Permanent Differences
A permanent difference occurs when a revenue or expense item is only included in pretax book income or in taxable income—it will never be included in both. For example, interest income on municipal bonds is included in pretax book income but is never included in taxable income because it is tax exempt by law. Deferred taxes need not be recognized because future tax consequences are not created with this income. Thus, the tax exempt income is simply subtracted from book income in the book to tax reconciliation on Schedule M-1.
Some common permanent differences are:
- State and municipal bond interest income: Included in book income but not included in taxable income.
- 50% of meals and entertainment deductions: Deducted in determining book income but not deducted in determining taxable income.
- Life insurance premiums when the corporation is the beneficiary: Deducted for book income but not for taxable income purposes.
- Life insurance proceeds received when the corporation is the beneficiary: Included in book income but excluded for taxable income purposes.
- FIT Expense: Deducted for book income but not for taxable income purposes.
- Payment of a penalty or fine: Deducted for book income but not for taxable income purposes.
- Dividend received deduction: Deducted in determining taxable income but not for determining book income.
Once you have completed the study of temporary differences, an illustration will show how permanent and temporary differences are used in calculating taxable income—given a corporation's pretax book income.
