Chapter 3 — Book-Versus-Tax Differences and Tax Attributes

3.2 Permanent Differences

ASC 740-10

Basis Differences That Are Not Temporary Differences

25-30 Certain basis differences may not result in taxable or deductible amounts in future years when the related asset or liability for financial reporting is recovered or settled and, therefore, may not be temporary differences for which a deferred tax liability or asset is recognized. One example, depending on the provisions of the tax law, could be the excess of cash surrender value of life insurance over premiums paid. That excess is a temporary difference if the cash surrender value is expected to be recovered by surrendering the policy, but is not a temporary difference if the asset is expected to be recovered without tax consequence upon the death of the insured (if under provisions of the tax law there will be no taxable amount if the insurance policy is held until the death of the insured).

25-31 Tax-to-tax differences are not temporary differences. Recognition of a deferred tax asset for tax-to-tax differences is prohibited as tax-to-tax differences are not one of the exceptions identified in paragraph 740-10-25-3. An example of a tax-to-tax difference is an excess of the parent entity’s tax basis of the stock of an acquired entity over the tax basis of the net assets of the acquired entity.

FASB Statement 109, which was codified in ASC 740, effectively described permanent differences as differences that arise from statutory provisions under which (1) specified revenues are exempt from taxation and (2) specified expenses are not allowable as deductions in the determination of taxable income.

In addition, ASC 740-10-25-31 provides guidance on tax-to-tax differences. For example, as a result of a nontaxable business combination, the acquiror’s tax basis in the acquired stock (i.e., outside basis) may exceed the tax basis in the acquired entity’s assets and liabilities (i.e., inside basis). Since such differences are not temporary differences, the recognition of a DTA is prohibited under ASC 740.

The table below illustrates many of the more common permanent differences that result from the application of U.S. federal tax law to items recognized for financial reporting purposes.

Accounting Description	Accounting Treatment	Tax Treatment
Tax-exempt securities:
1. Interest income	Income	Tax exempt (IRC Section 103).
2. Interest paid on debt incurred to buy or carry tax-exempt securities	Expense	Not deductible (IRC Section 265).
3. Amortization of bond premium	Expensed by using interest method (ASC 835-30-35-2)	Not deductible (IRC Section 171(a)); however, basis of bond must be reduced by amount of amortization (IRC Section 1016(a)(5)).
4. Gains or losses upon disposition	Income (loss)	No gain or loss if held to maturity (HTM) by original buyer. If sold or redeemed before maturity, capital gain (loss).
Illegal bribes and kickbacks	Expense	Not deductible.
Treble damages; payments involving criminal proceedings	Expense	Not deductible (IRC Section 162(g)).
Expenses paid or incurred to influence the general public with respect to legislative matters, elections, or referendums	Expense	Not deductible (IRC Section 162(e)(1)(c)).
Expenses paid or incurred with respect to legislative matters that are not in direct interest to the taxpayer’s trade of business	Expense	Not deductible (IRC Treas. Reg. 1.162-20(c)).
Fines and penalties paid to the government of the United States, a territory or possession of the United States, the District of Columbia, a foreign country, or a political subdivision of any of the above for the violation of any law	Expense	Not deductible (IRC Section 162(f)).
Worthless debts from political parties	Expense	Generally, not deductible. May be deducted by banks and other taxpayers if more than 30 percent of all receivables accrued during normal course of business are due from political parties (IRC Section 271).
Income and expenses from sources within possessions of the United States	Income and expense	Income may be exempt and deductions not allowed if certain conditions are met (IRC Section 931).
Certain expenses that a taxpayer chooses to claim a credit in lieu of (i.e., foreign tax credit [FTC], jobs credit)	Expense	Not deductible.
Entertainment expense	Expense	Not deductible (IRC Section 274(a)).
Meals expense	Expense	50 percent is not deductible for tax purposes (IRC Section 274(n)).
Political contributions	Expense	Not deductible (IRC Treas. Reg. 1.162-20(c)(1)).
Certain losses on the disposition of consolidated-group subsidiary stock	Expense	Not deductible (IRC Treas. Reg. 1.1502-36).

