Case study: the JCT's Enron report sheds light on the book vs. tax debate.The Joint Committee on Taxation's (JCT's) analysis of Enron's 1996-2000 returns, in Report of Investigation of Enron Corporation Enron Corporation, U.S. company that in 2001 became the largest bankruptcy and stock collapse in U.S. history up to that time. The company was formed in 1985 when InterNorth purchased Houston Natural Gas to create the country's longest natural-gas pipeline network. and Related Entities Regarding Federal Tax and Compensation Issues, and Policy Recommendations (JCS-3-03, February 2003) (Report), gives educators an opportunity to discuss the debate on tax accounting and financial accounting differences and whether current tax disclosure rules require improvement. The Enron Report, available at the JCT'S Website (www.house.gov/jct/ pubs03.html), is daunting daunt tr.v. daunt·ed, daunt·ing, daunts To abate the courage of; discourage. See Synonyms at dismay. [Middle English daunten, from Old French danter, from Latin , comprising more than 2,700 pages over three volumes. More accessible is the JCT's testimony, Written Testimony of the Staff of the Joint Committee on Taxation on the Report of Investigation of Enron Corporation and Related Entities Regarding Federal Tax and Compensation Issues, and Policy Recommendations (JCX- 10-03, February 2003) (Testimony), which is also available at the JCT's Website. The Silver Lining silver lining n. A hopeful or comforting prospect in the midst of difficulty. [From the proverb "Every cloud has a silver lining". Used as a case study, the Enron Report can stimulate debate over how corporations should report book-tax differences to shareholders. Although it focuses primarily on Enron's tax shelters tax shelter: see tax exemption. and compensation arrangements, the Report also provides a reconciliation of the company's financial statement income to taxable income Under the federal tax law, gross income reduced by adjustments and allowable deductions. It is the income against which tax rates are applied to compute an individual or entity's tax liability. The essence of taxable income is the accrual of some gain, profit, or benefit to a taxpayer. (Table 2 in the Report and the Testimony) and copies of its Schedule M-1 (book-to-tax reconciliation) from its 1996-2000 returns (Appendix A in the Report, Volume 2). These two items can form the basis of a case study in an introductory or advanced tax class, consistent with the approach recommended by the AICPA AICPA See American Institute of Certified Public Accountants (AICPA). Model Tax Curriculum to integrate tax and financial accounting concepts and promote multidisciplinary skills; see Model Tax Curriculum, p. 3, at www.aicpa.org/members/div/career/ edu/introduc.htm. To integrate these two concepts, current teaching methods primarily consist of students transferring appropriate tax-related data from a hypothetical corporation's financial accounting statements to Form 1120 and preparing Schedule M-1 to reconcile the differences; see Dennis-Escoffier et al., Tax Education, "Experiences with the Model Tax Curriculum" TTA TTA Telecommunications Technology Association (Korea) TTA Teacher Training Agency (UK) TTA Triangle Transit Authority (Raleigh/Chapel Hill/Durham, North Carolina, USA) , May 2001, p. 340. Depending on students' sophistication so·phis·ti·cate v. so·phis·ti·cat·ed, so·phis·ti·cat·ing, so·phis·ti·cates v.tr. 1. To cause to become less natural, especially to make less naive and more worldly. 2. level, educators can modify the Report to address the many aspects of book-tax issues. For example, in an undergraduate tax class, they can focus on Enron's financial statements (e.g., income, balance sheet, cashflows and shareholders' equity Shareholders' Equity A firms' total assets minus its total liabilities. Equivalently, it is share capital plus retained earnings minus treasury shares. Shareholders' equity is the amount by which a company is financed through common and preferred shares. ) and its "Income Taxes" Note 5 (see Exhibit 1 below) and "Common Stock" Note 11. In a graduate tax course, educators can also fully explore one or more of the company's intricate tax shelters. Educators can find Enron's annual reports from 1998-2000 at the company's Website (www.enron.com/corp/ investors) . These reports provide financial data for the period analyzed by the JCT JCT Junction JCT Jerusalem College of Technology JCT Joint Contracts Tribunal (UK build contracts governing body) JCT Journal of Coatings Technology JCT John Christner Trucking JCT Journal of Curriculum Theorizing (1996-2000). For a more manageable approach, educators can restrict the case study to an analysis of 2000 or the most recent two or three years. They can supplement the financial statements with Table 2 (in the Report or Testimony) and, if intrepid, the Schedule M-1 from Appendix A (in the Report). Educators can also include a summary of Enron's tax footnote Text that appears at the bottom of a page that adds explanation. It is often used to give credit to the source of information. When