Final answer:
Lamb Inc.'s tax loss carryback will result in a tax refund of $70,000 after applying the loss to Year 1 and Year 2, considering their respective tax rates of 25%. This calculation takes into account the $252,000 taxable income from Year 1 and the $28,000 that can be applied from the remaining loss to Year 2's taxable income of $224,000.
Step-by-step explanation:
Lamb Inc. experienced a tax loss of $(280,000) during Year 4 and has the option to carry it back two years. To prepare the entry for the loss carryback, we must apply the loss to the taxable incomes of the preceding two years, beginning with the earliest year first. The tax rates are also different for each year; therefore, we must calculate the applicable tax savings separately for each year. The tax rate for Year 1 and Year 2 is 25%, while for Year 3 and Year 4 it is 40%.
First, we carry back the loss to Year 1 (the earliest year) which had a taxable income of $252,000. We apply as much of the loss as we can to Year 1, which will be $252,000 of the $280,000 loss, reducing Year 1's taxable income to $0. The tax benefit for this is 25% of $252,000, resulting in a refund of $63,000 for Year 1.
We still have a remaining loss of $28,000 ($280,000 - $252,000) to apply to Year 2. Since Year 2's taxable income was $224,000, applying the $28,000 loss reduces it to $196,000. The tax benefit for Year 2 is then 25% of $28,000, resulting in a further refund of $7,000.
The total tax refund for the loss carryback would be $63,000 from Year 1 plus $7,000 from Year 2, equaling $70,000. Lamb Inc. would record this as a receivable for the tax refund due from the loss carryback against the income tax expense of Year 4.