3.2.1 Special Deductions

ASC 740-10

Anticipated Future Special Deductions

25-37 The tax benefit of statutory depletion and other types of special deductions such as those that may be available for certain health benefit entities and small life insurance entities in future years shall not be anticipated for purposes of offsetting a deferred tax liability for taxable temporary differences at the end of the current year. The tax benefit of special deductions ordinarily is recognized no earlier than the year in which those special deductions are deductible on the tax return. However, some portion of the future tax effects of special deductions are implicitly recognized in determining the average graduated tax rate to be used for measuring deferred taxes when graduated tax rates are a significant factor and the need for a valuation allowance for deferred tax assets. In those circumstances, implicit recognition is unavoidable because those special deductions are one of the determinants of future taxable income and future taxable income determines the average graduated tax rate and sometimes determines the need for a valuation allowance. See Section 740-10-30 for measurement requirements related to determining tax rates and a valuation allowance for deferred tax assets.

Other common permanent differences that result from the application of U.S. federal tax law include special deductions. The tax law permits certain entities to recognize certain tax benefits for special deductions. Such deductions are reflected in pretax income for tax reporting purposes but not for financial reporting purposes and therefore give rise to permanent differences. While the term “special deduction” is not defined, ASC 740-10-25-37 and ASC 740-10-55-27 through 55-30 offer four examples: (1) tax benefits for statutory depletion, (2) deductions for certain health benefit entities (e.g., Blue Cross/Blue Shield providers), (3) deductions for small life insurance companies, and (4) a deduction for domestic production activities. In addition, the deduction for foreign-derived intangible income (FDII) qualifies as a special deduction.

The next sections summarize the special deductions discussed above.

3.2.1.1 Statutory Depletion

IRC Sections 611–613 allow entities in certain extractive industries, such as oil and gas and mining, to take a deduction for “depletion” when determining taxable income for U.S. federal tax purposes. The depletion deduction for a particular taxable year is calculated as the greater of cost depletion or percentage depletion. Cost depletion is based on the cost of the reserves, and percentage depletion is based on multiplying gross income from the property by a specified statutory percentage, subject to certain limitations. As with other special deductions, entities cannot anticipate the tax benefit from statutory depletion when measuring the DTL related to a taxable temporary difference at year-end. The statutory depletion tax benefit would be recognized no earlier than the year in which the depletion is deductible on the entity’s income tax return.

3.2.1.2 Blue Cross/Blue Shield Organizations

IRC Section 833 entitles Blue Cross and Blue Shield plans to special tax deductions that are not available to other insurers. The deduction allowed for any taxable year is the excess (if any) of (1) 25 percent of the sum of (a) claims incurred during the taxable year and (b) expenses incurred in connection with the administration, adjustment, or settlement of claims over (2) the “adjusted surplus” as of the beginning of the taxable year.

3.2.1.3 Domestic Production Activities Deduction

The domestic production activities deduction was enacted into law in the United States on October 22, 2004, as part of the American Jobs Creation Act of 2004 (the “Jobs Creation Act”). The Jobs Creation Act allowed for a tax deduction of up to 9 percent of the lesser of (1) qualified production activities income or (2) taxable income (after the deduction for the use of any NOL carryforwards). This tax deduction was limited to 50 percent of W-2 wages paid by the taxpayer. ASC 740-10-55-27 through 55-30 provide implementation guidance clarifying that the production activities deduction should be accounted for as a special deduction in accordance with ASC 740-10-25-37. The domestic production activities deduction was repealed upon enactment of the Tax Cuts and Jobs Act of 2017 (the “2017 Act”).

3.2.1.4 Foreign-Derived Intangible Income

IRC Section 250 allows a domestic corporation an immediate deduction against U.S. taxable income for a portion of its FDII. The amount of the deduction depends, in part, on the corporation’s U.S. taxable income. The percentage of income that can be deducted is reduced in taxable years beginning after December 31, 2025.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.