Uniontown Books began operating in 2011.The company lost money its first three years of operations,but has had an operating profit during the past two years.The company's operating income (EBIT)for its first five years was as follows: The company has no debt,and therefore,pays no interest expense.Its corporate tax rate has remained at 34% during this 5-year period.What was Uniontown's tax liability for 2015? (Assume that the company has taken full advantage of the carry-back and carry-forward provisions,and assume that the current provisions were applicable in 2011. )

Question

Uniontown Books began operating in 2011.The company lost money its first three years of operations,but has had an operating profit during the past two years.The company's operating income (EBIT)for its first five years was as follows:  ​ The company has no debt,and therefore,pays no interest expense.Its corporate tax rate has remained at 34% during this 5-year period.What was Uniontown's tax liability for 2015? (Assume that the company has taken full advantage of the carry-back and carry-forward provisions,and assume that the current provisions were applicable in 2011. )

Quizplus · Accepted Answer

To calculate the tax liability for 2015, we need to first find the taxable income for that year. From the table above, we see that EBIT for 2015 was $800,000. Since the company has no debt, its operating income is also its taxable income.

Next, we need to find the tax payable on this income. To do this, we first need to calculate the income tax expense for each year, using the given EBIT and the corporate tax rate of 34%:

2011: $450,000 x 0.34 = $153,000
2012: $600,000 x 0.34 = $204,000
2013: $200,000 x 0.34 = $68,000
2014: $400,000 x 0.34 = $136,000
2015: $800,000 x 0.34 = $272,000

Note that the tax expense for 2015 is what we are looking for.

Since the company has no debt, we cannot use the interest tax shield to reduce the tax liability. However, the company can use its loss carryforwards from the first three years of operation to reduce its taxable income. The amount of loss carryforwards available in 2015 would be the total amount of losses incurred in the first three years, minus any losses already used in the past two years. This would be:

Loss carryforwards = ($450,000 + $600,000 + $200,000) - ($400,000 + $800,000) = $50,000

Therefore, the taxable income for 2015 would be:

Taxable income = $800,000 - $50,000 = $750,000

Finally, we can calculate the tax liability for 2015 by applying the corporate tax rate of 34% to this taxable income:

Tax liability = $750,000 x 0.34 = $255,000

Note that the company can use any remaining loss carryforwards in future years to offset taxable income and reduce its tax liability. The correct choice is D.

Uniontown Books Began Operating in 2011