accumulated and printed at the end of a document, they are called "endnotes." information; see Exhibit 1. The case study approach will help undergraduates to understand just how widely and why taxable income can vary for a multinational corporation multinational corporation, business enterprise with manufacturing, sales, or service subsidiaries in one or more foreign countries, also known as a transnational or international corporation. These corporations originated early in the 20th cent. . It can also help them to appreciate the current debate over whether the existing disclosure rules under Financial Accounting Statement (FAS) No. 109, Accounting for Income Taxes, are sufficient for shareholders to discern a corporation's tax status. The case study can include recent articles and viewpoints debating book and taxable income conformity and current disclosure rules, which will help in motivating students; see, e.g., Mills and Plesko, "Bridging the Reporting Gap: A Proposal for More Informative Reconciling of Book and Tax Income" (Brookings Institute working paper, April 2003), available at www.brook.edu/dybdocroot/views/ papers/gale/20030425_mills.pdf; Hanlon, "What Can We Infer about a Firm's Taxable Income from Its Financial Statements?" (Brookings Institute working paper, April 2003), available at www.brook.edu/dybdocroot/views/ papers/gale/20030425_hanlon.pdf; Knott and Rosenfeld, "Book and Tax: A Selective Exploration of Two Parallel Universes" (Part One, Tax Notes (5/12/03), p. 865; Part Two, Tax Notes (5/19/03), p. 1043); Lenter, Shackelford and Slemrod, "Public Disclosure of Corporate Tax Return Information: Accounting, Economics, and Legal Perspectives" (Brookings Institute working paper, April 2003), available at www.brook.edu/dybdocroot/views/ papers/gale/20030425_lenter.pdf; and McGill and Outslay, "Did Enron Pay Taxes? Using Accounting Information to Decipher Same as decrypt. Tax Status," Tax Notes (8/19/02), p. 1125. Case Study Outline The case study can begin with a "preamble A clause at the beginning of a constitution or statute explaining the reasons for its enactment and the objectives it seeks to attain. Generally a preamble is a declaration by the legislature of the reasons for the passage of the statute, and it aids in the interpretation of " explaining the motivation for the analysis to students. For example: In this case study you will examine Enron Corporation's Income Tax Note and related financial disclosures from 1998-2000. In addition to understanding how Enron computes its book effective tax rate and reconciles its effective tax rate with the statutory Federal tax rate, you will analyze the information that can be gleaned about the company's tax status from its disclosures about its U.S. and international operations Internal Operations (I.O., IO or I/O) is a fictional American Intelligence Agency in Wildstorm comics. It was originally called International Operations. I.O. first appeared in WildC.A.T.S. volume 1 #1 (August, 1992) and was created by Brandon Choi and Jim Lee. . The case study can also include a short discussion of accounting pronouncements that govern accounting for income taxes (e.g., FAS Nos. 109 and 5, Accounting for Contingencies; Auditing Practices Board, Opinion Nos. 18, The Equity Method of Accounting for Investments in Common Stock; 23, Accounting for Income Taxes--Special Areas; and 25, Accounting for Stock Issued to Employees; and SEC Regulation S-X S-X Sex , Rule 4-08(h)). (The papers cited above concisely summarize sum·ma·rize intr. & tr.v. sum·ma·rized, sum·ma·riz·ing, sum·ma·riz·es To make a summary or make a summary of. sum these pronouncements. In addition, a preamble the authors used in a similar case study is available on request.) Besides examining Enron's financial statements (along with Income Taxes Note 5 and Common Stock Note 11), students can ponder Ponder - A non-strict polymorphic, functional language by Jon Fairbairn <jf@cl.cam.ac.uk>. Ponder's type system is unusual. It is more powerful than the Hindley-Milner type system used by ML and Miranda and extended by Haskell. the following problems and questions: 1. In 2000, Enron reported $1.413 billion pre-tax net income and $3.101 billion taxable income on its U.S. return (before any net operating loss operating loss The excess of operating expenses over revenue. As with operating income, operating losses exclude revenues and expenses from operations that are not considered a regular part of the business. Also called deficit. Compare operating income. (NOL NOL - Never Offline ) carryforwards). For 1999, the company reported $1.128 billion net income before tax and a $1.458 billion NOL on its U.S. return. Using Report Table 2 as a guide, list four general reasons why the company's pre-tax net income and U.S. taxable income differed so widely. 2. Enron reported in its Income Taxes Note 5 that at the end of 2000, it had approximately a $65 million NOL carryforward applicable to U.S. subsidiaries. In its 1999 annual report, the company reported that the corresponding NOL was approximately $2.9 billion. Based on the change in the company's NOL carryforward from 1999 to 2000, estimate Enron's taxable income reported on its U.S. 2000 return. 