Question

On January 1, Year 1, Santana Corp. purchased equipment for $75,000 with a five-year useful life. Santana depreciates the equipment for reporting purposes using the straight-line method. Taxable income for Year 1 is $148,000. For tax purposes, the company depreciates 100% of the equipment balance in Year 1. The company’s current tax rate is 25%. However, in Year 1, the enacted tax rate increased to 35% beginning in Year 3 and beyond. What is income tax expense for Year 1 and what is the balance of the deferred tax liability on December 31 of Year 1? Income tax expense Deferred tax liability a. $56,500 $26,250 b. $60,250 $19,500 c. $58,000 $21,000 d. $56,500 $19,500

Answer 1

Income tax expense for Year 1 is calculated by multiplying the taxable income for that year by the current tax rate. In this case, the taxable income is $148,000 and the current tax rate is 25%, so the income tax expense is $148,000 * 0.25 = $<<148000*0.25=37000>>37,000.

The balance of the deferred tax liability on December 31 of Year 1 is calculated by comparing the depreciation for tax purposes and the depreciation for reporting purposes. In this case, the company depreciated 100% of the equipment balance in Year 1 for tax purposes, but it used the straight-line method for reporting purposes, which would have resulted in a lower amount of depreciation. The difference between the two amounts is the deferred tax liability.

The straight-line method of depreciation results in an annual depreciation expense of $75,000 / 5 years = $<<75000/5=15000>>15,000 per year. Since the company only used the equipment for one year, the depreciation expense for reporting purposes is $15,000. The difference between the depreciation for tax purposes and the depreciation for reporting purposes is $75,000 - $15,000 = $<<75000-15000=60000>>60,000, which is the deferred tax liability.

Since the current tax rate is 25% and the enacted tax rate for future years is 35%, the difference in tax rates is 35% - 25% = 10%. The balance of the deferred tax liability on December 31 of Year 1 is calculated by multiplying the deferred tax liability by the difference in tax rates, so it is $60,000 * 0.10 = $<<60000*0.1=6000>>6,000.

Therefore, the correct answer is $37,000 for the income tax expense and $6,000 for the balance of the deferred tax liability on December 31 of Year 1. The answer choices do not match the calculation, so the correct answer is not among the choices provided.