Question

Madison Company has taken a position in its tax return to claim a tax credit of $70 million (direct reduction in taxes payable) and has determined that its sustainability is "more likely than not," based on its technical merits. The tax credit would be a direct reduction in current taxes payable. Madison believes the likelihood that a $70 million, $42 million, or $14 million tax benefit will be sustained is 20%, 40%, and 40%, respectively. Madison's taxable income is $530 million for the year. Its effective tax rate is 40%. What is Madison's income tax expense for the year?

a $142 million

b $212 million

c $170 million

d $28 million

Answer 1

Solution:

Proabability Table
Amount of tax benefit that management expect to sustain	$70.00	$42.00	$14.00
Percentage Likelihood that the tax position will be sustained at this level	20%	40%	40%
Cumulative probability that the tax position will be sustained	20%	60%	100%

Therefore $42 million is the amount of tax benefit that would be recognized in the financial statement as it represents the probability to sustain tax benefite more than 50% (More likely than not).

Current tax payable = $530 * 40% - $70 = $142 million

Projected liability for reversal of tax benefit = $70 - $42 = $28 million

Total income tax expense = $142 + $28 = $170 million

Hence option C is correct.