Tax Deductions for Annual FAS 87 Expense

[Guest pjm]

Does FAS 109 establish the principle that, if a company accrues a SERP liability and expects that the accrual will result in a tax deduction in the future, the company can reduce its current year tax expense and record a deferred tax asset?

If the above is true, can the company effectively deduct its entire annual pension expense in the year accrued?

Does this principle also apply to DC plans, if so, can the company deduct the entire deferral or only interest on the deferrals?

Is GAAP required to apply this principle?

[Kirk Maldonado]

You are confusing tax and accounting rules. The tax rules are not affected by the accounting treatment.

[Guest pjm]

I realize that there are two sets of rules, that's why I am confused, I'm not an accountant.

What I really want to know is whether or not the current year's taxes can be reduced through accounting for the FAS 87 expense. I am assuming that FAS 109 allows the company to account for an income item that is equal to what would have been the tax savings on the FAS 87 expense (if it had been currently deductible). Does the accounting actually reduce the companies tax for the current year, or does it just add to the companies earnings on an accounting basis?

[RCK]

You are still confusing tax and accounting rules.

The tax deduction rules are (generally) in IRC section 404, and say that a contribution to a pension trust is deductible in the tax year in which it is actually made. As with any IRS rule, there are restrictions, but that's the general rule.

RCK

[Guest Harry O]

Book accounting and cash taxes are two different animals (and the differences drive 90% of the tax shelter industry in this country!). Just because you record a deferred tax asset for the anticipated future tax deduction for non-qualified pensions, does not mean that your cash taxes are likewise reduced. This is a book-tax difference that will be reflected on the Schedule M to the 1120. Short answer -- NO, the book recognition of a deferred tax deduction does not create an actual cash tax deduction. The cash tax deduction must wait until benefits are actually paid to employees under a non-qualified plan.

[mbozek]

In a non qualified plan, the employer claims a deduction only in the tax year that the employee includes the deferred amount in taxable income, as cash or property. The amount accrued or expensed is a not sufficent basis for a deduction. Its called the theory of tax tension. If the employer does not pay the deferred amount to the employee then the employer has to pay income tax on the funds.

[MGB]

All of the responses are incorrect.

Yes, you do adjust your taxes (this is ACCOUNTING for taxes, not the payment of taxes) for your SFAS 87 expense. You end up with a deferred tax asset on the books and, yes, this year's tax expense is reduced.

For example:

Net income (accounting) prior to recocognition of taxes and SFAS 87 expense: 500

Taxes paid and accounted for (assume no other deferred tax issue) prior to SFAS87 expense: 100

SFAS 87 expense: 50

Effective tax rate: 40%

The unwary would say that the net income for the year is 350 (500-100-50). But, it is not.

The taxes are adjusted for a deferred tax asset of 50*40%=20.

Tax expense for the year is now 100-20=80

The net income for the year is 500-80-50=370 (rather than 350).

Whenever the company makes a contribution, the tax deduction from that contribution offsets the deferred tax asset in the future, rather than being a reduction in income at the time.

Of course, as the other replies state, the payment of taxes this year is still 100 and is not affected by the accounting books that set up a deferred tax asset.