3. Enron reported a "current" $112 million Federal income tax expense for 2000 in its Income Taxes Note 5. According to according to prep. 1. As stated or indicated by; on the authority of: according to historians. 2. In keeping with: according to instructions. 3. the Report, Enron "paid" $63.2 million of Federal income taxes in 2000. FAS No. 109,[paragraph] 8 states, a "current tax liability or asset is recognized for the estimated taxes Federal and state tax laws require a quarterly payment of estimated taxes due from corporations, trusts, estates, non-wage employees, and wage employees with income not subject to withholding. payable or refundable on tax returns for the current year." List some general reasons why Enron's reported financial accounting current Federal tax liability differs from the amount reported on the company's U.S. return. 4. How much of Enron's actual $63.2 million U. S. tax liability in 2000 was due to the imposition of the alternative minimum tax? 5. Enron reported in its Common Stock Note 11 that in 2000, it recorded "tax benefits related to stock options exercised by employees of approximately $390 million." Where are these tax benefits reported in Enron) financial statements? How might one estimate the tax deduction Tax deduction An expense that a taxpayer is allowed to deduct from taxable income. tax deduction See deduction. from stock option exercises in 1999 using only the information contained in Note 117 How does the estimate compare to the $382 million stock option deduction shown in the Report (see Report Table 2)? 6. Enron reported a 30.7% effective tax rate in 2000 and 9.2% in 1999 (Note 5). Show how the company computed these rates. What caused the effective tax rate to increase so significantly from 1999 to 2000? Are such causes manageable by a company's tax department? 7. Enron reported very different tax numbers in its financial statements and Federal income tax returns. From 1996-2000, it reported cumulative "book income reported on [a] Consolidated Tax Return Consolidated tax return A tax return combining the reports of affiliated companies, that are at least 80% owned by a parent company. " that exceeded cumulative taxable income before NOL carryforwards by a staggering $12.628 billion. Some commentators believe that these differences are a natural and appropriate outcome of tax and book accounting systems having different rules and objectives. Others propose that there should be much more conformity between book and tax numbers, as the differences can hide aggressive tax shelter schemes. Some on either side of this debate contend that taxing authorities should require corporations to disclose their returns to the public, a major change to the longstanding policy of strictly protecting a taxpayer's privacy. What are your opinions on the conformity between reported book and return numbers and possible return disclosure? Your answer should address the potential costs and benefits of your positions. Besides asking students to address the above issues, educators can use Appendix A of the Report to emphasize the complexity and magnitude of the book-tax differences on the Schedule M-1 of a large publicly traded corporation. Also, Appendix A illustrates how corporations can interpret line 1 of the schedule differently. The first number on Line 1 is "net income per books" but the form's instructions do not define that term. Although that number supposedly comes directly from the income statement (for 2000, Enron reported $979 million "net income"), Enron used "book income reported on [a] consolidated tax return" (Report Table 2). This shows why any plans to change Schedule M-1 should begin with a uniform definition of net income per books. Advanced students can examine Enron's Schedules M-1 and list which items may be indicative of aggressive tax shelter behavior, to either confirm or call into doubt the contention that the public disclosure of Schedule M-1 would be the key for identifying abusive tax shelter Abusive tax shelter A limited partnership that the IRS judges to be claiming tax deductions illegally. abusive tax shelter A tax shelter in which an improper interpretation of the law is used to produce tax benefits that are behavior. Conclusion The wealth of return data and analysis available on Enron and the broad discussions in Congress and in the press about the company's aggressive accounting and tax strategies provide educators with an invaluable teaching opportunity. Editor's note Editor's Note (foaled in 1993 in Kentucky) is an American thoroughbred Stallion racehorse. He was sired by 1992 U.S. Champion 2 YO Colt Forty Niner, who in turn was a son of Champion sire Mr. Prospector and out of the mare, Beware Of The Cat. Trained by D. : If you would like further information about this column or answers to the case study's problems and questions, please contact Dr. Nellen at aneller@email.sjsu.edu, Dr. McGill at mcgill@ufl.edu or Dr. Outslay at outslay@ pilot.msu.edu.
