Further explanation of Asset for Future Income Taxes
Hello, I don't understand the explanation for the asset for future income taxes. In my mind should that not just simply be taxes pre-paid in the present that will have to be paid in the future (sort of like the DPAE)?
Here is the explanation given:
The asset for Future income taxes represents taxes that are pre-paid due to the fact that the tax
credit for losses is less than the actual loss reserve.
I don't really understand the part where it says.."due to the fact that the tax credit for losses is less than the actual loss reserve"
Doesn't this statement mean in plain English that: we recognize an asset for pre payment of taxes because tax credits will be less than reserves. How can tax credits be greater than reserves? Why are we comparing them reserves anyway? And how does this comparison imply a tax asset should be recognized??
Thank you
Comments
Hi,
I'll reference page 3 of http://www.actuaries.ca/members/publications/2005/205048e.pdf and the statement of income example on page 3 of https://www.theinstitutes.org/doc/resources/AIAF_114.pdf.
In the first reference, they say that the income tax deduction is based on the 95%*min(reported reserve, claim liability). I think the confusion lies here. We still need to multiply this by some taxation rate when determining the actual tax paid -- key word actual.
Now, on the Insurer's Annual Statement, we use reported reserve to compute the tax paid.
In the second reference, you can see the first two terms on the statement of income as Earned Premium minus Incurred Loss, where Incurred = Paid + Reserve. Let's just assume paid = 0, and focus on these two terms and simplify the math for the purpose of illustrating the idea of the tax credit:
Income tax regulations state that I pay taxes based on "Premium - Paid Claims - 95%*min(reported reserve, claim liability)". However, in the Annual Statement, my taxes would be based on "Premium - Paid Claims - reported reserve" (a smaller number). You can see from here that I'm paying more taxes than stated in the annual statement. As such, we have an asset for future income tax (very lightly, it's like I'm overpaying on tax).
Let me know if this is clear.
Hello,
I have the same issue as user10 in understanding: "due to the fact that the tax credit taken for losses is less than the actual loss reserve".
In the example given by javid, I understand we are comparing taxes based on income tax regulations vs taxes calculated as in the Annual Statement. This makes sense to me since we are comparing "taxes to taxes" but on different basis. But I don't see how that addresses the point made by user10, where I also understand that the definition in plain English compares "tax credit to loss reserve" which doesn't make sense to me.
Thanks
The way I understand this is to step back for a moment and consider the following general taxation concept that applies to any sort of a business enterprise:
Now for an insurance enterprise, loss reserves are considered "losses". That means they are a tax credit and you are allowed to deduct them from taxable income. If we deducted the entire amount, we wouldn't need this "asset for future income taxes". But if the tax credit you take is less than than the actual loss reserve, you generate a credit. In essence you overpaid your taxes because you under-recognized your deduction.
You can work through the formulas as @javid stated, but what I wrote above is the concept behind it.
Ok, by "tax credit" I initially understood as a credit in taxes entitled to because of too much taxes paid. But I hadn't in mind it referred to the losses, thus the confusion. It's clearer now, thanks
Great!