liability decrease would make the tax expense decrease and an increase in taxes payable would increase tax expense.

Thus, income tax expense for the period = $750 – ($2,000 – $1,500) = $250

Question 1

Which of the following statements is the most accurate?

1. If the income tax rate decreases, income tax expense will increase.
2. If the income tax rate increases, income tax expense and deferred taxes will also increase.
3. If the income tax rate decreases, it is uncertain what the impact of the decrement will be on income tax expense, income tax payable, and deferred taxes (assets and liabilities).

Solution

The correct answer is B.

A is incorrect. When the income tax rate decreases, income tax expense will also decrease.

C is incorrect. The income tax rate decrements will usually lead to decrements in income tax expense, deferred taxes, etc.

Question 2

At the end of the year 2016, Galambo Inc. reported a tax loss of $15,000. If you knew that Galambo had tax assets of $100,000 at the beginning of the year 2017 which went down to only $70,000 at the end of the year 2017, the reported tax expense for Galambo for the year 2017 is closest to:

1. $0.
2. $15,000.
3. $30,000.

Solution

The correct answer is B.

Tax expense = Taxes payable (recoverable) + Decrease of tax assets OR – Increase of tax assets = ($15,000) + $30,000 = $15,000