Exhibit 1: Enron income taxes note data (Note 5)
Components of income before
income taxes (in millions) 2000 1999 1998
U.S. $640 $357 $197
Foreign 773 771 681
Income before income taxes $1,413 $1,128 $878
Total income tax expense
(benefit) (in millions) 2000 1999 1998
Payable currently
Federal $112 $29 $30
State 22 6 8
Foreign 93 48 50
227 83 88
Payment deferred
Federal 13 (159) (14)
State 14 23 11
Foreign 180 157 90
207 21 87
Total income tax expense $434 $104 $175
Effective tax rate reconciliation 2000 1999 1998
Statutory Federal income tax provision 35.0% 35.0% 35.0%
Net state income taxes 2.5% 1.8% 1.7%
Tight gas sands tax credit 0.0% -0.5% -1.4%
Foreign tax rote differential -2.4% -7.0% 0.8%
Equity earnings 5.3% -10.1% -4.3%
Minority interests 0.0% 0.8% 0.8%
Basis and stock sale differences -11.9% -10.8% -14.2%
Goodwill amortization 1.6% 1.6% 2.0%
Cash value in life insurance 0.0% -0.9% -1.1%
Audit settlement 0.0% -1.8% 0.0%
Other 0.6% 1.1% 0.7%
Book effective tax rate (1) 30.7% 9.2% 20.0%
Components of income before
income taxes (in millions) 1997 1996
U.S. $96 $551
Foreign (81) 304
Income before income taxes $15 $855
Total income tax expense
(benefit) (in millions) 1997 1996
Payable currently
Federal $29 $16
State 9 11
Foreign 46 37
84 64
Payment deferred
Federal (39) 174
State (42) (1)
Foreign (93) 34
(174) 207
Total income tax expense $(90) $271
Effective tax rate reconciliation 1997 1996
Statutory Federal income tax provision 35.0% 35.0%
Net state income taxes -140.0% 0.8%
Tight gas sands tax credit -80.0% -1.8%
Foreign tax rote differential 13.3% 0.0%
Equity earnings -253.3% -3.3%
Minority interests 186.7% 3.1%
Basis and stock sale differences -526.7% 1.8%
Goodwill amortization 60.0% 0.0%
Cash value in life insurance -46.7% -3.2%
Audit settlement 0.0% 0.0%
Other 153.4% -0.7%
Book effective tax rate (1) -598.3% 31.7%
(1) Total income tax expense/income before income taxes
FROM GARY A. MCGILL, PH.D., CPA (Computer Press Association, Landing, NJ) An earlier membership organization founded in 1983 that promoted excellence in computer journalism. Its annual awards honored outstanding examples in print, broadcast and electronic media. The CPA disbanded in 2000. , PRICEWATERHOUSECOOPERS TERM PROFESSOR OF ACCOUNTING, FISHER SCHOOL OF ACCOUNTING The Fisher School of Accounting is the academic accounting unit at the University of Florida (UF). In 1977, the School of Accounting was established by the Board of Regents as a separate school within the College of Business, and was endowed in 1985 by Frederick Fisher. Dr. , UNIVERSITY OF FLORIDA University of Florida is the third-largest university in the United States, with 50,912 students (as of Fall 2006) and has the eighth-largest budget (nearly $1.9 billion per year). UF is home to 16 colleges and more than 150 research centers and institutes. , GAINSVILLE, FL, AND EDMUND OUTSLAY, PH.D., CPA, PROFESSOR OF ACCOUNTING AND DELOITTE & TOUCHE/MICHAEL LICATA TEACHING FELLOW, ELI BROAD Eli Broad (born June 6, 1933) a native of Detroit, Michigan is a Jewish American billionaire who lives in Los Angeles, California. His last name is pronounced as rhyming with road. Broad is well known for his philanthropy and extensive art collection. GRADUATE SCHOOL OF MANAGEMENT, MICHIGAN STATE UNIVERSITY Michigan State University, at East Lansing; land-grant and state supported; coeducational; chartered 1855. It opened in 1857 as Michigan Agricultural College, the first state agricultural college. , EAST LANSING East Lansing, city (1990 pop. 50,677), Ingham co., S central Mich., a suburb of Lansing, on the Red Cedar River; inc. 1907. The city was first known as College Park, but was renamed when it was incorporated. , MI Editor: Annette Nellen, CPA, Esq. Professor, Department of Accounting & Finance San Jose San Jose, city, United States San Jose (sănəzā`, săn hōzā`), city (1990 pop. 782,248), seat of Santa Clara co., W central Calif.; founded 1777, inc. 1850. State University San Jose, CA |
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